March 31, 2023

Today is the Federal Reserve's inflation number and Canada's GDP numbers.

They will give an indication of what might be coming in terms of policy next week.

The finance crowd will be split on talking about fast falling "consumer prices" in Europe because of the fall in energy prices. However, core inflation has "surprised to the up side". Read: real inflation is still sticking around.

Actual production in Europe has stalled. This is not a good sign given the recent announcements of tax credit-driven investment support from the European Union.

The budgets around the world in response to the current crises have had several interesting features:

1. Finance ministers talk about inflation, but the direct impact a budget will have on current inflation numbers are very limited. Inflation is a product of things done in the (relatively recent) past. Change in those prices is already in the pipeline.

   • Talking about inflation during the recent Federal budget is strange. The effects of spending announced today, which will not be seen until the end of the year.
   • Governments are adamant that inflation will be down by the end of the year.
   • Something has to give. If people actually think that inflation is down by the end of the year, government spending is of little consequence to that prediction.

2. The response from central banks to inflation is to increase interest rates. The point of this is to drive up private bank lending prices paid by businesses. These prices reduce economic activity.

   • But, the governments have launched budgets with massive tax credit (sometimes refundable) to businesses.
   • The result of decreasing the tax costs of businesses this way is essentially subsidizing borrowing costs (since most large businesses have to borrow to spend to get the tax cut).
   • Once again we have a profit subsidy given to large capital in the form of reduced costs of borrowing for those companies.
   • The question here is if this subsidy is going to businesses who were already going to spend that money?
   • If they were going to spend that money, it is going to be inflationary.

3. Locked into all of the budget decisions is (still!) the neoclassical idea that inflation is caused by workers wages and not by printing free money for profit subsidies.

   • The true inflation we are seeing is the result of the way that capital-friendly governments suppressed borrowing rates for banks so they would lend to capital. Free money, so long as it is spent on new production can drive growth and eat-up that newly minted money. However, when the economy slows, that money becomes inflationary.
   • The issue with the new round of capital subsidies is that the regular culprits of inflation are around. There is no indication that investments in new productive capacity are guaranteed (because these are after-the-fact subsidies).
   • What determines new investment is predicted profitability. And, that is not predicted to be very high in the near future right now.
   • Even with the tax credits, profitability could be too low for investment as I see no evidence that the governments have made this calculation.
   • If this is the case, this spending is inflationary and inflation will be persistently higher than their "target 2%".
4. The only way to actually get investment without inflation is for the government to build capacity for capital to grow. That means investing directly into new production. Similarly to what they have done in the auto sector—the only industrial strategy North America actually does outside of national defense spending.

These budgets are a gamble. In the USA, it is less of a gamble because it is just so much money. In Canada, it is a large gamble and likely not to result in the level of investment needed.