There are many causes of inflation, but there’s only one solution central banks seem willing to consider: increase interest rates. This has many people scratching their heads: Why would this bring down the price of rent, food or gas? Won’t it increase costs for anyone who pays interest on a variable-rate mortgage or consumer loan? And won’t it make essential green investments more difficult?
The current bout of inflation started with supply-side disruptions. COVID-19 disrupted everything, especially goods originating in China. Climate-worsened droughts disrupted farming. Then Russian President Vladimir Putin went and disrupted Ukraine. Supply chains broke for critical items such as oil, wheat, fertilizer and microprocessors, causing shortages that enabled producers to increase their prices.
Once inflation had started, some businesses took the opportunity to increase their prices, bringing the second cause: profits-push inflation. This is when companies use their market power to boost their prices. Average Canadian profits, which ran at 5 to 10% between 1960 and 2000, rose to 20%, while corporations enjoyed their lowest-ever tax rate.
The third cause of inflation was the increased price of oil that came with the invasion of Ukraine and seeped into many products. The fourth cause was increased mortgage and rental costs. Prices went through the roof when the Bank of Canada printed money in response to the 2008 financial crisis and then the pandemic, distributing it to the banks – combined with historically low interest rates in a relatively rigid housing market.
Conservatives and Republicans like to claim that inflation is caused by increased government spending, but this is true only when a corrupt or incompetent government prints money instead of raising taxes to pay for its cronies or its wars. In normal circumstances, every dollar that a government spends comes either from taxes or from loans in the form of bonds, and in both instances, money is taken out of the economy to pay the taxes or buy the bonds, so there is no impact on aggregate demand (the total demand for all goods and services in an economy).
Money created by central banks, on the other hand, does increase the money supply, risking an increase in aggregate demand and hence inflation, if supply is constrained. During the early days of COVID-19, central banks also used quantitative easing to buy government bonds, creating money that was distributed as support cheques. They pumped £895 billion (US$1 trillion) into the U.K.’s $3-trillion GDP economy with the explicit purpose of sustaining aggregate demand, and the Bank of Canada did likewise.
The Bank of Canada believes that it needs to cool demand, enabling supply to catch up, and its way of doing this is to increase interest rates, even if it causes a recession, increases unemployment and makes those essential green investments harder. In The Causes of and Responses to Today’s Inflation, however, the economists Joe Stiglitz and Ira Regmi show that there is no excessive aggregate demand in the United States, that real personal consumption has been largely below trend, and that the U.S. is not facing a wage-price spiral. The close linkage between our economies suggests that the same is true in Canada.
Rather than simply watching as central banks raise interest rates, what should governments do, given that those who suffer the most are those who are only just getting by?
1. Increase wealth taxes
Between 2008 and 2022, the world’s central banks gave US$41 trillion in quantitative easing to banks and corporations, which did inflate asset prices in the housing and stock markets, which is where the money ended up. An analysis by the Institute for New Economic Thinking found that increased aggregate demand in the United States is a fifth contributing cause of the current inflation but that 40% of the increased demand is coming from the wealthiest 1% and 75% from the wealthiest 10%, who made immense gains in personal wealth during the pandemic, mostly as a result of this same quantitative easing, and are now busy spending it.
We don’t need to cool general demand; we need to cool demand by the wealthiest 10%. This is best achieved not by raising interest rates but by increasing taxes on those who are already rich, for whom inflation is not a problem. At the same time, governments should encourage more green investment by developing a sustainable activities taxonomy, similar to Europe’s, favouring lending at low interest for critical items such as affordable housing and climate solutions.
2. Impose a windfall profits tax
When Canadian economist Jim Stanford analyzed profits in 52 Canadian business sectors, he found that compared to before the pandemic, the combined after-tax profits of the 15 most profitable sectors had increased by 89%, while profits in all other sectors fell. The big culprits are the oil and gas companies, followed by banks and financial intermediaries, mining, groceries, and home maintenance companies. Together, they took $143 billion out of the pockets of businesses and consumers (4.5% of Canada’s GDP), causing more than half of the current inflation. This then had a knock-on effect, further increasing prices for food and other consumer goods.
The same thing happened in Britain, where corporate profits were 73% higher in 2021 than in 2019, and in the United States, where the quarterly profits of corporations were 50% higher in 2022 than during the eight years before the pandemic.
