In Australia, successive Governments since the 1970s have focused on Inflation as the main driver of monetary policy. Some of what I have been reading lately suggests that this is more about protecting established wealth than it is about protecting the general population. If this is the case then why are we stressing about inflation rather than GDP growth, which is a better indicator of how well most people are living?First, I want to refer to Capital in the 21st Century. The main tenet of this book is that Income Inequality has been traditionally high between the 10% “Upper” classes and the general population and that the level of inequality decreased between World War I and the 1970s. In that time the difference in total income between the Top 10% and the bottom 50% was smaller than the long term and this meant less inequality. One of the most important drivers for the decreased gap in income was that Inflation (not ignoring the effects of financial collapse on the Great Depression and destruction of public and private assets in the wars as major contributors or perhaps triggers) went from a fraction of a percent per annum to 10% or more. Inflation effectively eroded the value of inherited assets (property, shares and family businesses) relative to income from labour, which rose in line with inflation. The book covers the detail very well and my review covers the main points.

Until the end of the 1970s high inflation and greater equality (less inequality) was acceptable to Governments for a variety of reasons. These included:

• an element of reaction against the past ruling classes who created the environment where two World Wars, an unprecedented financial collapse  and the Cold War
• inflation was a convenient way of eroding public debt that was locked in at relatively low interest rates through bonds etc
• inflation drove growth in housing construction by allowing more people to afford to own property and to upgrade to newer and more substantial properties
• tax and other Government income increased at a rate somewhat higher than the inflation rate
• along a similar pattern, investment in public infrastructure became more affordable because of the more affordable capital repayment
• as a result employment was high and GDP growth was much greater than at any other time in history

Then, particularly during the 1980s and 90s, a conservative push to control inflation started and investment in public infrastructure was reduced in response. GDP growth could be driven into the negatives and Stagflation even resulted. Given that Governments in the Western democracies were supposedly for the people it is hard to see how negative GDP was going to help people when it meant job losses and even losses of complete industries.

As a near direct result of economic policy to reduce inflation almost at any cost, the drive to Globalisation and finding least cost suppliers of goods and services accelerated. There were both good sides (more poor countries could become less poor) and downsides (destruction of traditional cultures and regional decline in the First World such as Detroit and the North of England).

So who benefits from low inflation? Not Governments with debt to finance public infrastructure and services. Not those reliant on a regulated income (superannuation, pensions etc) with a low interest return in line with low inflation.  However those with inherited wealth that is in property and cash based assets do benefit because low inflation does not erode the value of the assets. Wage and Salary earners are obliged to accept income increases at or below the inflation rate that means they hold steady or decline. Large scale investors and those who make their income from returns on rent, shares or businesses are not limited on the rate of return on those investments and typically make at least 4% over the inflation rate when inflation is relatively low but struggle to make that high a return when the inflation rate is higher (because the market will not bear it).

Capital stock is rising (the RBA figures show predominantly plant and similar means of production) and the household components of wealth are lower than the capital growth. The gap is going into the pockets of the wealthiest who own the businesses.

The measure of GDP seems to be much more in line with what matters for most people. Even the RBA seems to agree with that ( 29 October 2014). GDP is perhaps only one measure of what matters to most people. That is for another post.

This means that our Government is deliberately favouring the wealthy (really the top 2-3% who can accumulate significant wealth that generates an income which more than meets their own needs)  above the majority  of citizens. Has anyone else noticed?