Inflation creeping in

The inflation reading in Poland for July 2021 hit 5.0% year-on-year; the highest since May 2011 and the second-highest in the last two decades. Probably I would not gripe much about it, had the monetary policy been conducted in a proper manner. Sadly, it is not. Despite the rising price level and rapid recovery in the economy, benchmark interest rate in Poland stays at 0.10% (which in fact means the real interest rate is almost -5%, perhaps the lowest in the civilised world).

Interest rates in Poland were slashed to a record-low (by historical standards) level of 1.50% in March 2015, when Poland struggled a deflation. Then such move, with real interest rate of nearly 3%, was justified. Despite economic expansion, the central bank kept its rate level until March 2020, when it responded to the pandemic-related economic standstill by a rate cut of 50 basis points. In the next weeks the current level of 0.10% was reached. I will refrain from commenting on the legitimacy of such move in a situation of an unprecedented supply shock. I believe tools different than the cost of money should have been used to help businesses and customers out.

Customarily, I am referring you to my essay on harms inflicted by too loose monetary policy. Times have changed, economic principles have not, albeit some are intent on setting new paradigms.

Astonishingly many people realise why the Polish central bank does not react to the price growth which exceeds the statutory goal of monetary policy (i.e. inflation target of 2.50% +/- 1 p.p.). They do it to help the government finance its debt cheaply and pay negative interest on a large portion thereof. Not only the debt service spending is lower thanks to lack of monetary tightening. Higher prices mean higher tax inflows, predominantly from VAT. Inflation which spirals out of control always at least temporarily translates into negative real interest rates which facilitate transfer of wealth from creditors to debtors, including the biggest debtors in the world, i.e. governments.

Those particularly worse off are savers who now either accept a depletion of their savings kept in bank accounts by 5% yearly in real terms, or search for havens which might shield their money from inflation. Unlike me and my parents, not everyone noticed the opportunity of inflation-indexed 4Y government bonds in 2019 (which has turned out to be an excellent nearly risk-free investment making me give up on my resolution made a decade earlier). Folks with substantial savings have rushed to buy properties, as they believe tangible assets should store value. I am putting it down to Poles’ inability to invest in any other asset class than properties. Had flats purchased for investment reasons been put on the market for rent, this would have been quite okay, since thosee dwellings would meet someone’s housing needs. Horrifyingly, a growing number of flats stay vacant, as the purpose of their purchase was purely speculative, i.e. to benefit from value appreciation, despite bearing upkeep costs.

Moving back to the core topic of the post, i.e. to inflation, we should understand what drives prices up and why there is little chance the price growth decelerates.

1. Far too much hollow money has been printed during lockdowns. If goods or services are not produced, but economic actors receive a pecuniary compensation for being idle from a government, the link between a payment and goods or services offered in return is broken. A first-year student in economics would recognise it!

2. Recovery programmes run by governments to stimulate economies – they raise prices of specific goods and services, i.e. construction materials and services if a programme is aimed at such sector.

3. Broken supply chains, which have not been fully restored since early 2020. This problem affects several industries and strikes several markets off balances. These days the shortage of brand-new cars or bicycles is driven by shortage of components, without which vehicles cannot be manufactured.

4. Deferred demand – after several sectors were shut for months and as the general uncertainty seems over, customers rush to catch up on spending and business want to make up for losses incurred during lockdowns.

5. Lack of incentive to save. As people see their money evaporating on real terms from bank deposits, they are more eager to spend it, i.e. consume rather than invest.

6. Climate change and environment protection. This is the foremost reason. The time is coming to bring the price of several planet-destructive goods real and make them reflect the harm caused to the planet. For such reasons cars will have to be less affordable, prices of electricity generated from burning coal are bound to go up. Same needs to happen about rubbish collection charges, plane tickets, packaging, clothes and other goods humans thoughtlessly use in excess.

Having written that, I am happy I bought and furnished my dwelling in 2018, do not need to purchase a car, nor a bike and price growth of several goods does not affect me.