Inflation has always been a frontrunner in the list of highly discussed economic indicators. It dictates wages, living costs, and, in election seasons, it dictates our political leaders. Countries experiencing hyperinflation are seen as paragons of tyranny and reckless governance. They become the “it’ll never happen to us” fearmonger story that Western conservatives and liberals alike use to populate campaign speeches. Horrific and ironical images of unfortunate citizens burning paper money for warmth or frantically spending their half-daily pay check at lunchtime before prices are revised upwards at the end of the hour, have become almost throwaway anecdotes in economics textbooks.
Yet, this libel against inflation may seem surprising for some Australians considering that year-ended inflation in Australia hasn’t breached 5% in more than 30 years . At the current moment, however, rising fuel prices, supply chain disruptions, and imminent rate hikes from the RBA have caused that age old question to resurface in (Gelos, 2021) the population’s collective consciousness: what causes inflation, and how do we fix it?
Unfortunately, these catch-all questions can’t be answered definitively or even easily. The most intuitive way to understand the surface level workings of inflation is ‘too much money chasing too few goods’. To steal a line from Milton Friedman: “inflation is always and everywhere a monetary phenomenon”. So, when more money is being pumped into the economy while production lags, prices rise by necessity. To be sure, this is a relatively reasonable and intuitive assessment of many instances of inflation across the world, particularly within hyperinflation regimes. Within these regimes, excessive fiscal deficits, and snowballing interest payments on government debt – with just a hint of injudicious governing practises – prompts politicians to use seigniorage, the government’s profit from printing more money, to fund these fiscal burdens.
This monetary argument, unsurprisingly, is where the role of central banks becomes essential. Putting aside hyperinflation economies, it rests on central banks to pull the lever on money supply by targeting a certain cash rate. This policy cash rate flows through to all short-term rates in the economy. Since the global financial crisis of 2008, monetary policy has generally followed a sustained easing cycle due to subdued inflation pressures. Worldwide policy rates have fallen considerably. Central banks in Japan, the Eurozone and some Scandinavian countries have even adopted negative interest rate policies . Recent decades have also borne witness to unorthodox monetary phenomena, such as quantitative easing (QE) where central banks instead influence long-term market rates to pre-emptively ward off future, ingrained crises.
So, then, we must have a simple, neat solution: central banks should frantically hike up rates and restrict the money supply until inflation settles back to a comfortable and sustainable band. Most economists estimate ‘healthy’ inflation at approximately 2-3% to support long-term economic growth . The only drawback to this argument is history, annoyingly. America’s central bank, the Fed, did indeed follow an aggressive rate hiking cycle to combat the Great Inflation of the 1970s. Perhaps the most influential Fed Chair, Paul Volcker, raised the federal funds rate from 11.2% in 1979 to 20% in 1981 , alongside targeting growth in monetary aggregates – that is, measures of money supply. Indeed, inflation did drop from its peak of 13.5% in 1981 to 3.2% in 1983 during his tenure. But, less appealingly, another significant result was the severe and protracted recession lasting from July 1981 to November 1982 .
The situation faced by Volcker during the Great Inflation is not dissimilar to the current global economic environment: shocks reverberating through energy markets, geopolitical tensions, and concerns of a wage-price spiral inducing further inflation in America. It is therefore not surprising that many commentators are looking at Volcker as a foil to the current chair of the Fed, Jerome Powell.
Again, unsurprisingly, such a comparison also creates paranoia and unrest about the likelihood of another deep and protracted recession like the 1980s. Although Volcker and Powell face similar monetary environments, it is worth remembering that Volcker’s policy was implemented when it was already too late. Inflation in America had already seen considerable movements in the decade prior to his appointment, such that inflation was considered ‘baked in’. Cruel and ruthless monetary tightening was the quickest way to a solution.
The concern for all central bank policy makers now is to not let this broadening of inflation take hold. It is no wonder that policymakers tried very hard to convince both themselves and the public that recent inflation spikes due to COVID-19 supply chain issues were just ‘transitory’. The alternative of admitting sustained inflation pressures would provoke unmanageable and increasing inflation expectations among consumers. Such inflation paranoia would only serve to push prices higher and higher. The only mitigation strategy would then be an unrelenting Volcker-like monetary policy that would grind each of the central banks’ respective economies to a halt.
Obviously, this is quite a gloomy worst-case scenario. Thankfully, central banks can manage inflation expectations by promoting their own ‘inflation fighting credibility’. That is, as consumers we should be convinced that our central bank can and is willing to reduce inflation. Concerns over latent but aggressive policy decisions should be all but null in an age where central banks clearly articulate their expectations of policy rate cycles. The fearmongering of hyperinflation is also quite obviously hyperbolic and unfounded for most democratic countries who have independent monetary authorities. Managing inflation expectations alongside monetary policy is the only effective way forward.
Indeed, inflation can be considered a ‘monetary phenomenon’ to a certain extent – but we would do well to remember that optimism is also key. Central banks have far superior credibility, knowledge, and data since Volcker’s time. So, although rate rises are undoubtedly in our future, unease about the future of inflation and vague comparisons between central bankers is unlikely to help.
By Emma Searle
 Reserve Bank of Australia. (2022, January 25). Inflation. Retrieved from Measures of Consumer Price Inflation: https://www.rba.gov.au/inflation/measures-cpi.html
 Gelos, L. B.-M. (2021, March 3). IMF Blog. Retrieved from The Evidence Is in on Negative Interest Rate Policies: https://blogs.imf.org/2021/03/03/the-evidence-is-in-on-negative-interest-rate-policies/
 Mathai, K. (2020, February 24). Finance & Development. Retrieved from Monetary Policy: Stabilizing Prices and Output: https://www.imf.org/external/pubs/ft/fandd/basics/monpol.htm
 Dudley, B. (2022, March 19). The Washington Post. Retrieved from The Slower the Fed, the Harder the Landing: https://www.washingtonpost.com/business/energy/the-slower-the-fed-the-harder-the-landing/2022/04/18/6be855be-befe-11ec-b5df-1fba61a66c75_story.html
 Federal Reserve History. (2013, November 22). Essays. Retrieved from The Great Inflation: https://www.federalreservehistory.org/essays/great-inflation