Thank you for this conversation. Thank you very much. You have a very interesting theory about demographics, shifting demographics that is squeezing the labour force and is pushing the prices up. Please, tell us more about it.
The Western World saw a massive increase in the available labour force over the 30 years from 1990 to 2020. That was caused by, first of all, the very high birth rate in the earlier decades and they all entered the work force. And then, the birth rate in most of our countries went down very, very sharply below the sustainability rate and that allowed a very large proportion of women, who previously stayed at home to do housework to enter the workforce. So, one got a sharp increase in the working age population and much slower increase in the number of children and in the old of the working age population and those there, the women who make up half of the population, all entered the workforce to a much greater extent. You add to that the fact that after the fall of the Iron Curtain, the Eastern European countries, like Bulgaria, and China entered the world trading system and that actually more than doubled the available workforce. Put all that together and in 30 years, the available workforce to producers in the West, who could shift their production to the lower wage countries as in Eastern Europe – it was an incredible sort of three times increase. And it broke the power of labour and the power of private sector trade unions. And then, around 2010, the working age population began to slow down- in many countries, it actually fell. And, of course, we had the brake between China and the United States and that means that from having a massively expanded available labour force to anyone who could shift their production, we are now going to get a much smaller, even declining workforce in countries like Japan, China, Germany, Italy, most of the Continental Europe. The work for the available workforce would be going down in the USA and the UK, were it not for immigration. So, from having a massive increase in the availability of labour, we are now going to have a sharp decline in the availability of labour which is going to mean that workers are going to be in short supply and employers will have to bid up to fill the available vacancies, as it has started already following the Covid pandemic.
Professor Goodhart, what are the roots of current inflation?
It’s partly that the labour market is much tighter, virtually throughout the West than had been expected as recently as the summer of 2021. The reason why Chairman Powel made such an optimistic speech at Jackson Hole that year, in August 2021, was that they expected a flood of workers back which was going to offset the increase in demand that the expansionary monetary and fiscal policies had already brought about. So, they thought that there was going to be a slight increase in inflation and it will return to target very rapidly. Neither of those has happened.
When did the main inflation drivers occurred?
The main inflation drivers actually began from about the summer of 2021 and it really took until the late autumn - December of 2021 for the main central banks to realize that they got it wrong and then they started to move from expansionary policies towards beginning very, very slowly and gingerly to tighten. And then the whole situation got made a great deal worse by the adverse supply shock brought about by the Ukraine war.
Professor Goodhart, you say the corona virus pandemic is a dividing line between the times of deflation and inflation. How is that so?
It removed a lot of people from the labour market. Long covid, the aftermath of having caught covid is being more serious than we expected. And then, the expansionary policies in 2020 and 2021 meant that in 2021 people were relatively affluent, with asset markets having risen very sharply, interest rates very low and they had a lot of money on their hands. And that meant that the elderly people in our countries, age say from 55 onward thought that it was quite a nice time to retire early. They enjoyed working from home, getting away from the horrors of commuting into the big cities and so, they retired early. A mixture of early retirement and a dampening down of migration flows – all led the working population to be considerably lower in 2021 and 2022 than had been expected.
How persistent are these inflation drivers? How do you see them?
Our view, that is my coworker’s Manoj Pradhan and mine, is that these inflation drivers will be quite persistent because they are driven by demographic forces and also long-running political forces: the divisions between the Russia and China on one hand, and the USA on the other hand. And these aren’t going away at all so quickly. The central banks around the world and most economists still believe that after about another two or three years that inflation will go back to target and that we will have a return to a relatively low interest rates, both nominal and real. In other words, economists like Larry Summers and Olivier Blanchard still believe that the longer term future is going to be ‘lower for longer’ in terms of interest rates and inflation. That’s where we part company. We think that the underlying demographic and political forces will mean that inflation will be with us for the medium and longer term or rather inflationary pressures which will make it much harder for central banks to hold inflation down to target.
In fact, you believe we have decades of higher inflation ahead of us. Is that right?
Yes.
How is that so?
We are going to have much slower rate of growth of workers and there is going to be much higher dependency ratio with much more old and the old are very expensive fiscally – they require medicines, they require care and they get pensions. Therefore, the higher expenditures are going to have to be met by higher taxation, but the taxation will largely fall on the workers. So the tax rates will go up, the workers won’t like that and they will try to restore, if you like, the pre-tax real incomes and there’s going to be a return to much stronger labour power, more strikes, more industrial friction. And in a sense, it’s going to be something of a return to the conditions that we had in the 1970s in Western Europe.
The central banks are taking measures. They increase interest rates. How long and how hard must be these measures?
That’s not going to help. The problem is that the public sector debt ratio is so high that you’ve increased interest rates what happens is that the public sector debt… sort of, explodes. And you get the kind of conditions that we have just seen over the last few days in London with public sector interest rates rising to a level which becomes untenable, which causes much more recession, which worsens the deficit yet further and eventually, the central bank has to prevent interest rates exploding upwards. The increases that they are then forced to bring about in expansionary measures will lead to more inflation.
