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Liz Truss. Or: how not to pay for the war

Summary:
The Dutch September HICP inflation rate was 17,1%. One year ago it was 3,0%. Below, I will argue that this is a sign of kind of war economy, not of a cyclically overheated economy. Ways to mitigate inflation were pioneered by the English economist John Maynard Keynes in his ‘How to pay for the war‘. it’s useful to go back to his ideas. The first version was published in three parts in The Times of november 1939. It was partly based on his experiences in World War I and partly on the new system of national accounting (extended and improved by Keynes). The ideas weere based upon the idea of a monetary economy where consumer spending and consumer prices, production and producer prices and the use of factors of production and factor prices (wages, profits, interests, rents) are

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The Dutch September HICP inflation rate was 17,1%. One year ago it was 3,0%. Below, I will argue that this is a sign of kind of war economy, not of a cyclically overheated economy. Ways to mitigate inflation were pioneered by the English economist John Maynard Keynes in his ‘How to pay for the war‘. it’s useful to go back to his ideas.

The first version was published in three parts in The Times of november 1939. It was partly based on his experiences in World War I and partly on the new system of national accounting (extended and improved by Keynes). The ideas weere based upon the idea of a monetary economy where consumer spending and consumer prices, production and producer prices and the use of factors of production and factor prices (wages, profits, interests, rents) are intertwined. During a war, this system could lead to consumer and producer price inflation resulting in war time profits on one side and poverty on the other. He proposed changes to the system which would mitigate producer and consumer price inflation as well as war time profits. Fun fact: it’s about the opposite of the Liz Truss UK budget. The central idea of Keynes: we have to understand inflation not just as an increase of consumer prices but as interconnected changes in consumer, producer and factor prices, financed by income as well as borrowing/(forced) saving. Especially during a war, the connections will change in unwanted ways, policies to mitigate this can be enacted as long as we understand inflation as a system of interconnected expenditure, output and factor prices. Fun fact: Keynes acknowledges ‘Prof von Hayek’ for the idea of a post war levy on capital.

is it, at the moment,worthwhile to use such ideas to analyze the present situation? The first question to be answered is: ‘are we, as Isabella Kaminska suggests, in a war economy‘? Answering this requires a definition of ‘war economy’.

Googling for definitions leads us to Investopedia. Key words: rationing, defense spending, (higher) taxes, ensuring vital domestic consumer demands (rationing, production), government intervention (sometimes quite extensive), rapid technological progress. To this may be added the ideas of Keynes, who did not only look at consumer and product prices but also to factor prices (wages, profits, interest rates, rents). I would like to add: disruption of supply chains, changes in exchange rates, export and import controls and attempts at reshoring. A characteristic of war economies: large increases of some product prices (energy, food) coupled with (the other side of the transactions) our of control increases of profits, but not of wages. On the price policy side: interest rates and rents might be kept flat. Aside: my Ph.D. (and some subsequent publications) covered the first and second world war.

When we look at the present situation (the war in Europe, the fully predicted emanation of the climate disaster, the Covid pandemic plus the related policy reactions) we do see, in my opinion, a kind of war economy. Mutually reinforcing disruptions to energy and food supply chains caused by climate change and a major war (sometimes up to 1,000 casualties a day, if I read the signs right) contribute to high energy and food prices. The pandemic led, partly because of lock downs and other policy measures but also, as is beyond doubt by now, also because of long Covid, to additional disruptions of supply chains. Aside from supply chain problems, droughts and floods contributed to food price increases: Pakistan, Europe, USA, East Africa. Military spending of NATO countries has been increased by a lot, governments are forced to enact policies to sustain household incomes. The energy sector, but also some sectors of agriculture post record incomes and profits (while horticulture, which uses a lot of energy, is going bankrupt). There ‘western’ labor market is (at the moment of writing, but we may already have seen the peak) at its tightest for about fifty years – but wages are still not increasing too fast. It all sounds a ‘war economy’. Central Banks try to increase interest rates but the Bank of England has already experienced some problems with this policy. Energy prices are capped, governments are forced to interefere with production (for instance by not closing nuclear reactors). I can go on, the situation checks quite some war economy boxes.

But the point: we need coherent policies instead of ad hoc solutions. A kind of ‘How to pay for the war and the climate disaster as well as the pandemic while at the same time sustaining household purchasing power and admitting that inflation is more than just an increase of consume prices and can better be understood as the interconnected changes of a number of price levels inside one economy, changes and connections which are highly dependent on government policy‘ policies. We’ll have to speed up the New Green Deals, invest much more in medical and energy technology, cap house rents and central bank interest rates, admit that global agriculture is, at the moment, not a ‘degrowth’ but a ‘growth’ sector, make sure that (international) supply chains work as best as we can manage, introduce war profit taxes (including, life happens fast, taxes on large scale solar) and put more people in one house. Key to this is however to understand inflation not just as an arithmetical change in consumer prices but as sometimes idiosyncratic changes in the system of interrelated expenditure, factor and producer prices. Putting caps on some prices (rents, interest rates) can mitigate the amount of idiosyncrasy as well as contribute to less disruptive random shocks to household incomes. I’m not a fan of ultra low/negative interest rates. But at this moment, forced increases are unwise. Just like massive tax breaks for a very limited number of extremely rich people. Which reminds me of the main motive of Keynes to write the treatise: social justice which, according to him, was inherent to a free society.

Merijn T. Knibbe
Economic historian, statistician, outdoor guide (coastal mudflats), father, teacher, blogger. Likes De Kift and El Greco. Favorite epoch 1890-1930.

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