Can inflation save the European economy?

Can inflation save the European economy?

Consumer prices rose by 0.56 percent in January in Turkey. As a result, annual inflation jumped to 10.61 percent, which was a record level again after a short time. The estimated target of the Turkish Central Bank was 5.5 percent. There are many domestic and international reasons for this unexpected increase. However, explaining the surge in inflation using those reasons must not be understood as a consolation. The only consolation is the Central Bank’s target for this year, which is around 5 percent. Let’s hope some domestic and international factors will not change this optimistic target again.

Although not expressed openly, there is the somewhat hidden intention to use monetary expansion to prevent stagnation from transforming into a widespread recession in Europe. Similar action is also anticipated in the United States to boost total demand. For the present, the monetary authorities in both regions prefer to delay the implementation. But that does not mean they have changed their mind. Let us hope that they are somewhat uneasy on a new surge in inflation.

When the economic, social and even political damage created by uncontrolled price increases in the past are forgotten and whenever a crisis appears which causes economic stagnation and a rise in unemployment, the old enemy “inflation” begins to seem like a friendly solution. If that crisis deepens day after day because of a lack of enough private spending, nearly all governments and even some prominent economists advocate the stimulation of total demand by loosening monetary and fiscal policies without taking into consideration a new surge in inflation. Yet efforts to tame inflation have always been more difficult, as well as more time-, energy- and resource-consuming than fighting recession.

At first a mild inflation might not be seen as a problem for the sake of an increase in growth and employment. However, when that mild inflation begins to turn into first a creeping, then galloping, inflation, that “life saver” generally becomes the “killer” of growth and employment. This time, governments forget the stimulus packages in haste and begin to implement measures to control the rise in inflation, which naturally kills growth and employment further.

During a recession when rational measures cannot solve the problems, inflation is regarded as the last savior. It is true that during inflation, the value of existing debt is reduced. Inflation gives an extra push to expenditures when people begin to think buying now is cheaper than buying tomorrow. When interest rates stay below inflation, cheaper credit encourages borrowing and spending. These all seem favorable in an economy which faces deficit-debt problems, slow growth and rising unemployment.

However, some unlovable things also happen during inflation. If price increases begin to climb over wage increases, wealth transfer from workers to business reduces total demand and, as a result, stops the increase in employment in contrast to what is expected from the inflationary process.

Another important point is how a government approaches these problems when inflation is out of control. For example, if elections are near, governments generally dare not implement austerity measures and prefer to put off solving problems until the next term. This of course increases difficulties further but might reduce the political risk for the present government. However, if any government has still many years in power, the immediate implementation of austerity measures is a must. This means again reduced total demand, slower growth and rising unemployment.

Inflation also has a negative impact on income distribution. During a rapid inflation when some social groups increase their monetary incomes parallel to or even faster than the rate of inflation, some other groups are not able to follow the same way. This will cause income distribution to deteriorate even further, which is already unjust even in rich and democratic countries. This generally results in social unrest as observed recently all over the Western world.

In short, inflation is not a life saver, in Europe, in the U.S. or any part of the world. It is a kind of economic narcotic which creates a false paradise in the beginning, becomes a dangerous addiction and then destroys the whole body in the end. It must also be remembered that the treatment to cure this addiction is very difficult and time-consuming.

The last worldwide inflation period – stagflation – due to the first oil crisis continued a quarter of a century.