Home Markets CME Cautions on Inflation. Says Need to Cut Expenditure When Preparing for Budget 2022

CME Cautions on Inflation. Says Need to Cut Expenditure When Preparing for Budget 2022

It would be a mistake for a Central Bank to try and reverse policy and create a monetary contraction. This would be a case of two mistakes do not make things right.

by Gopalakrishnan Nair
Dr Carmelo Ferlito

The Center for Market Education (CME) invites the government to seriously take into account the issues of inflation and stagflation when preparing Budget 2022.

“Lockdowns have generated supply-side shocks, which are now pushing up prices of transports and commodities. However, the additional money supply created by expansive fiscal and monetary policies is exacerbating the risks of inflation and potentially undermining the future recovery”, explained Dr Carmelo Ferlito, CEO of CME.

“When the Covid Pandemic hit, governments around the world rapidly increased expenditure with very little access to any increase in taxation. The result was more borrowing which was supported by money printing under a QE (quantitative easing) or similar programmes depending on the country”, added Professor John Hearn, Fellow of CME and a Visiting Professor at the London Institute of Banking and Finance.

At this point we had a significant increase in money stock but, with lockdowns, a fall in the speed at which money was circulating followed. For a short while the impact of a plus and minus created an indeterminate change in monetary demand; however, as countries try to normalize, an increased money stock and an increased money flow add significantly to aggregate monetary demand.

“Within 12-18 months from these phenomena the economy will suffer inflation”, continued Professor Hearn. That is happening now in most countries and Central Banks and Governments are misleading people into thinking that higher inflation is caused by supply side problems such as energy price rises, supply chain difficulties etc. This is wrong, as the current inflation is the result of government overspending and monetary mismanagement; supply side shocks are not enough to generate generalized inflation, however increased money supply is.

“Furthermore, fiscal and monetary stimuli caused by the pandemic created a one-off misallocation of resources which means that productive factors are now in the wrong place and causing supply chain problems and holding back economic growth”, added Professor Hearn. That’s the reason why we experienced some sort of stagflation.

Professor Hearn continued by explaining that the only way out of this situation is that Governments need to cut back expenditure immediately to pre-pandemic levels. Unfortunately, the temptation will be for governments to say that now, as they do not need to spend as much on the pandemic, they have more to spend on other things. This would be a big mistake. Governments should be planning to balance their fiscal budgets within the next few years. Central Banks need to slow the growth in money supply and manage monetary demand to be growing just a little faster than output so as to achieve their inflation target (2 percent).

The inflation they have already caused needs to work through the system and certainly needs no more fuel from any excessive monetary and fiscal expansions. It would be a mistake for a Central Bank to try and reverse policy and create a monetary contraction. This would be a case of two mistakes do not make things right.

Finally the Central Bank needs to more closely align its official repo rate with market rates of interest and then we will begin to see a rebalancing of the economy, stronger, freer markets and accelerating economic growth.

“These are elements that the government needs to take into account when preparing Budget 2022. It must renounce the temptation to keep on overspending as giving into this temptation will pose the risk of a serious economic crisis in the near future”, concluded Dr Carmelo Ferlito and Professor John Hearn.

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