Regulation creates inflation – we need the government to pull out

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    Inflation in the euro area continues to rise and was last measured at 8.1 percent. At the same time, government interventions in the economic process are increasing. Production processes, products and supply chains are increasingly regulated.

    During the Corona crisis, service providers were temporarily forced to close. With the Ukraine crisis, trade with Russia is being sanctioned. This leads to rising production costs and prices. What is not obvious: Indirectly, central banks make a significant contribution to “regulatory inflation”.

    In principle, regulations usually benefit individual sectors. If, for example, electricity meters have to be replaced regularly, then their producers benefit. If old cars without an environmental badge are no longer allowed to drive into the cities, then sales of new cars will increase.

    The additional business can be an incentive for lobby groups – usually with the justification of consumer or environmental protection – to push regulations. Then the bureaucracy will also be expanded, because more control will have to be done.

    The companies have been suing for a long time. Since the European financial and debt crisis, banks have also been confronted with more regulations and costly reporting obligations. In the course of environmental policy, numerous rules were imposed on farmers. The result of rampant regulation is higher costs. When companies or banks – especially small ones – close their doors due to the burden of regulation, unemployment arises.

    Unless the state creates a balance. For many years, companies have been relieved by the fact that central banks have reduced financing costs with their increasingly loose monetary policies. The otherwise drastic consequences of the lockdowns for the labor market could be prevented thanks to powerful debt-financed state aid. Central banks provided the necessary backing by buying government bonds on a large scale.

    The growing international trade restrictions can also be linked to monetary policies. Since the turn of the millennium at the latest, the central banks have contributed to growing wealth inequality by driving up the prices of shares and real estate.

    At the same time, persistently low interest rates have taken the pressure off companies to drive productivity gains. Since productivity gains are the basis for real wage increases, the wages of broad sections of the population have grown only slightly.

    As a result, dissatisfaction is widespread. Politicians like Donald Trump have taken advantage of this by blaming trading partners for the misery. With a phalanx of tariffs against China and the motto “America First”, he won the support of many voters.

    The TTIP and TTP free trade agreements were overturned. The supply chain laws that are being sought in many countries could not only serve to improve labor and social standards in developing countries, but also to protect domestic workers against cheap foreign competition.

    New trade restrictions came with the Ukraine war in the form of sanctions. On the one hand, energy imports from Russia are to be greatly reduced, on the other hand, exports to Russia are under political pressure. Putin’s war and sanctions are driving up energy and food prices around the world. These had already risen significantly before the war as a result of the continued loose monetary and financial policies and climate policy (e.g. due to the CO2 tax).

    The extent to which the sanctions and climate policy are politically acceptable in the long term will probably depend on how the population reacts to rising inflation. The poor performance of the SPD and FDP in the recent state elections is also said to be due to high inflation. Accordingly, many governments are currently trying to mitigate the burden of inflation through petrol subsidies, co-payments for heating costs, caps on gas prices or financial contributions.

    However, since the coffers are empty, the associated spending obligations will probably only be financed by new debts. However, it should only be possible to place them on the capital markets without any problems if the central banks continue to buy government bonds. But now the big central banks have announced that they will stop buying government bonds and raise interest rates.

    It remains to be seen whether they will hold out on this course. If interest rates are raised gradually over a longer period of time, the highly indebted countries would have to cut spending and push ahead with comprehensive structural reforms – including cutting red tape. Corporate pressure on governments to help reduce costs through deregulation would increase.

    The forced withdrawal of the state from the economic process and the dismantling of regulations for companies, banks and farmers would not only enable a growth spurt, but also a higher real wage level. With growing satisfaction among the population, prosperity-enhancing globalization could also regain more social acceptance.

    Gunther Schnabl is an economist and has held the Chair of Economic Policy and International Economic Relations at the University of Leipzig since 2006. He also heads the Institute for Economic Policy.

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