Aurelia Butler

The return of inflation is not just an important economic event. It is also a political one. As it becomes decreasingly plausible that it will simply fade painlessly away, tough decisions must be made on how to react to it.This raises big issues. How did we get here? How large and durable a slowdown will be needed to bring inflation back under control? Is policy tight enough already? If not, what further steps might need to be taken? Not least, should inflation be brought down to previous targets or should policymakers give up and raise their targets instead?The latest Annual Report of the Bank for International Settlements provides an excellent analysis of what is happening. More important, it illuminates the dangers in shifting away from the regime of low inflation of the past 40 years.By April 2022, notes the BIS, “three quarters of economies were experiencing inflation above 5 per cent. Inflation was back, not as a long-sought friend, but as a threatening foe.” Indeed, inflation is by now both high and widely spread across countries and sectors. This was at first unexpected and then dismissed as transitory. Neither view has worn well. Inflation is also economically and politically salient. Quite simply, people care about it. Not least, unexpected inflation also means unexpected cuts in real incomes. Unsurprisingly, this is highly unpopular.

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The danger now is that of stagflation, defined as a prolonged episode of weak growth plus variable and persistent inflation. To help us understand the nature of this challenge better, the BIS explains the differences between a regime of low inflation and one of high inflation. It does so by looking “under the hood” at how inflation regimes actually work. Crucially, it turns out, inflation behaves differently in these two regimes.When inflation is durably low, for example, its volatility also falls, as does its persistence: it is self-equilibrating. This is partly because people expect it to stabilise and also because most of the time they just ignore it. The low volatility of inflation is not because of low volatility of individual prices, but of low correlation across them. Relative price changes, even big ones, then have little impact on the general price level.A regime of high inflation is the opposite. Big shifts in relative prices — large currency depreciation, for example — spread swiftly across the economy, as people struggle to protect themselves against the shocks to real incomes. The mechanism behind this spread is price-price and wage-price spirals. Moreover, the greater the worry, the more pre-emptive efforts become. Expectations are crucial. When people cease to know what to expect, they become even more urgently defensive.Explaining away what is happening as due to “exogenous” supply shocks is a big error. What is exogenous to any one economy is often endogenous to all of them. Thus, rapidly expanding demand in a number of significant economies will create a surge in global demand. Third, excess demand will always show up first where prices are flexible, notably in commodities, before spreading.Crucially, we are now on the cusp of a shift from a low to a high inflation regime. Why has this peril arrived? One explanation was overconfidence in the permanence of low inflation. Another was backward-looking targets of average inflation and overconfidence in the ability to provide forward guidance. Another was ignoring money when, yet again, it mattered. Yet another was overconfidence in supply capacity. Of course, there were also shocks, such as the war.The more entrenched such a shift in regimes becomes, the greater the costs of reversing it. At worst, it might take a sharp recession or a prolonged slowdown. So far, policymakers have not made this clear. This is also why they are rather likely to give in before they have achieved their goal. It is also why a prolonged stagflation is now quite likely.An important question then is whether policymakers have done enough to bring inflation down to their targets. The main argument that they have is that financial conditions have tightened sharply already. That is closely related to the rise in financial fragility since the stagflationary episode of the 1970s. At the same time, ratios of broad money to nominal gross domestic product are still at unprecedented levels, while real policy rates remain negative. It is quite possible that policy will have to tighten a great deal further in the months ahead.Confronted with the need for deeper slowdowns or tighter policy, central banks might flinch. Politicians certainly will. A possible outcome is a stagflationary cycle, as central banks oscillate between doing too little, reversing, then doing too little again. Another is that many policymakers agree that 2 per cent inflation is too strict. Why not go for 4 per cent or more instead? This would have the benefit of giving central banks more room for downward manoeuvre in interest rates in future, so reducing the need for quantitative easing in subsequent downturns.

