Last week, a TV news channel ‘broke the news’ that the price of petrol was going to witness a further increase after 12am that night. Within minutes, petrol stations were stormed by owners of all kinds of vehicles, wanting to get fuel at existing rates that were supposed to be increased the next day.

No such increase was announced by the government. It was ‘fake news’. But, of course, the manner in which petrol prices have been rising recently, the so-called ‘breaking news’ was instantly lapped up. The question is, even if the news about the petrol price increase were true, getting one’s tank full at old rates doesn’t mean the fuel would last longer.

Economists call this ‘inflation psychology.’ This is when consumers develop a state of mind which makes them spend money a lot more than they would otherwise. It is largely an irrational act triggered by the fear that prices are rising. But to them, it’s a rational act because they are convinced they can save money by buying a product today whose price is ‘sure to increase’ tomorrow.

Inflation psychology can become a self-fulfilling prophecy. An increase in consumer spending means less savings, and the speed with which money exchanges hands, swells inflation. According to the French economist Pascal Blanqué, “narratives play a role in spreading inflation exponentially, like a virus, turning it into a mass phenomenon with feedback loops.”

Consumers spending above normal believing that prices will continue to rise, can become a self-fulfilling prophecy. But countering this psychology requires tough decisions, even if they impact short-term electoral interests

Consumer fears, speculations, and ‘predictions’ proliferated by the media lead to the development of inflation psychology which, as mentioned, worsens inflation. According to the American economist Ben S. Bernanke, governments allow inflation to fester fearing a recession (when incomes and spending decline). This makes the consumer believe that inflation is here to stay, triggering frenzied spending which, in turn, leads to constant price increases.

This is exactly what happened in the 1970s in various countries. Bernanke calls that era ‘The Great Inflation’. According to him, unprecedented government spending on public welfare projects since the four-term presidency of US President F.D. Roosevelt (1933-44), and the opening of easy lines of credit without increasing taxes (for political reasons), led to deficit spending, creating inflationary trends. Bernanke also blames the billions of dollars infused by US governments that oversaw the US conflict in Vietnam.

Extravagant government spending and tax cuts ‘heated up the economy’, increasing the demand for labour and materials whose supply fell short, thus pushing up the price of everything. Price cuts failed to check the runaway inflation.

According to Bernanke, an inflation psychology developed, which influenced the way labour and companies negotiated. The workers constantly demanded higher wages to beat future price increases and to increase their consumption power which, in turn, made companies continue introducing price hikes.

The governments of Lyndon B. Johnson (1963-69), Richard Nixon (1969-74) and Gerald Ford (1974-77) let inflation fester because its reversal required a temporary introduction of a recession which would not have boded well for their political ratings.

And what about the Scandinavian countries during the ‘the Great Inflation?’ State and government spending was large in the public sector and on welfare programmes in Norway, Sweden, Finland, Iceland and Denmark. But by 1970, here as well, inflation began to creep in.

Most Scandinavian countries addressed inflation of the period through a policy of accommodation. Unlike in the US, taxes were high in Scandinavian countries. This aided their governments to sustain their welfare policies. But after the 1973 ‘oil shock’, when prices of petrol reached record levels, most Scandinavian countries too were impacted.

Their ‘welfare state’ model had done well for their economy, politics and society. So, in the case of rising inflation of the 1970s, they settled on accommodating the price hikes by spending more on providing subsidies. They expected inflation to be temporary, but the impact of the oil shock lasted till the late 1970s. And Scandinavian accommodative policies began to fall apart.

For example, in 1979, Sweden witnessed serious industrial turmoil. Thus began a slow reorientation of Scandinavia’s approach towards inflation — moving it closer to how the Great Inflation was addressed in the US after 1976.

According to Bernanke, US President Jimmy Carter (1977-81) waged an ‘epic’ war against inflation. He directly countered his short-term electoral interests by raising interest rates and the federal funds rate, to almost 20 percent — the highest it’s ever been. In doing so, he plunged the nation into a deep (albeit temporary) recession. But, Bernanke writes, he also set the stage for decades of stable prices and economic growth.

Carter lost the 1980 elections. But the overriding reason for this was his mishandling of a 1979 crisis that saw dozens of American embassy staff taken hostage by Iranian Islamist radicals in Tehran.

In the 1980s, President Ronald Reagan reaped the benefits of Carter’s bold economic initiatives. Bernanke has advised President Biden to take Carter’s route. Otherwise, a new inflation psychology developing in the US would land his presidency in hot waters. The populist presidency of Donald Trump has created a paranoid conspiracy culture which fuels today’s inflation psychology through populist media.

In Pakistan, when the populist Imran Khan was ousted from the prime ministership this April through a no-confidence vote, he left behind an economy that was heating up because of rising inflation. It isn’t in populists’ nature to sacrifice self-interest for the larger national interest. So, instead of trying to cool down the economy by reducing inflation and triggering a recession, he allowed inflation to fester. His ministers applauded this course of action by pointing to the number of Pakistanis buying motorbikes or visiting restaurants to eat.

But this was inflation psychology at work. The more they spent, the more bloated inflation got. The poor were hit. Their wages were increasing, but the value of their earnings was dropping. The multiparty opposition alliance led by Shahbaz Sharif and Asif Zardari were petrified to sign an IMF deal which would curb the spending power of the people. But after two months of deliberations, and perhaps getting a tentative green signal from the ‘establishment’, they have decided to take the plunge, like Carter did.

The need of the hour is to cool down the economy. But it is equally important to address the inflation psychology, which the populist media will continue to bolster.

Published in Dawn, EOS, June 19th, 2022