Everyone was talking about inflation this year – but where does it come from and what does it take to really understand it? A conversation with Tobias Straumann, Professor of Economic History at the University of Zurich.
Mr. Straumann, where do you feel the inflation in your everyday life?
I almost don’t feel them. Only electricity and heating have become significantly more expensive. We have gas supply in our settlement, so it’s expensive now. But in Switzerland, inflation is relatively harmless.
And yet it is omnipresent. What is it anyway – inflation?
For most, inflation is first an extreme, immediate loss of purchasing power. When inflation is 10 percent, like in Germany, you suddenly have 10 percent less money. This is extreme expropriation.
Where does inflation start?
When the inflation rate is higher than 2 percent, it is considered problematic. But that’s just a rule of thumb.
Who established this rule of thumb?
central bankers and finance ministers. It is unclear who exactly suggested them. Various anecdotes are circulating, some claiming that a New Zealand finance minister was responsible. In the 1980s, he spontaneously named the two percent in a television interview.
Half the world is oriented towards this two percent inflation target, based on anecdotes?
Yes, it’s not strictly scientifically proven, but there are serious considerations behind it.
Namely?
When inflation is well above two percent, there is turmoil in the system. And people are starting to talk about inflation. If inflation is 2 percent, nobody is talking about inflation. This is the ideal state. You want people to feel that prices are stable. And the reason why two percent inflation is better than zero percent: In a crisis, the central banks want to be able to lower real interest rates as much as possible, they need a buffer to avoid falling into deflation. Hence the two percent. It is an experience.
So inflation is psychology? At two percent nobody is interested, at five percent nervousness comes into the system.
Yes, but not only. From five percent inflation, the prices have to be adjusted more often, so that we lose track. You can’t say that from five percent the world will collapse – from ten percent it’s more likely. At the moment we can see it live in Europe and the USA, so to speak. People have to save because they no longer know how their purchasing power will develop in the coming months. This is not only a question of psychology, but also of budget.
To what point do we need to go back to understand this year’s elevated inflation?
Back to Covid times.
There was a pandemic and now we go to Migros and the margarine is twenty-five percent more expensive than it was two years ago. What happened?
In Switzerland, the state spent a lot of money during the Corona crisis. The economy remained stable, almost no company went bankrupt – the state probably did too much: the short-time work compensation was probably often misused to restructure the balance sheet. In this situation, companies waited to make investments. The supply fell accordingly. And at the same time, demand fell, especially for services, because people had to stay at home.
At some point the lockdowns ended.
Yes, and then the economy overheated quite quickly. I also underestimated the situation. I first thought the higher prices were mostly due to temporary supply chain issues – and soon disappeared. But at the same time, the demand increased enormously. People caught up on their purchases and companies started investing again. The fact that demand is rising again so quickly – this is historically unprecedented and, in addition to the scarce supply, contributed to the current inflation.
And then came the Ukraine war.
I agree. What I described earlier was before the war. The war has further exacerbated the crisis, especially with energy prices.
And that’s why margarine is getting more expensive?
Yes, in general one can say that production became more expensive, as did transport, labor and, at the latest since the war, energy too.
What are the higher prices for?
Inflation weakens demand through a loss of purchasing power. At the same time, this means that inflation already has its own way of combating it. People are now spending less again because they have to pay more for the energy, but wages have not yet increased accordingly. People are becoming more pessimistic. This is the counterforce.
Who can do something against inflation, against the high price of margarine? We name a few actors.
Yes?
The National Bank.
Because the increased inflation is also a phenomenon of increased demand, it has to dampen it. It achieves this by raising interest rates, i.e. making investments more expensive. That slows down the economy. The National Bank cannot do more, it has no direct influence on the offer. It cannot solve the energy problem.
The politic.
It can do a lot more on the supply side. You should now expand the available energy above all. Switzerland has been dormant in this area for decades. We are now paying a price for an energy strategy that is too long-term – it was always only about the year 2050, and it was forgotten that we already need a lot more electricity.
The consumer.
If you have reserves, you don’t have to look so closely. Everyone else has no choice but to save.
The companies.
They need to make sure their employees are fully committed, and so they should raise wages to compensate for the loss of purchasing power. A cost-of-living adjustment of two or three percent is reasonable. This means that no wage-price spiral begins to turn in Switzerland.
