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Livio Di Matteo: Cheap money is fun until the inflation hangover hits


The current public debate on inflation, the bank rate, and monetary policy has been disappointing on a number of levels, not least of which is the detachment from recent economic history and the operation of past monetary and fiscal policy. As the accompanying figure shows, despite the wringing of hands and gnashing of teeth, interest rates as measured by the 24-hour Central Bank Rate are actually still relatively low by historical standards given they are now approaching the levels last seen in mid-2007—which, incidentally, were also rather low by the standards of the 1980s and 1990s. As for inflation, at its peak in mid-2022, it was the highest it had been since the 1980s and has more recently come down to mid-1990s levels. 

Graphic credit: Janice Nelson

The current public debate on inflation is dominated by a number of themes focusing mainly on personal impacts including the burden of higher interest rates on borrowers—particularly mortgage holders as renewals loom, the higher cost of living for consumers, the threat of imminent recession and job loss as interest rates rise despite the ongoing resilience of the Canadian economy, and finally the ”there is a better way to fight inflation other than raising interest rates” argument. This has staked out the proposition that the current rate cycle increase is not working and it is corporate greed that needs to be reined in.  

This latter thread of discussion is the most intriguing because its calls for a “broader toolkit” reflects the largest disconnect between the current experience and history. If one goes back to the 1970s, the initial approach also included “other tools”, namely the wage and price controls of the Anti-Inflation Board (AIB) which operated from 1975 to 1978 that tried to limit pay increases and included an examination of company profits that returned several hundred million dollars to the market place.  

While the AIB appears to have had some success initially in restraining wage and price growth, it proved extremely unpopular with labour as well as corporations and was ultimately abandoned. As the above chart shows, there is a dip in inflation after 1975 but it then begins to rise again—even before the end of the program in 1978—and it is not until monetary policy in the form of higher interest rates kicks in that inflation comes down in the 1980s. Ultimately, it was monetary policy that had to do the heavy lifting. 

Left out of the current debate are other themes: the long-term costs to the economy if inflation is not reined in; the benefits of higher interest rates in the long term to savers and the spillover over to capital formation and even business decision-making; the reality that the whole point of increasing interest rates is to slow the economy down and still the most effective way to bring down inflation based on historical experience; and the continuing disconnect between expansionary fiscal policy and contractionary monetary policy.

The theory behind an interest rate increase is that by increasing the cost of borrowed money, aggregate demand for goods and services will go down bringing about an economic slowdown that will moderate the rate of price increases. That after 10 rate increases the economy remains rather resilient is indeed a testament to the continuing effect of labour shortages and supply chain disruptions in the aftermath of COVID, disruptions from Russia’s invasion of Ukraine increased demand due to population growth, and an ample supply of pandemic savings that have yet to be spent. Despite the steepness of this current cycle of rate increases, it is taking longer than expected to slow the economy down as even unemployment rates remain at historic lows.

Moreover, there is continued federal fiscal stimulus designed to “alleviate” the effect of higher rates which essentially works at cross purposes with monetary policy given the money is going directly to consumers to spend, rather than, say, as investment incentives for things like boosting housing stock. After all, if one wants to use a house fire analogy, the Bank of Canada is bringing in the pumper trucks to douse the flames while the federal government is still throwing on accelerants and fanning the flames. It is odd that in the clamour for different tools to fight inflation, restraining federal spending growth rarely makes it to the top of the list.

Going forward, one should not expect interest rates to return to their pre-pandemic levels as those low rates were a historic anomaly.  In the wake of the 2008-09 Great Recession, they were kept too low for too long and then reinforced by the quantitative easing of the pandemic. There are important reasons for keeping interest rates at more reasonable levels going forward—meaning a Bank of Canada policy rate closer to 4 percent—given the long-term effects on savings, productivity, and investment. 

Higher interest rates have short-and-long term effects. In the short term, they will eventually slow the economy down—perhaps even move it into a brief recessionary period. Indeed, that is the point of monetary policy that raises interest rates to reduce inflation. However, in the long-term, there are beneficial effects to this policy. First, bringing inflation down ends the distortionary effect of higher and less predictable prices on the economy making for better decisions by firms and consumers. Second, higher interest rates will finally end the last decade’s “war on savers” that reduced the return to saving. Anomalous pandemic savings notwithstanding, low interest rates skew preferences from saving to consumption thereby increasing the pool of domestic capital available for investment purposes.

