What’s really causing inflation?
by Alvaro Vargas Llosa · The Washington TimesOPINION:
Whenever inflation figures are released, politicians and news commentators are quick to blame rising prices on “capitalist greed” and the free market, both of which supposedly enable it.
Yet they are blaming the wrong culprits. The real guilty parties, more often than not, are the central banks.
When the Federal Reserve, European Central Bank, Bank of England and other central banks let their printing presses go crazy — that is, increase the amount of currency in circulation significantly beyond their economies’ rate of growth — the value of each unit of currency declines and prices seemingly rise.
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It is Economics 101.
If you look at what has happened with the European Central Bank, it is not difficult to understand why inflation is persistent in the Old World. Over the past 20 years, the consolidated balance sheet of the Eurosystem — European Central Bank and national central banks — has grown fivefold: from 1.2 trillion euros in 2006 to approximately 6.3 trillion euros today.
More simply put, this means that the amount of money added to the system has increased by more than 8% per year on average, dwarfing the Eurozone’s roughly 1.2% per year inflation-adjusted economic growth rate.
The Bank of England balance sheet has ballooned tenfold: from 80 billion pounds to approximately 809 billion pounds. This means — again, simplifying matters — that it has been growing the amount of artificial money at an average rate of 12.2% a year.
How much real annual growth has the British economy had on average in those years? Barely 1.3%.
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The balance sheet of the U.S. Federal Reserve has skyrocketed over the past 20 years, from $860 billion to $6.74 trillion — a 693% increase, or about 11% per year. Compare this figure with the U.S. economy’s roughly 2% annual, inflation-adjusted, growth rate during the same period.
Forget whether you think that the crises that triggered the worst periods of monetary expansion — the 2008 financial meltdown, the COVID-19 pandemic, the wars in Ukraine and the Middle East — left policymakers with no other choice at the time. What we must understand is the connection between monetary policy and inflation.
Although wars — including and perhaps especially trade wars — droughts, pandemics and other world events can certainly precipitate price increases and often do, monetary policy plays a greater role over time.
Just as promiscuous money printing can fuel inflation, a disciplined monetary policy can stanch it.
In the U.S., when Paul Volcker, who had been brought in to tame the high inflation of the 1970s, left his position as chairman of the Federal Reserve, he could boast that the Fed’s balance sheet had been growing annually at a much slower pace than the economy: 2.3% versus roughly 3%.
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It was Alan Greenspan — ironically, a former free-market libertarian and acolyte of Ayn Rand — who changed everything when he took over from Volcker in August 1987. During his tenure, from 1987 to 2006, the Federal Reserve’s balance sheet grew from $240 billion to $842 billion, an increase of more than $600 billion.
Greenspan’s successors continued the trend. Under Ben S. Bernanke, Fed chair from 2006 to 2014, the balance sheet surged by $3.25 trillion. Under Janet Yellen, chair from 2014 to 2018, and Jerome Powell, chair from 2018 to 2026, it rose even further, peaking at nearly $9 trillion in 2022 before declining to $6.7 trillion today.
The result is clear. The recently released August CPI-U, the Bureau of Labor Statistics’ most widely cited inflation measure, indicated that the year-over-year U.S. inflation rate stood at 3.4%, more than 50% above the Fed’s target.
Eurostat, the statistical office of the European Union, estimates an annualized inflation rate of 3.2%, and Britain reports an annual inflation rate of 3.1%.
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Whatever current events are preventing inflation from going down around the world today, it is crucial to bear in mind that the fundamental cause of higher prices is not capitalism, free markets, free enterprise, global trade, greedy corporations or even what economist John Maynard Keynes called “animal spirits.”
The cause of higher prices is the superstitious belief that creating money out of thin air is the same as creating wealth. Creating money in the absence of economic growth makes most of us poorer.
• Alvaro Vargas Llosa is a senior fellow of the Independent Institute in Oakland, California. His latest book is “Global Crossings: Immigration, Civilization and America.”