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Supply Factor – This leverage really helps against inflation

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Inflation has become a major burden for many citizens, even more so than fears of climate change. High price increases for everyday goods are forcing people with lower incomes to make cutbacks because they lack the financial buffer.

But savers also suffer from inflation because the purchasing power of their financial assets is dwindling. And recently even real assets such as stocks or real estate have been weakening because central banks are now letting some air escape from the price bubbles they have created with extremely low interest rates with more or less hesitant interest rate hikes.

All of this is brewing into a problem for mainstream politics, as rising inflation is grist for the mill of populists.

But inflation serves the economic purpose of restoring a disrupted market equilibrium. During the lockdowns at the height of the pandemic, entrepreneurs and employees were compensated by the state for their loss of earnings. The state obtained the necessary money by issuing bonds to finance budget deficits.

The central banks bought the lion’s share of it and used it to print the money he needed. As long as the lockdowns lasted, the newly created money could not be spent and increased savings.

But when normality slowly returned, it flowed into consumption. However, the demand was not matched by a corresponding supply, since interrupted supply chains hampered production. Rising prices matched real demand with reduced supply. The pressure to adapt became even greater when the war against Ukraine and China’s zero-Covid policy cut off the supply of raw materials, food and intermediate products important for the production of consumer goods.

Market equalization through inflation will not decrease again until demand falls, supply rises, or both. But the European Central Bank in particular is reluctant to raise interest rates long overdue to curb demand. The fear of driving heavily indebted euro countries into insolvency is too great. On the other hand, these countries are proving unable to ease the pressure on demand by cutting spending.

On the contrary: they subsidize energy prices in order to “relieve the burden” on the citizens, but they continue to increase their new debt and thus prevent inflation-neutral market balancing. The European Commission is eagerly trying to make its own contribution to higher new borrowing.

A policy to increase supply would therefore be helpful. Economics and Energy Minister Robert Habeck has at least made an initial contribution by ensuring more gas supplies in the Middle East and the USA and having LNG terminals built in an expedited manner.

This move should be followed by a large-scale campaign to remove supply shortages, from cutting red tape in energy and food production to negotiating with China and other key countries to restore damaged supply chains. As popular as it may be today to rail against “globalization,” it would be necessary now to work towards more “globalization.” Because the more supply can be expanded, the less demand has to be reduced to contain inflation.

Thomas Mayer is founding director of the Flossbach von Storch Research Institute. His new book “The Inflation Specter” was recently published.

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