Finally, and perhaps most importantly, the end of cheap money is actually good for business investment from a productivity standpoint in that it forces businesses to invest in projects with higher rates of return. This of course may seem counter-intuitive in that conventional economy theory argues lower interest rates generate more business investment. However, there are two dimensions to business investment: quantity and quality. Low interest rates in the end may allow for less discerning investment decisions as every project that comes along can be funded. Higher rates mean that business investments with a higher rate of return need to be selected given the higher borrowing costs. In the long run, a more reasonable range of interest rates will make for better and more productive business investment decisions that should positively affect long-term per capita GDP growth rates.

While Canadians were adversely affected by the high interest rate episodes of the 1980s and 1990s, they were in the long term rewarded by those monetary policy periods with a nearly thirty-year period of both low inflation and low interest rates. A key issue is that Canadians accustomed to a long period of stable inflation and low interest rates have taken this for granted and built it into their economic expectations. The recent spike in inflation and especially interest rates has been an inconvenient lifestyle surprise. However, interest rates particularly after the Great Recession of 2007-08 remained too low for too long which, when combined with weak supply growth, helped fuel housing prices and exacerbated the housing crisis now underway. An economy based on fiscal stimulus and cheap money is fun while it lasts but does nothing to boost long-term living standards. This is a lesson that appears to be periodically relearned. 

Michael Bonner: Conditions are ripe for a revolution from the Right


Your typical Canadian is not going to compare him or herself to formerly starving children on another continent. This will be the case, no matter how often we are told that the world is generally getting better. The problem is that the usual figures—rising incomes and life expectancies, plummeting infant mortality and poverty—are worldwide averages. People will rather think of their economic situation in relation to those of their parents and grandparents; they will compare their present condition to what it was in previous years. When the average Canadian does this, he or she realises that the cost of housing is exorbitant, the health-care system is slow and inefficient, and wages struggle against an ever-rising cost of living. We are working harder than our parents and getting less.

Such problems are now found everywhere throughout the Western world and will be with us for some time. The political and social tensions that attend them make headlines almost daily in every major democracy. Recent political enervation of Great Britain, the pressure-cooker mood of France, and outright warfare in Ukraine darken an already grim mood. But nowhere are contemporary problems more consequential than in the United States. America has been on the brink before, and it has successfully pulled back, of course. But the case for doom is more convincing now than at any other time in the last 50 years or so, and Peter Turchin is here to explain why.

Turchin’s argument in his new book End Times goes like this. Throughout much of the 20th century, typical American wages grew much faster than inflation. But this stopped in the 1970s, when median wages began, on the whole, to stagnate. Even when they have risen in absolute terms (as they have in some cases), their purchasing power has declined. The price of labour has remained artificially low, partly because of a massive increase in labour market participation from the 1950s onward and partly because of low-skilled immigration in more recent years. The result of all this has been an enormous upward transfer of wealth away from the middle and working classes to the ultra-rich. But it gets worse. In 1976, the average cost of studying at a public university was $617 annually; in 2016 it was $8,804 and has gone up since then. So a typical person earning the median 1976 wage would need 150 work hours to pay for a year of university, but now you would need 500 work hours. Similarly, a median-wage worker must now work about 40 percent longer in order to afford a typical house.

The non-economic state of affairs is no better. Turchin notes that height is a good proxy for overall well-being. If an archaeologist found that skeletons in successive layers of a digging site were progressively taller, he or she could safely infer improving living conditions, better diet, and relative stability. In America, heights reached a peak in the 1960s and have been declining. In other rich democracies, though, they have continued to rise. Similarly, American life expectancy began to fall in the 2010s, and the Covid-19 pandemic has accelerated this downward trend.

Amidst all this “popular immiseration”, Turchin notes a huge enlargement of the American elite, or “elite overproduction”, as he calls it. This can be measured by the number of people with higher degrees, as well as the growth in the top 10 percent of incomes—a state of affairs exacerbated by diminishing median wages, growing labour-force participation, and a growing economy. In other words, elite classes get richer and their numbers grow as more and more people try to leave the middle classes and join them. The problem is that the number of high-status positions within government and elite professions has hardly changed. There are too many elites, or aspiring elites, and not enough for them to do.

