Inflation and the central banks
The era of disinflation is over. By disinflation, I mean a rise in overall prices of goods and services, but at a slowing rate. Deflation means an actual fall in prices. That has not been the case for many decades, not really since the end of money as a physical commodity, namely gold and the arrival of what are called fiat currencies, ie money as coined, or ‘printed’, or digitally created by national states to replace gold. Only in rare occasions have states so restricted the supply of fiat money that it has caused deflation and really only happened when there was already a slump in capitalist production.
For the last 70 years or more, governments have controlled the issuance of currency and so the direct relationship between production of value in an economy and its representation by the supply and turnover of money has become separated. Inflation of prices has become the norm, but the pace of that inflation is now the issue.
In our (forthcoming) paper on inflation, Guglielmo Carchedi and I identified two separate periods of US price inflation in the post-1945 period to now. The first was from 1948-81 and the second was from 1981-2019. In the first period, the rate of inflation rose, constituting an inflationary period. In the second period, the rate of inflation fell, constituting a disinflationary period.
Between 1948 and 1981, the average annual rate of inflation was 4.3%; from 1981 to 2019 it slowed to 3.0%.
If we look at the annual average rate by decade, we can see the change even more clearly.
From the 1980s onwards, the US (and other major economies) entered a period of progressive disinflation, culminating in the Long Depression of the 2010s , a decade with an average rate of just 1.8% (and a rise of just 0.1% in 2015). But now in the 2020s, starting with the post-COVID pandemic inflationary spike in 2022, the major economies appear to have entered a new period of inflation ie. a rising rate of price change.
In various posts, I have argued, contrary to the mainstream theories that inflation is supply, not demand driven. What determines the rate of inflation in a modern capitalist economy with fiat currencies, is the rate of growth in the production of value relative to the rate of growth in the supply of money. The latter excludes the supply of money that is hoarded in banks or used for speculation in financial assets (fictitious capital, to use Marx’s term). The supply of money rose sharply in the 2010s as central banks tried to keep interest rates low and provide liquidity for the financial sector after the Global Financial Crash. This monetary injection was called ‘quantitative easing’. Mainstream monetarist theory argued that this would lead to a big rise in inflation. No such thing happened – on the contrary, price inflation slowed almost to zero, because a large portion of central bank monetary injection never left the banking system.
As unemployment fell to lows not seen since the 1960s, Keynesian monetary theory also argued that high government spending (large budget deficits) and ’tight’ labour markets would create ‘demand-led’ inflation. However, the empirical evidence for this theory – the famous Phillips curve that supposedly revealed the inverse trade-off between falling unemployment and rising inflation rates – was missing. The Phillips curve was flat. Low unemployment did not lead to high inflation. That’s because the differential between the rate of growth in money supply created by the banking system into the economy and the growth in value production had narrowed.
The post-COVID inflation spike was clearly supply-driven as the closing down of production and trade that produced the pandemic slump of 2020 was accompanied by a lingering breakdown of global supply chains and the squeezing up of prices in energy and key commodities by multi-national companies. A new Fed paper confirms that “underlying inflation dynamics have shifted since COVID.” The share of the consumption basket experiencing inflation above 3 percent remains well above the 2014–2019 average in the major economies, more than doubling in the euro area and the UK. The Fed still wants to blame this on ‘excessive wage increases’, but this is not born out by the evidence. Real hourly earnings roughly doubled between 1940 and 1970, but have barely risen since 1980.
Central banks have been at sixes and sevens in trying to control inflation. In the 2010s, they lowered interest rates to zero and raised money supply to new heights, but inflation slowed. Then in the post-pandemic period they hiked interest rates and introduced ‘quantitative tightening’ of the money supply. But that failed to stop inflation heading above 10% a year, a rate not seen since the supply-driven oil crisis of the 1970s. The story then was that 1970s US inflation subsided because the US Federal Reserve under Paul Volcker hiked its policy interest rate to an unprecedented high. The reality was that Inflation only dropped because the US economy went into a major slump in 1980-2 that decimated its manufacturing industry. The Fed’s high interest policy just added to that investment and production collapse. Stagflation turned into slumpflation. Indeed, the annual inflation rate stayed above the average of the 1960s until at least the 1990s.
Now with the Iran conflict and the reduction in oil and other commodity exports, inflation is back on the agenda. Global supply chain pressure was building even before the Iran conflict.
Supply disruptions in metals, grains, and livestock markets can generate macroeconomic effects comparable to oil shocks. When adverse supply disturbances hit these non-oil commodities, inflation rises persistently while industrial production falls, closely resembling the stagflationary dynamics typically associated with oil price spikes.
