The inflation conundrum

The inflation conundrum

Photo from Etienne Martin from Unsplash

Thomas Sablowski
Exploring Economics, 2023
Niveau: débutant
Perspectives: Économie politique marxiste, Autre, Économie post-keynésienne
Sujet: Crises, Critique du capitalisme, Institutions, gouvernements & politiques, Macroéconomie, Monnaie & dette
Format: Essay

This text has first been published on the website of the Rosa Luxemburg Foundation Germany.Rosa-Luxemburg-Stiftung: zur Startseite

The inflation conundrum

A critical discussion of the causes behind the current inflation is still at its beginning

Thomas Sablowski |

Mainstream inflation theories in economics do little to explain the recent acceleration in price increases. The associated economic policy recommendations further increase the misery of low-income groups.

Have central banks printed too much money?

One of the most widespread ideas is that central banks have "printed too much money." This notion is problematic in several ways. Cash in the form of printed banknotes makes up only a small part of the total amount of money; most of the money exists only as fiat money, i.e., it is created today at the click of a mouse and booked to accounts. But this is not the crucial factor for the question of inflation. At the core of the above notion is the assumption that the money supply determines the price level.

If the money supply rises, then the price level rises and so does the inflation rate - this idea is part of the predominant "neoclassical" approach to economic theory and is referred to as the "quantity theory of money". According to this theory, the product of the money supply and the velocity of money in circulation is equal to the product of the price level and the quantity of traded goods. The money supply is considered the independent variable and the price level the dependent variable. Inflation would then simply result from an excessive inflation of the money supply. This theory was advocated in different variants, for example, by the "Austrian school" of national economics and by "monetarists" such as Milton Friedman. The central bank is ascribed the task of avoiding inflation by controlling the money supply. However, the quantity theory is neither tenable in theoretical terms nor empirically sound.

First, the assumption that the entire existing money supply is used as a means of circulation, i.e. as a means of purchasing goods, is problematic. Part of the money does not increase the demand for goods because it remains within the financial sector, because it is withdrawn from circulation and saved. So, at most, the prices of goods could be affected by that part of the money supply that is actually used to buy them. But here, too, the question of the relationship between cause and effect arises: does the money supply determine the price level, or does the price level determine the money supply? After all, except in auctions and similar price negotiations, the price of goods is usually fixed before they are sold. Prices are set by the sellers, the firms.

It is more plausible that the quantity of money used as a means of circulation adjusts to the sum of commodity prices than that, conversely, the quantity of money determines commodity prices. There is also little empirical evidence in favor of the quantity theory and the explanation of inflation based on it. In the entire cycle between the global financial crisis of 2008-2009 and the Corona crisis, for example, the money supply grew very strongly in the U.S. and the euro area, but inflation rates remained at extremely low levels. Despite loose monetary policy, the European Central Bank (ECB) failed to achieve its target inflation rate of two percent - inflation in the eurozone has been consistently below that. A large part of the growing money supply did not flow into production, but remained within the financial sector or was used to buy existing securities and real estate, driving up their prices. In the last two years, too, money supply growth and inflation have tended to move in opposite directions. Money growth accelerated in 2020 during the first phase of the pandemic. Governments tried to counteract the recession with countercyclical stimulus programs, and monetary policy was loosened again, while businesses and consumers had to curb their spending due to the lockdowns and tended to save out of prudence, i.e. they accumulated financial buffers. In 2021 and 2022, the growth rate of the money supply declined, yet the inflation rate rose in just those two years.

