Current inflation is not the product of ‘excessive demand’ (Keynesian) or ‘excessive monetary injections’ (monetarist). It is the result of a ‘supply shock’ – a dearth of production and supply chain breakdown, induced by the COVID pandemic and then by the Russia-Ukraine conflict.

Central banks have little control over the ‘real economy’ in capitalist economies and that includes any inflation of prices in goods or services. For the 30 years of general price disinflation (where price rises slow or even deflate), central banks struggled to meet their usual 2% annual inflation target with their usual weapons of interest rates and monetary injections. And it will be the same story in trying this time to reduce inflation rates. As I have argued before, all the central banks were caught napping as inflation rates soared. And why was this? In general, because the capitalist mode of production does not move in a steady, harmonious and planned way but instead in a jerky, uneven and anarchic manner, of booms and slumps.

I would argue that this supply-side ‘shock’ is really a continuation of the slowdown in industrial output, international trade, business investment and real GDP growth that had already happened in 2019 before the pandemic broke. That was happening because the profitability of capitalist investment in the major economies had dropped to near historic lows, and as readers of this blog know, it is profitability that ultimately drives investment and growth in capitalist economies. If rising inflation is being driven by a weak supply-side rather than an excessively strong demand side, monetary policy won’t work.

US inflation is much higher than wages which are only growing at between 3-4%, that means real wages are going down for most Americans. Financial assets are rising even faster. Housing prices are up by roughly 20% on an annualized basis. Just before the pandemic, in 2019, American non-financial corporations made about a trillion dollars a year in profit, give or take. This amount had remained constant since 2012. But in 2021, these same firms made about $1.73 trillion a year. That means that for every American man, woman and child in the US, corporate America used to make about $3,081, but today makes about $5,207. That’s an increase of $2,126 per person. It means that increased profits from corporate America comprise 44% of the inflationary increase in costs. Corporate profits alone are contributing to a 3% inflation rate on all goods and services in America.

Then there is the ‘psychological’ explanation of inflation. Inflation gets ‘out of control’ when ‘expectations’ of rising prices by consumers takes hold and inflation becomes self-fulfilling. But this theory removes any objective analysis of price formation. Why should ‘expectations’ rise or fall in the first place? And as I mentioned before, the evidence supporting the role of ‘expectations’ is weak.

All these mainstream theories deny that it is the failure of capitalist production to supply enough that is causing accelerating and high inflation. And yet, evidence for the ‘supply shock‘ story remains convincing. Take used car prices. They rocketed over the last year and were a major contributor to US and UK inflation rises. Used car prices rose because new car production and delivery was stymied by COVID and the loss of key components. Global auto production and sales slumped. But production is now recovering and used car prices have dropped back. Indeed, prices of home electronics are now falling.

A Marxist theory of inflation looks first to what is happening to supply and, in particular, whether there is sufficient value creation (exploitation of labour) to stimulate investment and production. Guglielmo Carchedi and I have been working on a Marxist inflation model, which we hope to publish soon. But the key points are that the rate of price inflation first depends on the growth rate of value creation. Employing human labour creates new value and using technology reduces the labour time involved in the production of goods and services. So more output can be produced in less labour time. Therefore prices over time will tend to fall, other things being equal. Capitalist production is based on a rise in investment in fixed assets and raw materials relative to investment in human labour, and this rising organic composition of capital, as Marx called it, will lead to a fall in general profitability and an eventual slowdown in production itself. This contradiction also means price deflation is the tendency in capitalist production, other things being equal.

But other things are not always equal. There is the role of money in inflation. When money was a (universal) physical commodity like gold, the value of commodities depended partly on the value of gold production. In modern ‘fiat’ economies, where money is a unit of account (without value) created by governments and central banks, money becomes a counteracting factor to the tendency for falling prices in value creating production. The combination of new value production and money supply creation will ultimately affect the inflation rate in the prices of commodities.

In our initial research, we showed that when money growth was moderate, but value creation was strong, inflation rates were high and rising (1963-81); but when value creation weakened, money creation avoided deflation but was not enough to stop price inflation from subsiding (1981-2019). This tells you that if the major economies slow down sharply or even enter a slump by the end of this year, inflation too will eventually subside – to be replaced by rising unemployment and falling real wages.