These businesses have been able to profiteer from inflation because they do not face enough competition. In Canada’s food sector, five supermarket chains control most food distribution, and at least three seized the opportunity to increase their prices. Industry-wide, their average margins are 75% higher and their net incomes are 120% higher than they were before the pandemic.
If companies knew they would be taxed heavily on their windfall profiteering, they would be less likely to do it. Prime Minister Justin Trudeau’s government has promised a 3% surtax on banks with profits greater than $1 billion, and the NDP has called for a 15% tax on larger companies with higher-than-normal profit margins. In the U.S., Bernie Sanders has called for a 95% windfall profits tax. In Portugal, parliament has approved a 33% tax on windfall profits by energy companies and food retailers, and the Czechs are proposing a 60% excess-profits tax on energy companies. The European Union wants to raise 140 billion euros by taxing the windfall earnings of energy companies to help households and businesses pay their massive gas and electricity bills. To stop future profiteering, governments need to use anti-trust regulations to break up oligopolies.
3. End the affordable-housing crisis
Between 2021 and 2022, apartment rents in Canada rose by an average 11%, from $1,676 to almost $2,000 a month. Rental inflation was 37% in London, 30% in Calgary, 19% in Vancouver and 17% in Toronto. In these cities, tenants are paying $600 to $1,000 more every month. In the United States, mortgage costs have risen by 18.8%, rents by 17.6%. For many mortgage-holders, the higher interest rates are really hurting.
I have suggested solutions to the housing crisis here and here, so I won’t repeat myself. Among other things, we need to control the spread of short-term rentals, and we need a massive increase in affordable home-building. Increased interest rates will make this harder.
4. Reduce our dependency on oil
The solution here is to speed up the transition to sustainable transportation. If you drive an electric car, or if you get around by foot, bike or public transit without need for a car, the price of oil has much less impact. The annual increase in the carbon tax, reaching $170 per tonne by 2030, is essential as a persuasive mechanism. The federal government could advance the 2035 ban on the sale of new gasoline vehicles to 2030 and phase out heavy-duty vehicles by 2035, in collaboration with the U.S.
5. Give workers the pay they need to keep up
Once inflation had set in, workers needed wage increases to keep up, and employers who couldn’t find staff offered more pay, contributing a sixth supposed cause: wages-push inflation. Since 2017, prices in Canada have risen by 20%, however, so low- and middle-income workers whose wages have not increased are actually contributing to reduced demand. Central banks often blame the inflation on workers’ wage demands, rather than the five other causes, which is where it belongs.
Nearly two-thirds of Canadian workers' wages are falling behind the rate of inflation, according to a report by the Canadian Centre for Policy Alternatives (CCPA); the economist Robert Reich has shown that most U.S. the purchasing power of workers’ paycheques is also shrinking. The CCPA report found that public-sector workers’ wages over the past two years grew by less than the rate of inflation. Last year, healthcare and social-assistance workers got 2.1%, educational workers got 1.6%, and public administration workers got only 1.5%. Underpaid workers are actually dampening inflationary pressure, since their lack of income means they consume less. For the lowest-paid workers, this means less food, less heat and more risk of eviction. It can’t be right to seek to tame inflation by placing the burden on those who are least able to carry it.
6. Invest in immigration, childcare and seniors’ care
Canada has a record number of job vacancies, causing employers to increase wages to attract workers. The solution is to expand the labour market, by increasing immigration beyond the current record level of 450,000 a year, including more investments in training opportunities while accelerating the construction of affordable housing and expanding affordable childcare and seniors’ care, enabling more parents and caregivers to return to work.
7. Help low-income families
Businesses can pass their increased costs on, but families can’t. The lower your income, the more you suffer. Canada has doubled the GST rebate for 11 million low-income families and individuals and offered $500 in rent relief. The U.K. is giving £1,200 each to eight million vulnerable families. Italy is paying up to 5,000 euros to help low-income people cope. In Canada, most federal income supports are indexed to inflation, but provincially, while most minimum wages are indexed, most child, seniors’ and social-assistance benefits are not. Only in Quebec are all five major supports for low-income citizens indexed. In Alberta, the Northwest Territories and Nunavut, none are.
Why do central bankers insist on raising interest rates? Is it because their economists have been trained in neoclassical economics, which teaches that the market always knows best and government intervention is to be discouraged? And yet raising interest rates is an intervention. Or is it because raising interest rates happens to bring more profits to bankers and investors, who have the most power, and dump the pain on low-income workers and families, who have the least? There’s a lot to untangle here.