Despite this, many companies forego inflation adjustments.
This is short-term thinking, in the end a company needs a motivated workforce. It is also not the case that the companies are in a particularly precarious situation. Most of them survived the pandemic well.
Thanks to the tax payments and taxpayers.
Yes, exactly. We have done a lot for these companies. Now it’s time for them to give back. A company that can’t pay inflation adjustments now doesn’t have to survive – it’s not healthy.
Up until now, younger generations only knew inflation from textbooks. Now, for the first time, they are experiencing on their own wallets what currency devaluation means.
I also!
What should we do with our money in the savings account?
I am not an investment expert. But in a time of inflation one should shift the money saved into real assets, into real estate, into stocks. But because hardly anyone can afford real estate in Switzerland anymore, only stocks are actually left. Shares allow you to participate in economic growth. But that only makes sense if you can leave the money lying around for a long time. You must never look at nervous stock prices. But not everyone can afford that either.
Who benefits from inflation?
Anyone in debt. Individuals, companies, states. Anything defined in nominal prices will decrease in value.
In the USA, inflation was over seven percent in November, in Germany it was ten percent and in Switzerland only three. Why are we getting away?
For two reasons. Firstly, in Switzerland a large part of the prices are administered by the state. Of course there will also be an adjustment in rents and energy prices here, but this will be spread over a longer period of time. Direct democracy has prevented full liberalization of the energy market. And that’s just as well. In England, the energy supply is organized in the free market. This is now fully reflected in private households.
What is the second reason?
The appreciation of the Swiss franc. For example, oil is traded in dollars. If the dollar weakens against the franc, the oil price for Switzerland will fall. At least it’s not rising as much as elsewhere.
Does Switzerland always get away with it?
I don’t know of any counterexample. We have always had a well diversified and flexible economy. Social partnership has also contributed to this since the Second World War. During the financial crisis in 2008, for example, some companies suddenly said that employees would have to work longer for the same wages, but would then be paid later. And people participated. That would be unthinkable in France, during the financial crisis factories were occupied and managers kidnapped.
The special case of Switzerland.
Robust economic policies are also crucial. The debt brake is worth its weight in gold. The financial policy leeway was therefore extremely large during the Corona crisis. We didn’t have to think about how much money we were allowed to spend. Things are different in a country like Italy, which is already entering a crisis with high levels of debt.
Financial crisis, corona crisis, energy crisis: are we learning from crises?
You draw conclusions, but they are not necessarily correct for the next time, because crises are only superficially similar. During the Covid crisis, politicians put together huge financial policy packages because they wanted to prevent what had happened with the financial crisis: that the economy would only recover very, very slowly. Looking back, we know that fear was exaggerated.
Wouldn’t it be best if we didn’t learn too much from crises?
We don’t have that choice. The big lesson from all crises is that we have to build buffers. The financial sector needs buffers, we need reserves of raw materials, reserves of goods, and since this year we have known that we also need energy reserves.
Perhaps a lot has been done right this time: inflation rates are already falling again.
Inflation isn’t going away anytime soon, I’m convinced of that. In January there will be another price increase in Switzerland, especially for energy and rent. Inflation is on people’s minds, expectations have already adjusted upwards.
The most recent rate hikes by the central banks were interpreted positively. The economy is expected to pick up again soon.
That’s what the markets say. It’s just that the markets have gotten everything wrong about inflation lately. I was influenced by that too. I’ve become more careful.
The worst isn’t over yet?
The war is not yet decided, the energy question is unresolved, inflation is not yet defeated. No, it’s not over yet.
Professor and former journalist
Tobias Straumann – Economic historian
Tobias Straumann, born in 1966, studied history, sociology and economic and social history in Zurich, Bielefeld and Paris. He received his doctorate in 1995 with a thesis on the history of Basel chemistry in the 19th and 20th centuries, worked for several years as a journalist in Switzerland and in New York and finally returned to research as an assistant. Today he is Professor of Economic History in Zurich. His research interests are European monetary and financial history as well as Swiss economic history. For the “NZZ am Sonntag” he writes the column “Geld & Geist” every two weeks.