The assumption that the central bank can control the money supply is also problematic. Of course, when deflation looms, the central bank can try to increase the money supply by cutting interest rates or buying government bonds to facilitate investment. Conversely, when inflation rates are rising, it can raise policy rates or sell securities in an attempt to reduce the money supply. The problem is, however, that the central bank can influence the credit creation of commercial banks only indirectly. Their lending is subject to the motive of profit maximization, and their calculations are also determined by factors other than central bank policy. Most of the money in circulation is not central bank money, but credit money created by private commercial banks. The mode of action of central bank intervention is asymmetric: In general, it is easier to choke off economic activity by raising interest rates than, conversely, to encourage banks to lend more to businesses and thus trigger an expansion of output in an environment characterized by low profit rates and deflationary tendencies by lowering interest rates. Raising key interest rates is the standard method used by central banks to counter high inflation rates. However, this may involve accepting a recession and rising unemployment.

Is inflation caused by excessive wage increases?

Another common inflation theory is the theory of the wage-price spiral, which is also advocated by Keynesians. According to this theory, excessive increases in wages are said to cause inflation. Rising wages would mean higher production costs, and these would be passed on by firms to prices. From this follows, the policy stance to curb wage growth if it exceeds labor productivity growth. It suggests itself that the theory of the wage-price spiral is in line with capital interests. From a theoretical point of view, however, the question arises whether firms are really able to pass on rising wage costs to prices under conditions of competition or whether falling profit rates are not rather the consequence of rising wages. Furthermore, the question arises whether companies do not react to rising wages by replacing workers with machines, thus again reducing the wage bill they have to pay. Rationalization investments could lead to rising unemployment, weaken the bargaining power of unions and thus limit wage increases. The question, then, is whether a wage-price spiral will occur at all. In any case, only wage increases that exceed productivity growth could lead to rising inflation rates. Whether they are more likely to lead to falling profit rates or rising inflation is likely to depend on competitive conditions. Moreover, the question of causality also arises here: High nominal wage increases could be a consequence of high inflation rates rather than their cause. In addition, cost increases for companies are not only the result of rising wages, but also of rising costs for means of production. This point of view is also likely to be the more relevant one for the current price increases, if we think, for example, of the rising prices of fossil fuels.

Let's take a look at the actual wage development in Germany [1]. Here, the nominal wage bill rose by an average of 4.25 percent per year between 2013 and 2019. The "harmonized consumer price index," the most common measure of the inflation rate, rose by an average of only 1.15 percent per year during this period. Real wages, which are the difference between nominal wages and the inflation rate, thus rose by more than three percent per year during this period. Inflation remained low despite the significant nominal wage increase. In the 2020 Corona crisis, nominal wages decreased by 0.24 percent. The consumer price index increased by 0.4 percent. Thus, wage earners suffered a real wage loss of 0.64 percent. In 2021, the nominal wage total increased by 3.5 percent compared with the shrunken baseline of the previous year; the nominal wage increase was thus still well below the wage increases of the years 2013-2019. However, it was now offset by a 3.2 percent increase in the consumer price index. In real terms, therefore, wage earners gained only 0.3 percent in purchasing power. In 2022, nominal wages grew by 5.5 percent, but the consumer price index rose by 8.7 percent. Wage earners thus suffered a real wage loss of 3.2 percent on average. This example shows that there is no clear correlation between wage increases and inflation, no "wage-price spiral." Rather, in certain phases of capitalist development, real wage increases are possible while inflation remains low. In the current phase of accelerated inflation, on the other hand, nominal wage increases could not compensate for the rise in prices - wage earners lost considerable purchasing power. What would be needed, therefore, from the perspective of wage earners would not be lower, but higher wage increases to correct the redistribution in favor of capital brought about by recent price increases.

Another explanation of inflation, while also focusing on wages as the supposed drivers of inflation, does not assume cost pressures on the supply side, but rather the demand pull triggered by rising wages. Rising wages would lead to rising demand, and this would drive prices up. This ignores the fact that rising profits are also a source of demand. If the share of wages in the value product rises, the share of profits falls - and vice versa: If the share of profits rises, the share of wages falls. Prices can be driven up only if the combined purchasing power of wages and profits rises - and if output cannot keep pace with this rise in purchasing power. The latter seems to be the critical point in explaining the recent wave of inflation.

