Elżbieta Mączyńska: How to Deal with Inflation

Every crisis is a lesson. The lesson here is that you should not loosen monetary policy too much. The question is how to do it without harming the actual economy – says Professor Elżbieta Mączyńska in an interview with Jakub Dymek.

Jakub Dymek: Europe and the world have been hit by a wave of inflation unseen for years. Policymakers, experts, and journalists are asking themselves, “Why is it worse in our part of Europe, previously so much praised for the transition and rapid growth?”

Prof. Elżbieta Mączyńska: Indeed, in the countries of Central Europe and the Baltic states – that is not only in Poland or the Czech Republic, but also Estonia, Lithuania and a couple of other countries – there is over-inflation. This is true. But the level of inflation must always be compared with the rate of economic growth, and this was higher in our part of Europe. In a word, a more heated economy earlier means more severe inflation later, if this problem arises. 

There is also, however, a second reason. We are a neighbour of Ukraine, which has been the victim of aggression and is currently at war.

We are treated as a frontier country, whether we like it or not, and this affects, for example, the confidence in our currency.

And the exchange rate of the currency affects the ability to purchase raw materials and energy carriers, which are today the object of an economic war between Russia and the broader West. And while today the problem of a weak currency does not really affect those countries that have adopted the euro, inflation hits all the harder in countries depending on energy imports, although the euro itself, which is sometimes forgotten in the debate, has also been historically weak against the dollar.

So when Polish government leaders today talk about Putinflation, are they right or wrong?

It is never the case that only one factor or, as in this case, one person is responsible for inflation! So let’s put aside these either-or questions for a moment. The reality is that we are dealing with a multiplication of crises: the pandemic is not yet over for good, we have not restored the broken supply chains, and we have the energy crisis engineered by Putin and his allies on top of all that. 

Polish economists argue about the extent to which the government is shifting responsibility for inflation to the war and Putin. To some extent, this is certainly the case. But there is no denying that the war is a strong inflationary factor. I recall a quite recent U.S. analysis from late 2021 indicating that the effects of global shocks were responsible for up to 70% of inflation. 

And this is a debate that goes on all the time.

Exactly. And one upside of this crisis is that research on the subject has intensified and more and more comparative studies are being done. The question economists are asking today is whether national governments and central banks could have done more and earlier to mitigate this inflationary shock; by raising, amongst other things, interest rates earlier. In Poland, for example, there are quite a few voices saying that it was a mistake to kind of “cut the dog’s tail off piece by piece” – raising rates by very small increments. But, on the other hand, analyses of previous crises have shown that in more than half of the cases sudden rate increases led to a heavy recession. So we are between a rock and a hard place. 

In what sense?

Any responsible government must take into account not only monetary policy, but also the actual economy and the consequences of various decisions on the lives of citizens. Economists are divided on the question, for example, as to whether monetary policy should be accompanied by fiscal stimulus to protect households from the effects of the energy crisis. In other words, there is more than one position on the whole so-called “policy mix”. And we will find out who was right, as it usually happens, once we have put this crisis behind us. 

Some economists believe that, in an increasing number of developed countries, the relationship between central banks and governments has long since ceased to be characterized by independence and autonomy.

Specifically, that central banks have been delaying increases in interest rates for political reasons also in Europe. This argument can be refuted, however, by showing that this approach of European central banks may have rescued many countries from recession. There are calculations showing that we will possibly also avoid a technical recession in Poland and achieve a gross domestic product growth of 3.5-4%. Because, to tell the truth, we are dealing with a “quid pro quo” situation. 

The excessive inflation in Poland is also the price we are paying for an overheated economy, relatively short lockdowns and what is commonly assessed – by the International Monetary Fund, for example – as a rapid escape from the COVID slump. 