Past experience suggests that elite overproduction is extremely dangerous. Turchin reminds us of the revolutionary tendencies, not of the immiserated poor as popularly imagined, but of disaffected elites. Think of the disgruntled lawyers of 18th-century France, or the Taiping Rebellion in China (1850–1864) which was a gigantic uprising against the reigning Qing led by a group of malcontents who had repeatedly failed the civil service examination. But Turchin rehearses many other examples. The revolution is not yet upon us, he notes, but intra-elite competition over a small number of high-status positions is becoming ever more aggressive and acrimonious. One of the main weapons in this war is so-called cancel culture, by means of which rivals can be publicly shamed and disqualified from employment. This technique used to be confined to politics where many candidates compete for a single position: revealing gaffes, faux pas, or other real or imaginary failures was the easiest way to get ahead. Now the technique has spread to the higher professions. Similarly, the proliferation of diversity and inclusion bureaucracies and compliance officers, and so on, can be understood as an effort to create new high-status positions for the elite. But I would not call it especially successful so far.

Turchin’s observations carry some important implications. American elites have screwed up badly, and earned the disapproval they now face. But, more generally, they have failed to maintain any sort of connection with, or basic respect for, the great mass of Americans. Elite contempt in this connection is embodied in Obama’s dismissal of the immiserated working class of the Rust Belt who “cling to guns and religion”; in Mitt Romney’s ignoring the “47 percent of the people” who are “dependent on government” and who “believe they are victims”; and in Hillary Clinton’s “basket of deplorable” comment. Those are only the three most prominent expressions of elite contempt for proles who failed to find a new place within a globalised economy. But there are other examples in the form of right-wing attacks on blue-collar unions, corporate America’s embrace of identity politics, and advertising campaigns that seem to denigrate or mock the values of ordinary people.

This is how Turchin sums up the problem:

The American ruling class today finds itself in the predicament that has occurred thousands of times throughout human history. Many common Americans have withdrawn their support from the governing elites. They’ve flipped up “a throbbing middle finger in the face of America’s ruling class.” Large swaths of degree holders, frustrated in their quest for elite positions, are a breeding ground for counter-elites, who dream of overthrowing the existing regime. Most wealth holders are unwilling to sacrifice any personal advantage for the sake of preserving the status quo. The technical term for it is “revolutionary situation.” For the ruling class, there are two routes out of a revolutionary situation. One leads to overthrow. The alternative is to adopt a series of reforms that will rebalance the social system, reversing the trends of popular immiseration and elite overproduction.

Turchin’s idea of a counter-elite is an interesting one. The archetype would be the likes of Julius Caesar or Robespierre—successful revolutionaries who degraded and overthrew a moribund patrician order. In our own time, we have the example of Donald Trump who embodied the “throbbing middle finger in the face of America’s ruling class,” in Turchin’s quotation. Incidentally, that phrase is from Tucker Carlson’s 2018 book Ship of Fools which is essentially an exposition of all the elite failures that provoked the election of Donald Trump. As far as Turchin is concerned, Carlson is “a very dangerous man”. Though the Trump Administration failed, the counter-elite insurgency has many adherents and will continue under the leadership of Tucker Carlson and his ilk. Turchin’s book went to print before Rupert Murdoch fired Carlson from Fox News, but Carlson’s new Twitter platform, which is more popular than ever, suggests that Turchin’s analysis is right. If Trump returns to the White House, or if another president carries on his legacy and successfully deposes the American elite, Carlson’s influence will be one of the main reasons why.

Back to the Trump Administration. One of Trump’s main advisers, Steve Bannon, was a self-described Leninist. “Lenin wanted to destroy the state and that’s my goal too”, Bannon famously said. “I want to bring everything crashing down and destroy all of today’s establishment.” Bannon and his followers (and he still has some) do not belong to the Republican tradition of Reagan and the two Bushes. They are revolutionaries. In one very obvious way, this should not be surprising. America’s founding myth surrounds an actual revolution; the populist, fiscally-conservative movement known as the Tea Party founded in 2009 was notionally animated by the revolutionary spirit of 1776. But something different is brewing now.

