“Bracing for a More Inflationary World”

2024 07 15

In “Bracing for a More Inflationary World”

[https://www.project-syndicate.org/commentary/inflationary-pressures-from-aging-deglobalization-climate-and-immigration-policies-by-raghuram-g-rajan-2024-07]

Raghurm Rajan (an ex-President of the Reserve Bank of India that was too responsible for Modi) focuses on fiscal and other policy challenges that central banks will have to deal with in coming years:

1.        Populist pressure to incur deficits greater than the amount of activity with NPV>0.  [Yes, this is a problem that OUGHT to be combated with less spending on activities with NPV < 0 and with greater revenue collection, but combatted more for its growth debilitating effects than for the effects it may have on monetary policy.]

2.        Deglobalization. [Yes, although, as with deficits, this more important as a drg on growth than as a challenge to monetary policy makers.  It OUGHT to addressed with RE-globalization as Western liberal democracies seek to reduce import dependence (although not total “decoupling”) on hostile powers, especially China.  The correct corollary would be to increase integration with non-hostile powers, “friendshoring” as it’s called.  To the extent the net effect is greater restriction on trade, however, that will reduce real incomes, but unless it occurs quite rapidly, it should be managed without central banks needing to resort to over-target inflation.]

3.        Anti-immigration sentiment. [To the extent immigration restrictions cannot be resisted, the effect will be similar to “deglobalization,” reducing real income but without necessarily requiring central banks to engineer over-target inflation.]  

4.        Greater military spending.  [Yes, unfortunately these increases will be necessary but this is a subset of issue #1, an example of an activity with NPV < 0 that calls for additional taxes.  If deficits do increase as a result, central banks would be required to reverse their soon expected cuts in rates.]

5.        “Positioning populations for AI” [What could Rajan have in mind here?  Does he foresee AI that is highly substitutable for human capital leading governments to invest to keep real incomes of affected people from falling?  If so, these could well be investments with NPV > 0 and so merit increasing deficits and so be worth the negative effect of higher interest rates on private investment.

6.        Climate change.  [Managed well, with taxes on net emissions of CO2, _mitigation_ of climate change will reduce government deficits (or at least be neutral if taxes on net emission are combines with a “carbon dividend” to increase political feasibility).  Managed by subsidizing substitutes for CO2 emitting activities, this will create the need for other taxes to prevent mitigation from causing increases in deficits and reducing other investment.  Adaptation to the effects of already emitted CO2, WILL create the need for investment and even if these are well chosen and executed (NPV > 0) they will pose another challenge to government budgets.]

All the challenges boil down to government deficits.  Rajan seems to presume that whether to finance NPV > 0 activities or those with NPV < 0, governments will, in the face of the listed challenges, fail to increase taxes by enough to maintain or reduce deficits.  It is this failure that raises the issue of whether central banks will hold to their inflation targets or choose higher inflation.  His personal experience may be making him pessimistic.  

Image prompt: A group of well-dressed people holding up a large object labeled “Deficits.”  The people may be perspiring or showing the strain of holding up the object. [Does Dall E3 misspell words on purpose or is it only the free version?]

 [Standard bleg:  Although my style is know-it-all-ism, I do sometime entertain the thought that, here and there, I might be mistaken on some minor detail.  I would welcome comments on these views.]