Between 2009 and 2014, the U.S. Federal Reserve Board pumped $3.5-trillion (U.S.) into the financial system in an effort to stimulate lending and reinvigorate economic activity – a phenomenon referred to as "quantitative easing." This followed the infamous bank bailout of 2008, which saw the U.S. government reward the recklessness of Wall Street with $700-billion in public money.
While the United States busied itself with these protectionary financial measures, prominent monetary economists began issuing ominous warnings about runaway inflation and economic ruin. These dire projections were based on the quantity theory of money, the idea – traceable to Nobel Prize-winning economist Milton Friedman – that inflation is "always and everywhere a monetary phenomenon."
These predictions have not been borne out by subsequent events. Despite the historically unprecedented injection of funds, core U.S. inflation (which excludes food and energy prices) averaged just 1.7 per cent between 2009 and 2015. If monetarist thinking about inflation was correct, quantitative easing should have led to an inflationary spiral, not disinflation.
Why did the forecasts of inflationary ruin not come to pass? To some extent, higher levels of inflation did not occur because risk-averse financial institutions buried a large portion of this new money in the federal funds market. In so doing, they refused to act as a conduit of liquidity to the wider economy.
However, there is a deeper misunderstanding at play. Far from being a monetary phenomenon traceable to the supply of money, inflation has an important conflict dimension to it. The conflict is between employers and workers, and it is over the division of corporate-level income between wages and profit.
Despite being sharply at odds with mainstream economic thinking, we recently explored this claim in research published in the Journal of Economic Issues. According to mainstream economics, workers receive as wages what they contribute to firm income in the way of output. This production theory of distribution may be gospel in the economics profession, but the historical facts tell a different story.
From the turn of 20th century onward, changes in the average Canadian wage rate have been tightly synchronized with strike activity, and the share of national income going to labour in the form of wages has mirrored union density. In other words, the institutional power of labour organizations in conjunction with the exercise of the strike weapon helps explain the distribution of income.
As this distributive conflict gets pushed though the economic system, it eventually manifests itself in the form of higher prices. The periods when workers tended to win the distributive struggle also tended to be inflationary (the 1940s to the 1970s, for example), and the periods when corporations tended to win tended to be disinflationary (the 1980s to the present, for example).
This finding supports the notion that inflation is a demand phenomenon.
A simple expansion of the money supply will have no necessary impact on the general price level because money is endogenous to the economy – it's created within the economic system. Inflation requires workers fighting for, and securing, higher wages.
Recognizing the shortcomings in the quantity theory of money opens the door to a broader understanding of why inflationary episodes in Canada have tended to appear alongside periods of rapid wage growth and middle-class expansion. The same reasoning helps explain why the disinflation witnessed since the 1980s has been accompanied by a prolonged depression in Canadian wages and contraction of the middle class.
All this implies that inflation and monetary policy are factors in the level of Canadian income inequality. It also implies that the contemporary politics of inflation management is misguided.
Sure, high food prices and energy prices are not, in themselves, something to be encouraged, and at some point, higher inflation levels can have a corrosive economic effect. However, obsessing over the surface-level manifestations of inflation conceals the fact that the middle class was largely built on the back of trade union power, working-class struggle and an inflationary increase in labour compensation.
To some extent, then, inflation reflects the democratic ability of working people to assert themselves in their fight for higher wages and equitable living standards. Anti-inflationary monetary policy, by contrast, can be seen as the use of state power to suppress the wage demands of workers.
At the least, we need to reopen the national debate on inflation and explore new perspectives on monetary management. Our shared prosperity depends on it.
Scott Aquanno is a lecturer at the University of Ontario Institute of Technology. Jordan Brennan is an economist with private sector labour union Unifor.