The signs of a return to inflation are already there in the rise in inflation rates so far in 2026. The latest March CPI data for the US show that another inflation spike is underway. Consumer price inflation rose to 3.3% in March, a near 1% pt leap from February. And there will be a further rise ahead towards 4% or more this year as the lasting impact of the energy and trade blockage feeds through.
Trump’s tariff tantrums are only adding to the inflationary pressure. Based on 2025–2026 data, the US Federal Reserve reckons that tariffs have resulted in a “near-complete pass-through to consumer prices, contributing roughly 0.8 percentage points to core PCE inflation and explaining the excess inflation in core goods.”
Goods inflation was +0.84%, a huge month-over-month increase (10.6% annualized) and the largest since Jan 2022.
And the Euro area is experiencing a similar spike.
Again, the major central banks are in confusion. Federal Reserve policymakers sparred during the central bank’s March meeting over how to respond if the Iran war triggers a prolonged period of high energy prices. Minutes of the March meeting showed “most” members of the Federal Open Market Committee fretted that a lengthy war could warrant cutting rates to support the jobs market, while “many” suggested it might require raising them to counter higher prices.
Before the war, the ECB had been expected to keep rates steady in 2026. However, the war-driven surge in energy prices revived inflation concerns. ECB governing council member Olaf Sleijpen warned that sustained energy disruptions could still feed into broader price pressures. “Persistently high oil prices will ultimately feed through to the prices of other products, and thus also to wage formation, which could amplify inflationary effects,” he said. “In that case, the ECB will naturally intervene to keep inflation around 2% in the medium term”.
Divisions within the Bank of England have emerged. Andrew Bailey, the bank’s governor, indicated that he expects depressed UK demand and labour markets to make “second round” effects from surging energy and food prices less dangerous than in 2021-22, reducing the risk of another wage-price spiral. But other Monetary Policy Committee members including chief economist Huw Pill and deputy governor Clare Lombardelli sounded less sanguine.
This confusion could be resolved if central banks recognised that monetary policy has little influence over price inflation, which depends first and foremost on the pace of value creation. If economies’ output slows and the monetary authorities react by increasing money supply and lower the ‘price’ of money (interest rates), then inflation will accelerate. If money supply growth stays close to value growth, inflation subsides.
Having seen monetarism and Keynesian monetary policies fail, central banks economists have diverted to a psychological theory of ‘consumer expectations’ of inflation, namely that inflation rises because consumers expect it and act accordingly by buying more to beat price rises. But as Federal Reserve economist Rudd concluded in 2021: “Economists and economic policymakers believe that households’ and firms’ expectations of future inflation are a key determinant of actual inflation. A review of the relevant theoretical and empirical literature suggests that this belief rests on extremely shaky foundations, and a case can be made that adhering to it uncritically could easily lead to serious policy errors.” But central banks are not going to admit this because it would remove their perceived role in the macro-management of the capitalist economy and reduce it to just acting as a ‘lender of last resort’ for the banking system.
In its latest World Economic Outlook, the IMF reckons that economic growth will not slow much if the Iran conflct is shortlived. But it sees global inflation rising significantly. Moreover, this time the ‘supply shock’ won’t be easy to contain. IMF: “the 2022 surge reflected an unusually steep aggregate supply curve, with strong demand running into supply bottlenecks, allowing central banks to achieve disinflation with limited output losses. Evidence now suggests a return to a flatter supply curve, making disinflation more costly.” Nevertheless, the IMF advocates that central banks must be prepared to hike interest rates because “if medium- or long-term inflation expectations drift up as prices and wages pick up, restoring price stability must take precedence over near-term growth, with a swift tightening.”
The Iran war and ensuing oil and commodity price rises are clearly a supply-side problem. Falling supply will raise prices but it will also lower growth, as it will cut into the wages and savings of households and raise costs for companies. High energy prices are a regressive tax,falling heavily on middle- and lower-income consumers. Weaker non-energy consumption and rising costs beget pressure on corporate margins which beget lay-offs, and the job market cracks. US fourth-quarter real GDP growth was just 0.5% (quarter-over-quarter annualised) and the consumer sentiment index just hit an all-time low.
The major economies are not in ‘slumpflation’ yet. In the US, corporate profit margins remain at record highs. And corporate earnings for the first quarter of 2026 are expected to be very strong. Trump’s planned fiscal handouts to US companies are substantial with tax incentives for businesses investing in machinery and factory equipment. And a weaker dollar in the latter half of 2025 will help boost dollar earnings from foreign investment revenues.
But the bulk of these earnings gains are concentrated in the US silicon valley tech giants. The rest of the corporate sector is struggling. Profits for the whole of the non-financial corporate sector fell in 2025.
And the impact of the Middle East conflict on profits has yet to be fully felt.