Enter Patrick Deneen’s new book Regime Change. It is ostensibly a sequel to his 2018 work Why Liberalism Failed, which reiterated many long-standing criticisms of liberalism, but without political recommendations. Regime Change notices much of the same popular immiseration presented by Turchin and lays the blame on…liberalism. I am of two minds about this blame. On the one hand, it seems obvious that liberalism was destined to loosen or dissolve ties to places and persons since that is what John Stuart Mill and his ilk intended it to do. And everyone from de Maistre onward has been complaining about this tendency. Because of its power to dissolve bonds between individuals, liberalism also contains the seeds of tyranny.

This idea was most famously asserted by Alexis de Tocqueville and has been explored by others since the early 19th century. Deneen reminds us that J. S. Mill actually embraced this idea of a liberal despotism, in that he saw the greater part of the populace as inherently conservative and resistant to individual autonomy which a dictatorial elite would have to impose. Contemporary liberals seem to have forgotten this: they will scoff at Deneen’s reiteration of the same analysis, though they would benefit most from taking it seriously.

On the other hand, I wonder whether American social decline rather invited heavier emphasis on the atomising tendency of liberalism. This is a problem worth pondering because the social decline now seen in the liberal West is also found in such obviously non-liberal places as Russia and China. So the real culprit may be modernity itself, or the sort of rapid technological progress that liberalism is unable to control or temper.

However that may be, both Turchin and Deneen seem to agree with the new American revolutionaries that the American elite is bloated, parasitical, and incompetent. And the insurgents are unanimous in attacking the elite’s ever more deranged emphasis on personal autonomy, total economic freedom, supremacy of market forces, and the doctrine of a borderless, globalised world as a set of self-serving and harmful ideas.

But, unlike Bannonism-Leninism, Deneen’s vision of deposing the American elite rests on a broad philosophical basis. Regime Change revives the Aristotelian political analysis of the Many and the Few, and urges the balancing of antithetical class interests within a “mixed constitution”. The political recommendations all boil down to replacing a self-serving and ham-fisted elite with a new one that shares the virtues of the middle and working classes: love of stability, attachment to family and religion, localism, patriotism, and so forth. In Deneen’s view, this would mean “the raw assertion of political power by a new generation of political actors inspired by an ethos of common-good conservatism”. Elites will bristle at that phrase, but for no good reason. Something like Deneen’s vision has happened before in America when the Gilded Age of the robber barons gave way to the New Deal, and many elites sank into oblivion and a new middle class arose—a transformation which Peter Turchin also notices as one possible way out of the present mess.

But that is an unusually peaceful example. More typical in human history would be either outright civil war in which one group of elites kills off another, or mass executions and exiles such as those at the end of the Roman Republic, the Glorious Revolution in England, or the French revolutionary Terror. Deneen fears and condemns violence, but Turchin reminds us that civil war is a real possibility.

Despite historical precedent, I am inclined to believe that, in the present age of intellectual paralysis and exhaustion, civil war is probably not going to happen. Moreover, the present non-aristocratic elite, unattached to any particular place, deriving power from the manipulation of narratives and abstract ideas, would be very hard to pin down and destroy. But they may very well be done in, not by a new political alliance, but by the very market forces and long-term trends in which they once placed so much confidence.

I am thinking here of rising interest rates, reindustrialisation, and demographics. The rising cost of money should mean that investment in start-up jobs and hyper-financialisation, on which the elite have thriven, cannot be long for this world. Recent layoffs in the media and in tech appear to support this prediction. As America and the West re-jig supply chains away from China, off-shoring will mutate into “friend-shoring”, and money will flow into enlarging the American industrial plant. This will add to discontent, as technocratic elites grow less relevant, and gradually sink back into the middle classes. The demand for blue-collar skills will grow, and those jobs will become increasingly lucrative. Meanwhile, the cohort of the more rooted, more religious people favoured by Deneen will grow, since they tend to reproduce more abundantly than other groups. Meanwhile, the Baby Boomers—the largest generation ever, and over-represented in the American elite—will die out, making room for their children and grandchildren.

If I am right, the elite will shrink inevitably, though it may be hard going as that happens. The worst fears of Turchin and Deneen may not come to pass; but there will be radical change, whether we like it or not. But if there is one thing we should take from these books it is that the defenders of left-liberalism stand only for the status quo. They have become, in effect, conservative. The new revolutionaries are coming from the Right.