“Keep wage increases below inflation.” The politics of central banks

The Bank of Canada, and other central banks, are ‘aggressively raising interest rates’, ostensibly to stifle inflation. For the same reason, the Bank of Canada’s Governor, Tiff Maklen, recently said that employers should resist labour and supply contracts based on high inflation expectations: i.e. employers shouldn’t raise wages, nor pay their suppliers, in line with inflation.

This central bank approach is understood as a-political, as technocratic: central banks are simply fufilling their mandate to keep inflation under control. Of course, controlling inflation is not necessarily a bad thing: it is a good idea to avoid hyper-inflation. However, systematically keeping inflation low, and actively resisting commensurate wage increases at the expense of all other considerations, is highly political.

Central banks are therefore political, because their core mandate (keeping inflation low) is itself political.

Men wearing sandwich boards reading “I voted for ham and eggs” and “I believed the banks” walk down a Los Angeles street, Oct. 24, 1938.  (Photo: Associated Press). Source: https://www.federalreservehistory.org/essays/recession-of-1937-38
Why is it political to keep inflation low?

Low inflation has at least two – related – effects which are simple to understand. First, it preserves the value of cash (i.e. money sitting in the bank keeps its value) and, crucially, it maintains the value of debt (i.e. if there is no inflation the money you owe, say for a car, will be of similar value today as in a year: if inflation is running at 7%, the money owed will be worth 7% less in a year).

Who has cash sitting in the bank? Mainly well-off people and corporations with large cash reserves.

Who benefits from maintaining the value of debt? People and corporations who are owed money – again, mainly well-off people who, through their various investments, own banks and corporations, which themselves are owed money.

Conversely, who owes money? Who would benefit from inflation? Oddly enough, and contrary to current populist rhetoric, it is most of the middle-class as well as poorer people who are in debt: they usually carry credit card debt, vehicle debt, mortgages, student loans, etc… These people would benefit from inflation (not to be confused with hyper-inflation) since the value of their debt decreases as inflation gnaws it away1.

What is the impact of hiking interest rates? Whether or not high inflation rates are the correct solution for the particular mechanisms currently fueling inflation, their direct impact is: to increase the cost of repaying debt (further reducing disposable incomes of the non-creditor majority); to make life difficult for Small and Medium sized Enterprises2 (which are also servicing debt: they invest less, cut jobs, or even close down); and to maybe cause further inflation by reducing the supply of goods and services (if, that is, inflation is caused by supply and logistics issues rather than by monetary issues).

Keeping inflation low is political, as is central bank’s sole solution: low inflation (as well as the means to keep it low – high interest) is a way of institutionalising inequality, of ensuring that debtors stay poor and creditors remain rich. Piketty, in his historic analysis of debt, income, and wealth distributions, shows that the (unusual) period of increasing wealth and income equality, lasting from about the 1940s to the 1980s, was partly a consequence of higher inflation (and consequent devaluation of debt) brought about by the two World Wars.

Needless to say, there is disagreement about this, and more right-leaning commentators have been vocal in picking holes in Piketty’s analysis. The problem these commentators face is that his analysis is based on meticulous compilations of data: without being above critique his basic points are robust to ideologically motivated ripostes that downplay the data.

Does this mean that inflation is good?

Inflation is not desirable, especially if it gets too high: but inflation can have many causes. Hiking interest rates and calling for lower real wages may not address underlying issues. Whether inflation is a necessary economic adjustment, a symptom of structural problems in the real economy, or a sign of monetary disfunction are a key questions. Only if they are answered can we – as a society – decide if inflation should be suppressed and, if so, how to do it.

Take the current situation.