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The argument is appealing, not least politically, but there are strong objections. Giving up when the going gets tough tells people that policymakers will always give up whenever it gets tough. Furthermore, there is the alternative of using negative policy rates instead. Above all, at, say, 4 per cent inflation will be all too evident all the time. In such an inflation-sensitive environment, people will not only find it far harder to separate relative from general price changes, but will just be waiting for the policymakers to deceive them once again.Money is an essential public good. Sound money underpins political and economic stability: it must not be thrown [email protected] Martin Wolf with myFT and on Twitter More

LONDON (Reuters) – Ex-finance minister Rishi Sunak, the favourite to become Britain’s next prime minister, kicked off his campaign on Tuesday promising “honesty”, in a increasingly testy and divisive battle to succeed Boris Johnson.An initial 11 candidates put their names forward to become leader of the governing Conservative Party and Britain’s next premier after Johnson was forced to say he would step down when support drained from him over a series of scandals.Only those who get nominations from 20 of their 358 Conservative colleagues in parliament on Tuesday will go forward to the first vote on Wednesday. The field will be then be quickly whittled down a final two, with Conservative Party members making the final decision. Transport minister Grant Shapps became the first to end his bid, throwing his support behind Sunak, whose resignation helped provoke the revolt by ministers and Conservative lawmakers that forced Johnson to say he would resign last week.The new leader faces a busy in-tray as well as falling opinion poll support.Britain’s economy is facing rocketing inflation, high debt, and low growth, with people coping with the tightest squeeze on their finances in decades, all set against a backdrop of an energy crunch exacerbated by the war in Ukraine which has sent fuel prices soaring. As the contest heated up, rival campaigns stepped up private criticism of each other and pointed to either financial or other questions hanging over their opponents.With most candidates saying they would cut taxes if they win, Sunak, the current bookmakers’ favourite, has sought to portray himself as the serious candidate, promising “grown up” honesty “not fairy tales”.”It is not credible to promise lots more spending and lower taxes,” said Sunak, As finance minister, Sunak set Britain on course to have its biggest tax burden since the 1950s, and the other prime ministerial hopefuls have turned their fire on him on tax, with most saying they would oversee cuts immediately. Sunak said he did not want to distance himself from the fiscal decisions he made during the COVID-19 pandemic.”Whilst that may be politically inconvenient for me, it is also the truth. As is the fact that once we’ve gripped inflation, I will get the tax burden down,” he said. “It is a question of when, not if.”‘SOUND MONEY’The former finance minister has the widest support among colleagues who have publicly expressed their view, including the backing of Deputy Prime Minister Dominic Raab.”I know that Rishi has got what it takes,” Raab said, introducing Sunak at his campaign launch event. Penny Mordaunt, a junior trade minister who is also heavily tipped, topped a poll of Conservative members on Monday and she too has tried to strike a more measured tone on tax, saying that while she would cut taxes: “I will pioneer sound money.””I am a small state, low tax conservative, but I also believe we need to use the levers of government to support jobs and livelihoods through difficult economic situations,” she wrote in the Daily Telegraph newspaper.Among the others to launch their campaigns on Tuesday were Tom Tugendhat, the chair of the foreign affairs committee, and Kemi Badenoch, a former junior minister who is scooping up some support on the right wing of the party.Foreign Secretary Liz Truss was also hoping to challenge those at the top of the leader board and received the backing on Tuesday of two ministers closest to Johnson – Nadine Dorries and Jacob Rees-Mogg – who have both been critical of Sunak.On Monday, the 1922 Committee of Conservative members of parliament agreed the rules for the contest, saying the field will soon be whittled down with repeated votes in the next few weeks and the final two being presented to the party by July 21.It said the winner, and Britain’s new prime minister, would be announced on Sept. 5.The main opposition Labour Party will put forward a motion of no confidence in the government on Tuesday to try to force Johnson out of office straightaway. The vote will be held on Wednesday and although some Conservatives have voiced concern at Johnson remaining as prime minister, they are very unlikely to support it.The new leader will have to reverse evaporating support. A survey by Savanta ComRes on Monday put Labour at 43% compared with 28% for the Conservatives, its biggest poll lead since 2013. (This story corrects typo in headline) More