To what extent is inflation a result of the economic war between Russia and the West?

In the public debate in Germany, it is sometimes argued that the high inflation rates are essentially a result of the war in Ukraine and the associated sanctions imposed by the "West" on Russia, as well as Russia's counter-sanctions against the "West". However, this is only partially correct. Fossil fuel prices were certainly driven up by the decline in Russia's exports in terms of volume, as were grain prices due to the collapse in supplies from Ukraine and Russia. However, a look at the statistics shows that inflation rates began to rise as early as 2021, before the escalation of the war in Ukraine. The rise in inflation rates started slightly earlier in the U.S. than in the EU. In the U.S., the year-on-year increase in the "harmonized consumer price index" was 2.8 percent in March 2021, 4.8 percent in April, 5.9 percent in May, 6.3 percent in June, and eight percent in December[2]. In the EU, the increase in the "harmonized consumer price index" first exceeded the ECB's target inflation rate in May 2021, averaging 2.2 percent. It then climbed to 5.3 percent in December 2021. The fact that the development of inflation in the EU followed that in the U.S. with some delay once again points to the fact that the U.S. is still the dominant center of the capitalist world economy and, in particular, the pacesetter in the Atlantic region. Thus, the escalation of the Ukrainian war did not trigger the rise in inflation rates, but it amplified it considerably.

In March 2022, the consumer price index rose by 9.8 percent year-on-year in the USA and by 7.8 percent in the EU. The inflation wave in the USA reached its preliminary peak as early as June 2022, when the consumer price index rose by 10.1 percent; in the EU, the peak was only reached in October 2022, when it averaged 11.5 percent. The impact of the war on the inflation rate was obviously more noticeable in the EU than in the USA. There, the strong increase in demand after the 2020 recession, which was also supported by the stimulus packages of the U.S. government, was of greater importance and could not be met by a corresponding expansion of production. In the EU, the energy crisis certainly played a key role in the first place, and here in particular the rise in gas prices. It is important to note that gas prices in Europe were already rising enormously in the summer of 2021. Russia is accused of having tightened gas supplies to the EU already in 2021 in order to increase pressure for the approval of the Nord Stream 2 pipeline [3]. Gas prices at the central hubs in the EU or on the spot markets then climbed to astronomical levels after the war escalated. Gas prices rose in the U.S. as well, but nowhere near such heights. The price of gas in the US at the peak of the price increase in the summer of 2022 was still below the level it had at earlier peaks in 2005 or in the summer of 2008. Something similar applies to the price of crude oil in the EU, which has not risen quite as much as the gas price either. It should also be noted that the mere increase in fossil energy prices alone cannot explain the rising inflation rates, even though fossil fuels are an essential input for many downstream industries.

Before and after the Great Recession of 2008 to 2009, there were already similar sharp increases in fossil fuel prices, without these being associated with such a sharp rise in inflation rates. Between 1991 and 2020, the inflation rate in the U.S. was always below four percent. The same has been true for the EU since the mid-1990s and with the exception of 2008. While the impact of the gas crisis on inflation in the EU is plausible, the impact of the rise in energy prices on inflation in the U.S. is less clear. It is true that energy prices in the US also rose more sharply than prices of other commodity groups after a deep slump in the wake of the pandemic and the accompanying recession, namely by more than 50 percent between Q4 2020 and Q4 2021 and again by almost 30 percent between Q4 2021 and Q2 2022. Nonetheless, excluding the rise in energy prices and food prices (i.e., the "core inflation rate"), the increase in the consumer price index was still 4.7 percent between Q4 2020 and Q4 2021 and between Q4 2021 and Q4 2022. In the EU-27, excluding energy and food prices, the increase in the consumer price index was only 1.8 percent in 2021 and 4.7 percent in 2022. In contrast, the consumer price index including food and energy prices increased by 5.3 percent in the U.S. and 2.9 percent in the EU in 2021, and by 8.7 percent in the U.S. and 9.2 percent in the EU in 2022.

