Belgium (Brussels Morning Newspaper) To tame inflationary pressures in the long run, Europe should focus on remedying structural issues: labor mobility, reskilling, banking reform and stability, intra-EU coordination of policy measures, and the like.
But, by far, the most pressing problem may be inequality. Leaving aside its ramifications in terms of social unrest, inequality creates perverse incentives and extreme misallocation of economic resources.
Income Inequality and Deflation
The core problem in Europe might ultimately be the rising income and wealth inequalities almost to American levels in some countries.
The more money we make, the less we appreciate its relative, respective, and proportional value to others. With very few exceptions, rich people, no matter how stingy, seem to lose touch with the pecuniary reality of the “99%” of the population who are poor(er). Indeed, to the wealthy, money is not a store of value as much as a token which allows them to participate in economic and non-economic games.
I call this process of desensitization to the value of money “personal inflation” because, precisely like “classic” inflation, as far as these affluent persons are concerned, it thwarts the price signal and distorts the efficient allocation of economic resources. It also misinforms their decisions and adversely affects their motivation to work, save, and invest.
Rich people have an “inflationary mindset”: they prefer to spend their capital, but owing to the amounts involved, are forced to hold on to the bulk of it, tied down in assets, both tangible and financial. They wish to consume (inflationary effect), but end up saving (deflationary outcome.)
Poorer folks have a deflationary state of mind: they would like to hold on to their money, but are forced to spend most of it, or even all of it (not to mention avail themselves of additional credits and loans.) They wish to save (deflationary effect), but end up consuming (inflationary outcome.)
Thus, all economic players in the marketplace wind up acting irrationally: against their innermost as well as expressed wishes and preferences. This gulf between the desires and actions of all economic agents is the main source of instability and uncertainty in the capitalist system, based as it is on wealth transfer from the many to the few and its accumulation in the hands of the latter.
What are the effects of these discrepancies in the perception of money between the rich and the rest of us? How is this psychological gap – indeed: this abyss – manifested in economic expectations and in one’s grasp of one’s purchasing power (based on streams of future income)? How does the price signal react to income inequality?
The larger the disparities between rich and poor, the greater the share of national wealth held by the rich, the more deflationary the economy. Rich people consume only a tiny portion of their wealth. The rest is tucked away in the vaults of financial institutions, in real-estate, or in art. Their money is effectively taken out of circulation and its velocity drops precipitously.
Admittedly, rich people’s savings do serve as a source for investments, but only when the transmission mechanisms of the financial system are intact and when trust is reasonably high. In times of crisis and recession, financial institutions tend to be rendered dysfunctional and trust abates. Redistribution via schemes of progressive taxation does ameliorate some of the deflationary effects of income inequality, but can never counter it wholly.
The political will to tackle this pernicious problem is not there, alas. The revolving door between politics (including regulatory agencies) and business is a major disincentive to any true reform.
The absence of political zeal to introduce change is everywhere. This is why Europe’s tax burdens and governments’s shares of GDP have been soaring inexorably with the consent of the citizenry, for example. People adore government spending precisely because it is inefficient and distorts the proper allocation of economic resources. The vast majority of people are rent-seekers.
Witness the mass demonstrations that erupt whenever governments try to slash expenditures, privatize, increase the pension age, reduce their debt burdens, and eliminate their gaping deficits. This is one reason the IMF with its austerity measures is universally unpopular.
The fight against inflation should never take center stage. It is an unwelcome distraction. Reforming Europe is the key. Inflation comes and goes. Europe’s economic deficiencies and deformities are here to stay unless they are confronted resolutely. Indeed, in the long-term, these are the very engines and causes of inflation.
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