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And as we are all aware, the global economy and individual countries are experiencing a rise in inflation that we haven't really seen since the 1970s. And the question is, is this a transient episode or is it a return to the dynamics that drove inflation in the 1970s into the 1990s?

My view is that this is a transitory episode and that doesn't necessarily mean that it's short run. It just means that there's no additional propagating mechanisms that are present to drive the initial supply shock, which has generated the inflation into a more structural, long lived episode.

Now, what I mean by that is that we we clearly have a range of supply constraints that emerge during the pandemic because workers were sick. Factories were closing. Shipping was severely disrupted. Local transport systems were disrupted by sickness, which created a shortage of in the supply of goods. Now, at the same time, especially in 2020 and 2021, services supply was effectively artificially closed down by government restrictions.

And so we weren't going out to cafes or or theatres or sporting events or whatever. Also, at the same time, we were saving money, not going into the service sector, and our incomes were in the main being somewhat protected and with some glaring deficiencies by government policy. And so what happened was that we started to divert our spending into goods rather than away from services. Of course, a lot of us were confined to our homes through lockdown arrangements. And so a lot of home renovation went on in that period. So there was a strong demand for goods and weak demand for services artificially constrained.

And the service and the goods sector on the supply side couldn't keep couldn't supply because of the factory closures and the transport disruptions. And so we started to see some price pressures emerging there. No doubt about it.

Now, is that a demand side phenomenon or is it a supply side phenomenon? Well, it's really a supply side phenomenon because if you advocated bringing spending back into line with the diminished supply, then we would have had massive recessions as well as the pandemic to deal with. And so that wouldn't have been very smart. Now, on top of that, of course, with from the beginning of last year, we had the Ukrainian situation that is further disrupted food supplies.

And on top of that, we've had the OPEC cartel taking advantage of those situations, constraining supply of oil production and pushing up the price of energy, which filters into transport costs, which filter into final goods and services like food and supermarket costs.

Now they're not demand side factors, they're supply side factors. And the question then is will how permanent and will most of those factors are not going to be permanent.

And that's why I say it's a transitory episode.

Now, the point about propagating mechanisms is that in the 1970s there was an oil shock which pushed up the price of oil. And at that time, trade unions were much more powerful. And corporations obviously had market power to set prices. And so the the proper guiding mechanism to drive the inflation on in the 1970s after the initial supply shock was the distributional struggle between unions and corporations.

As to who was going to take the real income loss from the imported higher imported prices of oil. And because they both had market power, the workers couldn't resist the real wage cuts and the corporations could pass on the wage rises from this struggle, and that drove the inflation further.

Now we don't have those dynamics anymore. There is no wage price propagating spiral in this current episode. And so as factories reopen and transport routes sort of rises themselves out. And there's also been other temporary factors like floods in China, Australian bushfires and things like that, as those things get sorted out, you'll see inflation dropping relatively quickly and we're already seeing that around the world. That it's peaked and it's on its way down.

Now the question then is what are central banks doing?

Because they're pushing up interest rates, which has the logic that they want interest rates to rise, to stifle spending capacity. That spending capacity will bring demand back in into some closer balance with the supply side, allegedly. That why you get an old fashioned austerity type discipline on the inflation process. Now that works through creating unemployment, creating business failures, and eventually it gets to a stage where there's no further wage demands and businesses are not in a position to push their margins out further and the inflationary pressures stop. Now, the cost of that type of strategy is very large because it relies on unemployment rate rising significantly. But it's also the logic is about there's got to be a wage price spiral.

And if there's no wage price for war, then there's no wage pressures coming from from the labor market. Now, that's what we see today. And moreover, what we're observing is a massive redistribution of income from poor to rich.

Now, because what the central banks are doing is causing hardship for low income mortgage holders. The interest rate rises, giving massive rewards to bank shareholders who are typically not in the low income category. The central banks haven't got coherent research on what the net effect of the distributional effects of interest rate rises are. The damage done to borrowers is a reward to the lenders, and that is they don't know what that net effect is. And moreover, any business who has a working capital overdraft, which is most particularly medium and large businesses, well their unit costs are going up.

And if they've got market setting, pricing power, they're going to pass those unit cost rises on in the form of higher prices, which means effectively that the interest rate rises are inflationary, not deflationary.

Now, we don't know the full extent of that, but that's probably happening. And there's good evidence that last week in Australia they the evidence was that wages and unit costs in real terms are not rising, but profits are. There's real evidence to support the thesis that this inflationary pressures as supply side constraints abate. The inflation is being driven by profit gouging. Central banks are increasing interest rates and looking to deal with that problem.

So the last thing I want to say is, well, what would be a better solution? And think about Japan. The Bank of Japan formed the view at the start of this episode last year that the inflationary pressures were transitory and would sort themselves out in time. And so they resisted any pressure to put interest rates up. And meanwhile, the Japanese government,

who is in charge of fiscal policy, took short term measures to ease the cost of living pressure for households with some cash transfers and also gave businesses in financial incentives not to pass on imported cost pressures in the form of local price rises. And so their inflation is falling. It's relatively lower than other countries, and they haven't put up interest rates at all.

The best method is the fact that you provide some fiscal support to low income families to get them through the cost of living squeeze. You put pressure on business firms not to profit gouge and you wait the inflation to end.

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