In the beginning there was inflation

Before I ramble on, I think I should ask for the understanding of my esteemed fellow physicists. I am, of course, referring to the article's intellectual strolls through the not-so-familiar to me "pastures of science," which I at the same time find immensely fascinating. However, I suppose that my level of fascination with physics (astrophysics) is poorly correlated with the physical knowledge at my disposal. I treat this knowledge as a known unknown (x=?). There remains at least a hope that this correlation is not negative.

X we know about and those we don't

Donald Rumsfeld, former U.S. Secretary of Defense, once said, "As we know, there are known knowns, which are things we know we know. We also know that there are known unknowns, that is, things we don't know. But there are also unknown unknowns - things we don't know that we don't know." To illustrate these categories of data in an economic context, let me use an example. We know that there is inflation. But when one asks what the average annual price increase will be in 2022; when the inflation trend will reverse; what impact the "Polish Deal" will have on inflation and vice versa - the talk is of known unknowns. We know they exist, but we don't know them (e.g. as to their value). This is not the worst yet. The worst is what we do not know that we do not know. And we don't know about surprises, because those by definition are unknowns. For example, we didn't know at the end of 2019 that the SARS-COV-2 virus would soon spread across the globe and we would experience something entirely new - a pandemic that has been ongoing for two years. Thus, translating Rumsfeld's words into the language of mathematics, we have known x, unknown (but looked for) x, and x that we don't yet know exists (i.e., we don't even look for it).

What physics and economics have in common... inflation

Alan Guth, a physicist at MIT, proposed the famous inflation theory in 1981, which describes what happened to the Universe right after the Big Bang. Literally immediately, after less than a second, well, after a tiny fraction of a second - after 10-35 seconds. Inflation then began, which in the relative terms of the time took a very long time, as long as 999∙10-35, which is almost a thousand times longer than it took from the Big Bang to its initiation. Consequently, inflation ended about 10-32 seconds from the very beginning of the Universe. The theory of inflation is that during this very short time, the cosmos expanded incredibly fast, so that objects were moving away from each other at speeds faster than the light is moving.*

In economics, we also have inflation, and it too involves a kind of balloon blowing (space inflation is similarly depicted). In this case, the balloon is the economy and the air is money. The problem is that every bit of the balloon grows, not because we "pump" more rubber into it, but because we stuff it with more and more money. That is, the economy doesn't grow in real terms, it only grows nominally. And because of that, each piece of it (a physicist might say a quantum, but I simply mean a unit of product) starts to cost more and more. Sometimes it happens that inflation - this economic inflation - turns into cosmic inflation, although it has nothing to do with theoretical physics. For example, in Venezuela, inflation in 2018 was, according to the estimates of the International Monetary Fund, 130 thousand %! Someone will say, what is our modest 8.6% in December (year-on-year) compared to that? But a comparison to Venezuela is not the most appropriate. And the current inflation is a very serious problem for the economy and society.

What little could have been predicted, however...

Let us compare these two examples of inflation- physical (cosmic) and economic. The one in Guth's theory was very brief, one might say, transitory. Certainly, when it came, it was unpredictable. If only because no one or nothing would have been able to predict it in such a short time as 10-35 seconds. 

Well, rather, it was also not, as someone could say, troublesome. Nobody with normal (similar to our) senses would notice it. It lasted too short, as we have already established.

It is completely different with inflation in the economy, and especially with the current inflation experienced by many countries in the world, including Poland. First of all, it was to some extent predictable, as economic data had already heralded it before the pandemic. The inflation target of the National Bank of Poland (2.5% with a deviation of +/- 1pp.) was exceeded already in 2019, even before the unfavourable events on the commodity markets. This was a harbinger of sending us - the public - a bill for the generosity (justified by income inequality on the one hand, but irrational on the other) of the welfare state (e.g. 500+, 13th and 14th pensions, lowering the retirement age). The incomes of less well-off people have risen, and at the same time, by lowering the retirement age, the economy has been boosted by the departure from the labor market of those still able to work.

Consequently, we started to deal with a market of the worker, which together with a systematic increase in the minimum wage led to an increase in wages, which, however, was not adequately covered by an increase in labor productivity. Thus, employees began to be paid more not only because they were able to produce more goods in a given unit of time, but also because of the limited supply of labor. Employers found it difficult to find someone in the market who would take the same job at a lower wage.

There has been an increase in income caused by social transfers and rising wages, but at the same time labor productivity has grown slower than wages, which has acted as a barrier to the growth of the supply of goods and services. Demand grew faster than supply and ... that's inflation. And this could have been predicted.

…but that is not all

It was impossible to foresee the pandemic and its consequences in terms of disrupted supply chains and the need to pump huge amounts of money into the economy as part of a "crisis shield" (which was a justifiable action - what was needed was a rapid and large-scale measure to protect against rising unemployment). In 2021 came another bill - to protect the economy from the pandemic. Money pumped into the economy, as well as deferred consumption (e.g., due to lockdowns), triggered a significant increase in demand. Added to this were supply shocks in the energy carrier markets.

We know that now, just as we know that inflation will stay with us. However, we do not know for how long, as it is difficult to have confidence in the NBP's forecasts today due to the fact that they evolve very quickly over time. Over the past several months, the central bank has pursued a very inconsistent information policy. As recently as in the first quarter of 2021, the President of the NBP was more concerned about deflation than inflation, only to convince us in the second half of the year that inflation is temporary, and then, together with the Monetary Policy Council, start a series of interest rate increases.

In January, the President admitted that in his opinion the level of interest rates should exceed that currently expected by the market. It is difficult to formulate forecasts as to the further path of inflation based on such announcements. But it is certain that inflation in the economy will last much longer than the one just after the Big Bang. Probably the whole year 2022 will be marked by inflation, and in 2023 we can expect an inflationary "thaw". But after all, there are still unknowns x that we don't even know we don't know about.

*See: https://www.komputerswiat.pl/artykuly/redakcyjne/astronomowie-w-koncu-m…