  • Is inflation attributable to COVID hand-outs (i.e. to money created during COVID)? Partly, but who benefited from that money? If most of this money has ended up as corporate profits and savings for the better-off, maybe inflation is necessary to flush out this excess cash.
  • Is inflation attributable to supply and logistics bottlenecks? Partly. If so, inflation is a mechanical response to the reduced supply of goods. Monetary policy can’t solve this: other realms of policy (e.g. industrial, transport, infrastructure…) – which our governments seem incapable of even imagining – are necessary to sort things out.
  • Is inflation attributable to run-away wage demands? Despite the labour shortage, the answer seems to be categorically ‘no’. There is no sign that wages have been driving inflation: on the contrary, wages are not keeping pace, so living standards for most people are declining. The Bank of Canada wants it to stay this way.
  • is inflation caused by oligopolistic corporations making excessive profit? Partly. Why then does the governor of the Bank of Canada only call for wage restraint (even when wages are manifestly not driving inflation?) – double standards seem to be at play here.

Jacking up interest rates with no consideration for underlying inflationary mechanisms will in all likelihood exacerbate inequalities:

  • it will hit small debtors. The lower and middle classes, already losing purchasing power to inflation, will face higher interest payments. As they default, they will lose houses, vehicles, or make tough choices about which basics to prioritize. Then, if high interests do their job and eventually lower inflation, their new debts (boosted thanks to the period of high interest) will remain. And remember: the bank of Canada is advising that wages not increase with inflation…
  • it will hammer small and medium businesses (often, also, in debt). SMEs will shrink or close, people will lose jobs, and Canada’s capacity to address production and logistics bottlenecks will decline, exacerbating inflation.
  • it will benefit creditors. Keeping inflation down ensures that money owed to creditors maintains its value (and/or that they can pick up collateral in cases of default, further concentrating wealth): it also ensures that current cash (sizeable portions of which have accrued thanks to public efforts to keep the economy afloat during COVID) keeps its value.
  • it does nothing to address excess profit.
We need to recognize that central banks are political

I do not have a magic solution. I do not know how we can can get through these turbulent economic times. Unfortunately, neither do central bankers, whose monomania with inflation is no help: they have one tool, the blunt hammer of interest rates, and see every economic process as a nail.

The complex science of central banking. Source: https://www.rgbstock.com/photo/2dRWLtK/Hammer

When the Canadian central bank enjoins employers to not raise wages (and pay no heed to excess profits) one is forced to wonder: on what planet can such advice be considered a-political?

Devising a solution to current economic turbulence requires genuine politics, not simplistic one-size-fits-all admonitions: by this I mean open debate, information that helps us all understand the real-world bottlenecks that are causing inflation, and deciding – as a society – what to prioritise and why. Do most Canadians really think that keeping their wages down and increasing their debt repayments are good for them or the economy? Can other courses of action be imagined?

Currently, debate cannot happen because central bank ‘independence’ has baked a particular set of politics and values into our economy, and placed them beyond debate.

It is time to break free, and recognize that there has never been such thing as an independent (if, by this, we mean a-political) central bank.

1 Needless to day, things are not so simple: the transition periods between low inflation and high inflation (and the reverse) are very bumpy and can lead to hardship, because prices and wages do not adjust at the same speed. Also, in a labour system such as the current one – where power (labour shortages notwithstanding) remains in employers’ hands – inflation can be a way of further transferring wealth from labour towards employers. Typically, as we see now, prices and profits rise fast, and wages lag substantially.

2 Power is also at play. Small debtors – the 99% – are in trouble when interest rates rise. Large debtors (e.g. large corporations, very wealthy individuals) simply renegociate their debt. As J. Paul Getty is reputed to have said: “If you owe the bank $100 that’s your problem. If you owe the bank $100 million, that’s the bank’s problem.”

Published by Richard Shearmur

I am a professor at McGill's School of Urban Planning. I perform research on innovation, on how we locate work activities (in a world where people often work from many places), and on urban and regional economic geography. I used to work in real-estate, and teach a course on this. I am an urban planner, member of the Ordre des Urbanistes du Québec and of the Canadian institute of Planners.

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