Russia’s parliamentary session ended last week without the bill being passed. That makes any progress unlikely until at least mid-September, when the lower house of parliament, or Duma, begins reviewing proposed laws in its autumn session.Some experts now doubt whether the proposed law will be implemented at all.”The fact that it only passed the first reading and got stuck means there is no consensus in the government about its further fate,” said Tatiana Stanovaya, founder of political analysis firm R.Politik. The delay may ease concerns that Moscow is taking a more aggressive approach to remaining Western firms, heightened by President Vladimir Putin’s decision last month to seize full control of the Sakhalin-2 gas and oil project by decree.It is unclear whether Putin could issue a broader decree to seize assets from other industries. Russia already closely monitors companies that leave, whether abruptly or smoothly, to ensure their obligations to employees were met in line with Russian law, Kremlin spokesperson Dmitry Peskov said on Tuesday.”The government is keeping very tight control over this, so one can say that work is well established there,” Peskov told reporters on Tuesday, adding that questions on the law’s progress would be better addressed to the Duma.The ruling United Russia party, whose lawmakers tabled the draft bill, did not immediately respond to an emailed request for comment.The proposed law would allow Russia to intervene to protect local jobs or industry, letting it appoint administrators to foreign-owned companies that want to quit Russia.It won initial parliamentary approval in May, with backing from First Deputy Prime Minister Andrei Belousov, who had warned against allowing companies to “leave, lock the door and leave people without work and consumers without products.”While the draft has now been put on ice, the parliament can reconvene in emergencies and will gather on Friday for an extraordinary session to discuss a raft of issues, including some on competition and information policy. The Duma has not said which specific laws it will discuss on Friday. The Kremlin on Tuesday declined to comment on the upcoming session. Russia launched what it calls its “special military operation” in Ukraine on Feb. 24. The United States and its allies responded with the most severe sanctions in modern history on Russia and Moscow’s business elite, steps Putin has cast as a declaration of economic war. Putin has repeatedly warned that Moscow would respond in kind, but so far, Western businesses that continue to operate in Russia say they have seen little interference.”In the beginning there was very hawkish rhetoric on nationalisation, expropriation, to counter the scope of Western sanctions … but then it faded,” said Maria Shagina, research fellow at the IISS think tank. Companies have been wrestling with how to leave Russia in ways that limit the financial impact, do not put employees at risk and, in some cases, offer the opportunity to return in future.Western companies, including Nike (NYSE:NKE) and Cisco (NASDAQ:CSCO), accelerated their departures in recent weeks amid speculation that the new laws were imminent. The delay gives those remaining time to assess options. More

MADRID (Reuters) -Spain will hit power companies and banks with temporary taxes that should rake in 7 billion euros ($7.02 billion) in 2023-2024 to help Spaniards cope with soaring inflation, the government said on Tuesday, triggering a selloff in some banking shares.Sabadell fell as much as 12%, while Bankinter, and Caixabank were down around 10% following the announcement, dragging down the Spanish IBEX 35 bluechip indexPrime Minister Pedro Sanchez told parliament in a state of the nation speech that annual revenue in 2023 and 2024 from a tax on extraordinary profits of power utilities made this year and next should reach 2 billion euros, while the surprise tax on financial institutions would bring in 1.5 billion euros a year.Sanchez said the government would impose the tax on “big banks as they were already starting to benefit from (expected) interest rate rises”.But analysts said banks were already under pressure from recession fears and the possibility that any rate hikes might not be as significant as expected.”The impact on Spanish banks has been immediate because this measure was not expected and it has come as a cold shower,” said Nuria Alvarez, an analyst at Madrid-based brokerage Renta 4.The levy would put further pressure on lenders’ ability to generate profits at a time when their provisions are also likely to rise, she said, adding that banks with largely domestic operations were more affected than those with more diversified businesses such as BBVA (BME:BBVA) or Santander (BME:SAN), which were down around 5%.Shares in utilities Iberdrola (OTC:IBDRY) and Naturgy were down between 0.4% and 0.7%. The government had already said it was going to tax power firms.Sanchez said inflation, caused to a large extent by Russia’s invasion of Ukraine, was the biggest challenge for Spain, likening it to “a serious illness of our economy that impoverishes everyone, especially the most vulnerable groups”.Sanchez also announced 100 euros a month in complementary scholarships for students older than 16 years who already receive scholarships, and free multiple-trip tickets for suburban and medium-distance trains between September and end- December.He also gave the green light to a major real state development plan which plans to build 12,000 housing units in Madrid.($1 = 0.9971 euros) More