One reason for the rising energy prices even before the recent escalation of the Ukraine war could be the declining investment in fossil fuel production in recent years. It is also possible that the public discourse on climate policy has led to a certain reorientation on the part of financial investors. How sustainable this will be remains to be seen. In any case, the fact is that global investments in fossil fuel production fell from $905 billion in 2018 to $873 billion in 2019 and to $671 billion in the pandemic year 2020, according to International Energy Agency data. Thereafter, they increased again, but were still below the 2015-2019 level at $852 billion in 2022. The timing of inflation and the decline in investment in fossil fuel production - which is, after all, necessary from an environmental perspective - points to the enormous challenges and risks involved in the desired "decarbonization" of the economy[4]. If the production of renewable energies is not sufficient to avoid bottlenecks in the energy supply or if, for example, the production of metals, which is necessary for "green" capitalism, cannot be increased sufficiently, an increase in inflation rates can also be expected in the future.

In addition to the War in Ukraine, the disruption of  'supply chains' in the wake of the Covid 19 pandemic is also understood as a reason for the price increases. The various "lockdowns" and events such as the six-day blockade of the Suez Canal by the grounded container ship Ever Given in March 2021 have made clear how vulnerable global production chains are. Sectoral production bottlenecks in the chip industry, for example, have become well known. The change in working patterns (growing importance of the home office) and consumption patterns in the wake of the pandemic has led to growing demand for computers and consumer electronics and thus for microchips, while demand for automobiles slumped briefly during the recent recession. Chipmakers reoriented accordingly, prioritizing demand from the computer and consumer electronics sectors. By the time demand for automobiles picked up, chipmakers were already running at capacity and unable to meet demand for chips in the automotive industry.


The monetarist theory of inflation based on the quantity theory of money and the wage-pressure theory also advocated by Keynesians cannot explain the recent rise in inflation rates. Inflation can neither be attributed to an excessive expansion of the money supply nor to an excessive increase in wages. It is more plausible that disruptions in international supply chains in the wake of the pandemic contributed to inflation and that production, which was severely constrained in 2020 by the pandemic, could not keep pace with the upswing in demand in 2021. Furthermore, it is likely that the decline in investment in fossile fuel sector and the curtailment of gas supplies by Russia in the summer of 2021 in the wake of the conflict over the Nord Stream 2 pipeline have contributed to the rise in fossile fuel prices. Prices for energy and food in particular were then pushed up further by the escalation of the war in Ukraine as well as the sanctions imposed by the West and counter-sanctions imposed by Russia.

The inflation theories of mainstream economics are obviously implausible. The critical discussion about the new wave of inflation is basically still in its infancy. One contentious issue in the Marxist debate, for example, is the significance of monopolies or oligopolies for inflation dynamics. The significance of speculative price formation on commodity futures exchanges would also have to be discussed in more detail. How to reconcile the analysis of current inflation with the Marxian theory of the capitalist mode of production and with a general theory of inflation will have to be discussed further[5].



[1] The following figures are based on the data of the Federal Statistical Office on "compensation of employees" and on the "harmonized consumer price index".

[2] The following figures are based on the National Income and Product Accounts (NIPA) data of the Bureau of Economic Analysis (BEA), on Eurostat data and on own calculations.

[3] Cf. Frank Umbach: Natural Gas as a Weapon. The Kremlin, Europe and the Energy Question. Berlin 2022, 46ff.

[4] Cf. Cédric Durand: Energy Dilemma. Sidecar, 5.11.2021, online:

[5] Cf. for example: Anwar Shaikh: Capitalism, Oxford 2016, 44ff, 677ff; Michael Roberts, Guglielmo Carchedi: Capitalism in the twenty-first century, London 2023, 75ff.

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