The fund and spend, but not too much growth conflict throws me for a loop.
Interest rates only work if the economy is rate sensitive and large amounts of fiscal spending has made developed economies today much less rate sensitive in my opinion.
In the past when central bankers raised rates the vast majority of borrowing and spending occurred in the private sector so as rates rose borrowing and spending would fall. Today a huge amount of borrowing and spending is done by the government where that rate sensitivity doesn't really exist.
In the UK for example something like 40% of adults are on some form of government welfare and that welfare has increased in line with inflation over the last year (~10%). So basically 40% of adults in the UK have income which is inflation hedged by the government.
But worse still is that the government is now borrowing more than ever in the UK to hedge inflation for UK consumers while also paying more than ever to service its increasing debt. So this is a toxic combination of higher inflation, higher rates and ever more debt.
I keep trying to explain to people here in the UK that the government are basically screwed and we need to cut spending now before the public debt burden gets any worse. Unfortunately I don't think people here really appreciate the magnitude of the hole we've dug ourselves just yet and think we can just spend our way out of this like we have in the past. Even wealth taxes won't fix the deficit we've created with debt-to-GDP in excess of 100% and government borrowing rates going to 6%+. Wealth taxes might raise $20-30b in an optimistic scenario – but our deficit is twice that and growing.
It's going to be interesting to see how governments deal with over the next decade because the cost of health care and pensions are only going to continue to increase so either we'll be forced to increase tax revenue to unprecedented levels with destroying the economy, or we borrow ever more to fund all of this spending and eat the cost for it via inflation. Well that or cut government spending.
However we see both minimum wage and pensions increasing 10%+. Now sure those on minimum wage will spend it on something frivolous like food, but those on indexed linked pensions, who already pay far less tax per pound received than a working person, have even more money to spend.
Roll NI into Income tax, it will raise money spent and take it from those who actually have money to spare and are thus driving inflation by created demand where supply can't keep up. Throw in a land value tax to encourage people to utilise land better and thus reduce the cost of housing, and pretty much remove the planning system anywhere within 2 miles of a station with a <60 minute service to a major city.
Not just people! Companies, municipalities and other levels of government too. These rate increases mean literally every entity in our over indebted nation is going to feel pain.
It probably should have been 5-6% to encourage a real decline in spending power. Not that it makes me happy to say.
This is easily explained by the fact one is an elected body that has to appeal to the people, while the other is essentially unaccountable. But I agree, the conflicting strategy is not optimal.
The government not cutting spending is an appeal to the people though. Seems like the BoC is the one acting like grown ups.
To whom are they accountable? Poilievre has been campaigning on threats to apply pressure on the BoC, but there's no mechanism to actually do so.
Have the people of Canada been asked what the best balance of inflation and unemployment is? Or has the BoC decided for us, despite how the average Canadian might be harmed in the process?
I know this is a rhetorical question, but yes people of Canada will be voting on that issue in October 2025 (or before) when they elect their government. The BoC is still very much ruled by parliment and their mandate is set by the elected party.
The reason their mandate does not change with every whim of public opinion is precisely because people don't like the medecine (high interest rates). Alternatively they also dislike high inflation and labor shortage caused by record-low unemployment.
The meagre supports we've seen from the government to date are largely micro-targeted at low income persons who are most feeling the existential threats of this inflation crisis.
Meanwhile the BoC raising interest rates is dissuading wealthy business owners and investors from further investment and expansion, actions that at least at first are targeted at limiting business investment by the 1% and limiting consumer spending by the top 10% that own homes with big mortgages.
(now if the bank goes overboard and induces a recession, well then those 1% business owners will go on and start layoffs, which will start to have some broader effects...)
On the other hand, lower interest rates allow banks to synthetically create more money at a lower cost (e.g. corporations borrowing say, a million dollars at 1% interest is very attractive) and that will drive inflation more broadly, because its new money created. Raising rates makes creating money more expensive (setting a higher "floor" on the price of new money relative to what the banks get it at)
This is why interest rates rising in theory, will depress housing prices because it costs more in monthly payments to cover the interest on the mortgage to buy the house, which means fewer people can buy more expensive homes and it takes more money out of the economy as a result, because borrowing is more expensive. This is why you can get 5% yield CDs at banks quite suddenly, because giving you favorable terms on savings is cheaper than borrowing the money from the central bank.
Its false equivalency to think cash assistance and many other forms of social welfare drives inflation more broadly, in the general case.
I will caveat there are specific cases where inflation can be driven by government spending directly, but its not generally the case with things like cash assistance, in due part because its not creating new money.
[0]: I'd like to just point out, I'm explaining a very complex system of inputs and outputs in very simplistic terms. While its not incorrect per se, it certainly is more complex than I'm laying out in reality. Conceptually however, I think this explanation is rather sufficient in getting the point across that I'm asserting
[1]: if I'm wrong, I'd love for someone to point out what I'm wrong about. I'm assuming most of us aren't economics majors here, therefore, as noted, I omitted alot of nuance, while acknowledging that there are cases where the government can cause inflation via spending.