When we take a look at the European Central Bank, for instance, we see they are increasing interest rates, but they also have a quantitative easing programme. Aren’t these two mutually exclusive things?
Yes, to a large extent. And I think they are undoubtedly mutually exclusive in the United Kingdom, as well, where we’ve just come back to quantitative easing at the same time as we are raising interest rates. It’s a mess! And the policy at the moment is not entirely coherent, certainly not in my own country. That’s going to be the problem because it’s very difficult to deal with inflation solely by monetary means unless you have a much tighter fiscal policy. Because if you cannot deal with it just by monetary means, you just get the increase in interest rates, which worsens the public sector debt ratio payout and is likely to drive us into recession. The policy mix at the moment is really quite a mess.
What do you think, and this is a side question, what do you think about this cashless payments trends? Do you think that inflation would influence somehow these trends? Do you expect interest in notes to pick-up again?
No. There’s a lot of innovation in the field of payments. Many central banks are thinking of introducing central bank digital currencies (CBDC) and I think there will be improvements in the payments mechanism. I don’t think they will have very much effect on the underlying inflation rate, though. They are two very separate issues.
What about the digital currencies. We know the ECB is working on the digital euro, in the US they are preparing the digital dollar. How will this change the financial architecture right now?
It depends how it’s introduced. There are many, many ways of introducing a digital currency. The problem is not so much introducing the digital currency. The problem is that the central banks don’t want to get involved in lending to the private sector, because that impinges very closely on the political issue of allocation. So, they’ve got to effectively return the money to the banks, commercial banks in order to enable the commercial banks to undertake the lending. And the problem is going to be that if any of the banks looks suspicious and gets into trouble, then people will move out of the banks and into the CBDC and then there’s going to be a problem for the central bank that is going to put money back into the bank under suspicion, that people think might be doubtful. If it doesn’t put the money back into the bank that is facing a run, then that bank would collapse and you are facing a financial crisis. If it does put the money into the bank that is facing a run into digital currency, then you’ve got the problem that the central bank may be propping up a failing bank and losing some of its money by doing so. That’s going to be really a headache for central banks and it hasn’t yet been worked out at all, how they will handle this kind of issues.
Professor Goodhart, would you like to comment the current situation in the UK: I mean, the perfect storm on the markets, the finance minister’s tax cut programme and the announced programme of Bank of England to intervene on the market with 65 billion pounds.
Well, it’s been a mess. Their basic problem is that the chancellor is issuing a very large, fundamental and intended to be permanent cut in taxation, implying that this was going to result in a large scale addition in borrowing without actually indicating, at all, how in the longer term the public sector debt was going to be sustainable rather than blow up and likely cause considerable inflation. With the result that since there was no clear analyses or description of how the extra deficit would actually be financed, the markets took fright.
In my view, in advance of that mini-budget announced on Friday, the Bank of England knew that the government was going to cut taxes. They didn’t know exactly by how much. I think the Bank of England should have raised interest rates by considerably more, at least by 75 basis points rather than 50, preferably by 1% and it should not have then said that it was going to go ahead with tightening, quantitative tightening of selling gilts into the market at a time when the gilts market was clearly going to be under very considerable stress. So, the Bank of England made a bit of a mess of what it was doing on Thursday. It’s then a combination of a bank not having done enough and a chancellor doing far too much without indicating at all how this was going to be financed, effectively financed, reasonably financed. The markets took fright and that was going to lead to financial instability. The Bank of England was quite right the other day and do a complete U-turn and shift from promising quantitative tightening more or less immediately, to actually bailing out the gilt market by a form of short term quantitative easing. And one of the worst aspects of this is that the chancellor is not going to come out with this strategy for maintaining debts sustainability until November 23. Which first of all suggests that hasn’t yet even got a plan and second, he is going to leave the markets in limbo for something like about six or seven weeks which is not a very ideal or sensible way of behaving.
Professor Goodhart, tell me at the end what are the new trends that your see? I know, for instance, that you believe that the inequality in the decades to come will be lower but that’s because the rich people are going to lose money or because the poor are getting richer?
The rich people will lose a lot of money because interest rates will go steadily down; now going up quite sharply. Bond prices have already tumbled very sharply, housing prices will go down, equity markets will go down, by how far nobody knows – so the rich will become poorer and the shortage of labour is going to mean that particularly the unskilled jobs, the lower educated will become better paid. The poor, who don’t have much in a way of assets, will have higher incomes, relatively higher incomes and the rich will become a lot poorer. So, both ends will reduce inequality.
Thank you very much for this interview for the audience in Bulgaria.
Thank you it’s been pleasure talking to you.
It’s been pleasure talking to you, too.