Note, for example, the so-called Okun index, also known as the misery index, which brings inflation and unemployment rates together. Politicians pay close attention to it because it is a measure of how badly people are doing. In Poland, for example, we have a terribly high inflation rate, over 16 percent in September 2022, but unemployment is virtually non-existent, because an unemployment level below five percent is actually natural unemployment. We may wonder if the increased interest rates will produce an increase in unemployment. In my opinion, they won’t, not under the current conditions. But a sudden big hike of interest rates might have such an effect. 

That’s why I say that in the economy we are almost always faced with dilemmas of the “quid pro quo” type, and today we are between a rock and a hard place.

A quick, sudden and substantial raise of interest rates also has its consequences – and those in power must answer the question, what is more important: people or monetary policy and healthy currency.

The threats to the stability of our currency are serious, but let’s remember that when people lose their jobs, the consequences are no less serious, and sometimes even drag on for generations. 

Or perhaps we have entered an era when interest rate shifts alone are no longer enough? Such voices are increasingly often heard, even from rather conservative institutions like the World Bank and the UN. 

This claim had appeared before February 24 and the war in Ukraine. There was talk of “the broken teeth of monetary policy”. But declining effectiveness of central bank decisions entails the risk of even tighter cooperation between governments and central banks. There could be a situation where monetary policy stops caring about the value of money and focuses solely on fighting inflation and its effects. But perhaps this is an altogether different problem.

There are economists – and I count myself among them – who are critical of subordinating all measures and assessments of the health of the economy to a single indicator: GDP growth.

Politicians have begun to fear GDP declines like the plague, so they have pressured central banks to cut interest rates and keep them low for a long time. This policy was not without its consequences either. 

And are there any alternative or unconventional ways out of this impasse?

Maybe we need a different approach to both monetary and fiscal policy? An approach that would allow us to avoid the use of two mutually exclusive measures – reducing the money supply by central bank decisions and at the same showering people with payouts, compensating them for the energy crisis. But this is easier said than done.

Every crisis is a lesson. The lesson here is that you shouldn’t loosen monetary policy too much. The question is how to do it without harming the actual economy. Undoubtedly, what we need today is to look both forward and backward in our analyses: to compare the current situation with previous crises and future scenarios. 

But could anyone make similar forecasts in a situation of an unprecedented pandemic and a breakdown or stoppage of economic life on an almost global scale?

Nassim Nicolas Taleb, who is wrongly portrayed as some kind of opponent of strategic planning, insists that even the pandemic was not a “black swan”. After all, there were warning signs! Let me repeat: in my opinion, the problem with the analyses and the whole perception of the economy is the focus solely on GDP growth.

If this and only this indicator is considered as a measure of development, it is no wonder that our debate, completely blind to other signals, consistently ignores many phenomena and symptoms.

To some extent, today’s inflation is also a consequence of the pursuit of GDP growth – what mattered was not, figuratively speaking, the ‘health’ of the economy after the pandemic, but its ability to rapidly produce growth. Hence the pressure on central banks. An extreme example of this approach is certainly Turkey, where successive Central Bank governors quickly come and go, as anyone who wants to tighten the monetary policy is fired. 

And today’s situation is probably unprecedented – because of the consequences of the pandemic and the war, it was necessary to switch from stimulating the economy to cooling it in record time and on a very narrow and unforgiving road bend. 

Precisely. Such a multiplication of crises has not been seen before. The Great Depression of the twentieth century was more transparent in many aspects. So was the 2008 crisis, which began with the real estate market crash. But there were, for example, no crisis multipliers in the form of food problems, sanctions, energy wars and so on. Compared to today’s situation, the previous crisis was a textbook example of its kind! And now it is not like that at all.

Elżbieta Mączyńska

Prof. Elżbieta Mączyńska is a Member of the Supervisory Board, PZU SA and Honorary President of the Polish Economic Society (PTE).

Jakub Dymek

is a columnist and author. His book about the rise of the revolutionary political right in USA, Poland and Russia entitled “Nowi Barbarzyncy” (“The New Barbarians”) was published in 2018 by Arbitror Publishing.

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