Although this would be true to a certain extent wouldn't this drive inflation as it would cause an increase in demand without a corresponding increase in supply? Since suddenly a lot more people can purchase things that they couldn't before. E.g. Cars at the beginning of COVID, consumer electronics, etc.
Short term inflation (usually horizon of less than 18 months) can significantly increase due to demand outstripping supply, absolutely. Market efficiency though, should cause rapid normalization and eventually prices will fall due to competition, at least in a healthy functioning market economy (that's another debate).
That said, I'm considering what drives long term inflation, which extends beyond an 18 month horizon. We're approaching year 3 of dramatically increasing inflation across the board, and one of the only mechanisms we have at that point is driving up the cost of new money and allowing that to ripple across the economy. So much of our economic system is centrally based around borrowing, whether its cars, homes, business expansion etc. These decisions are in part, driven by cost. When the cost of borrowing is lower, its easier to spend higher sums and drive long term inflation. It also lends people to seek greater and greater returns with "cheap money", driving these boom bust cycles.
My general argument is long term inflation is driven by cheap money, and short term inflation that may be caused by government assistance is just that - short term, and measurable, and should, in a functioning market, normalize itself away.
tl;dr, demand side inflation naturally curbs since high demand outstripping supply will natural raise prices to an equilibrium, and bring them back down as it cools off, supply side inflation is more opaque in reality, esp. when it comes to controlling borrowing costs (IE, creating new money)
> Its false equivalency to think cash assistance and many other forms of social welfare drives inflation more broadly, in the general case.
This is also probably why you're getting down voted - it's just wrong
1. taxation, either explicit or implicit through interest rate manipulation, doesn't impact monetary supply at the scale we're talking about here. It impacts the cost of, and therefore the availability of capital.
2. cash assistance to the poor isn't a simple "take $100 from Peter and give it to Paul" transaction. It transforms capital (what taxes impact) into money. This is a weird distinction, but capital isn't money. Think of it as two separate streams - there's a fictionalized capital stream of stock markets etc, and a "real world" money stream that interacts with good and services.
3. Cash assistance to the poor directly drives inflation because the demand for goods is decoupled from reality. By giving cash to the poor, you generate increased demand for the same amount of goods and services. This is econ 101 - demand goes up, prices go up. Because the monetary supply has been manipulated by injections from capital, this demand is decoupled from the cycles that would tamp it down.
Let me repeat that: a sudden increase in demand, coupled with more money in the system, decouples prices from the systems that keep them in place and drives inflation.
If you'd like an object lesson in this, I'd refer you to the past 3 years of experimentation with wealth transfers in the US, and the current inflation as a result of that.
Edit to add - I make no moral statements here. I think that cash assistance to the poor _is_ generally the least bad option of government assistance; however, we should be clear eyed about the costs of these actions, and not hand wave them away, only to be shocked, shocked, shocked, when those costs come due.
Cash assistance to the poor / middle class is more murky. While yes, short term inflation in part was driven by the broad relief payments[3], it is sustained by cheap money[4].
My argument is centrally that cash assistance to the poor and middle class, broadly, won't sustain inflation as prices rise and demand normalizes, as an efficient market should do. The distortion on that market happens with a combination of low interests, which drives cheap capital creation, which distorts natural price normalization, and fuels riskier investments, which are all observable economic cycles.
My conclusion, based on what I understand and evidence there in, is that cash assistance, especially in limited one shot capacity, is not going to sustain inflation at the pace we've been seeing it most broadly. One particular note is PPP loans (which were largely forgiven) + "cheap money" is a big driver in being able to sustain higher prices via "buffing" the balance sheets of businesses. If I can sustain demand loss at a higher price because my operating costs dropped significantly due to cheap (or in some cases "free") money, you've just distorted the market.
In a healthy environment, high prices should naturally have lead to lower demand, which would kick off the deflation cycle, which in a certain band, is healthy for the economy as a whole.
This is why there's arguments over whether interests rising more dramatically is the "right tool for the job".
To be honest, I'm not sure our understanding differs that much on this aspect, only in as so far as I am less critical of direct cash assistance to the poor / middle class than the assistance given to wealthy / corporations (in, for instance, form of PPP loans). I also don't think that cash assistance is the real long term driver of inflation at this stage.
I'd also like to note, I wasn't talking about pandemic relief per se, I was more talking about general cash assistance that you would typically see in welfare programs, which is provided via taxation, usually.
[0]: https://home.treasury.gov/policy-issues/coronavirus/assistan...
[1]: https://www.cnbc.com/2023/06/26/ppp-loan-fraud-drove-home-pr...
[2]: https://www.stlouisfed.org/en/publications/regional-economis...
[3]: https://www.federalreserve.gov/econres/notes/feds-notes/fisc...
[4]: https://www.imf.org/en/News/Articles/2022/07/11/CF-US-Econom...