Ever wondered why inflation rates are higher most of the time in the US than in Germany or Switzerland? Ever wondered why Italy and Spain seemed to be more prone to inflation than France or Belgium before the introduction of the Euro?
Most of the current economic research focuses on the influence of central bank independence on inflation rates. This is because economists found out that there is a clear relationship between these two factors. But is it a causal relationship, i.e. is central bank independence causing low inflation rates? Let me show you this chart:
I did some research on home ownership rates and found out this clear relationship. The more people own their homes, the higher the average long-run inflation rate is. Contrary to the theory that “independent” central banks matter, this makes sense to me. What is an “independent” central bank? We have seen in New Zealand since the 1990s and also in Western Europe and North America that it is impossible to isolate central banks from political pressure. The New Zealanders had a law in the 1990s that said that the central bank president had to be fired, if inflation was over its target rate for a longer period of time. In fact, the inflation rate in New Zealand has been over its target rate for most of the time since the foundation of an “independent” central bank, but the president was never fired.
As Milton Friedman once said, even a dictator can’t do everything he likes to, because at some point the people will (at least) throw him out of office. In democracies the popular pressure is so immense because of constant elections that politicians have large incentives to push through the inflation rates that the majority of people want. Owning a house is probably the biggest investment that most people will make in their lifes. It is also an inflation-proof investment, because their prices move with inflation (as all goods and services do) and they depreciate only slowly, which is why it is better than buying bottles of milk to protect oneself from inflation ;-).
If the majority of people own houses, they have most of their wealth invested in so-called ‘real assets’. On the other hand, most debt will be held in bank accounts as ‘nominal assets’, which are not secured against inflation. In this case, higher inflation rates will be in the interest of the majority of the people, at least in the short run.
This explains why it is so popular to get rid off high inflation rates by pegging the currency to other major currencies like the US Dollar. By doing this politicians practically abolish the central bank and make other countries responsible for monetary policy. This is one way of not having to deal with public pressure against tight monetary policy. Is it just a coincidence that Southern America, where home ownership rates are pretty high, has had so many problems getting inflation under control for most of the 20th century?
Some will say that, if the inflation rate is determined de facto democratically, then low inflation rates should prevail in the long-run, because high inflation rates harm the economy. Well, that’s not true. Firstly, economic research says that inflation rates have to reach double digits to harm the economy. Secondly, most people in our societies suffer from a disease called ‘time inconsistency’. Put simply, this means that they don’t care for what happens in 5 or 10 years. Higher inflation rates need a couple of years to harm the economy so much that people realize it. Take a look at New Zealand, Australia, or Great Britain. These countries had an average inflation rate of 10% or higher for over 10 years before public pressure against inflation somewhat increased.
I think it’s time for economics to look deeper into the general causes of inflation, instead of simply saying “it’s central bank independence, stupid!”. The relationship between home ownership and inflation may be one important cause that has been totally neglected.