---
title: "Inflation and Fiscal Dominance — Sami Miettinen on Puheenaihe 198"
titleOriginal: "Talous: Inflaatio ja fiskaalidominanssi (Sami Miettinen & Sauli Vilén) | Puheenaihe 198"
description: "Leevi Leivo puts a listener's question about the price of pasta to Sami Miettinen and Inderes analyst Sauli Vilén, and the answer runs from supply bottlenecks to why the ECB cannot raise rates at all. The episode explains fiscal dominance, the asset price inflation nobody measures, why the risk-free rate has become a guaranteed loss, and who actually pays when inflation runs at five per cent."
format: "podcast"
show: "Puheenaihe"
episode: "198"
hosts: ["Leevi Leivo"]
date: 2022-01-21
duration: "46:56"
language: "fi"
original: https://www.youtube.com/watch?v=-e02sm4M_cU
canonical: https://www.neuvottelija.com/media/puheenaihe-198-inflation-and-fiscal-dominance/
---

# Inflation and Fiscal Dominance — Sami Miettinen on Puheenaihe 198

**Leevi Leivo** opens with the most ordinary possible question — why has the price of pasta and
coffee jumped? — and Sami Miettinen and Inderes analyst **Sauli Vilén** spend the next
three-quarters of an hour taking it apart until it reaches the European Central Bank.

## What inflation actually is

Miettinen starts from the mechanism. Inflation is the price at which a market clears; where the
market is not allowed to clear, a clever official sets the price instead. Demand and supply meet,
and a triangle governs the result: demand, supply, and **the unit of account**. Individual goods
have individual explanations — coffee is mostly a harvest story — but the third corner of the
triangle is the one being manipulated, because money is being printed.

Vilén's frame is the same from the other end: inflation arrives either from **bottlenecks** on
the production side or from a change in demand.

## The inflation nobody measures

The episode's sharpest observation comes early. There is a consumer price index, a producer price
index and a core measure with energy stripped out — but **none of them include asset prices**.

In 2021 US asset markets rose about 30 per cent and European ones about 20. Was that inflation of
thirty per cent, or the two per cent the official measure reported? Both men treat it as a genuine
theoretical dispute rather than a rhetorical question. Miettinen's addition is distributional: for
a wealthy household, asset prices are a large part of the real consumption basket, so those without
assets have simply missed the "good" inflation — which makes it a mechanism of inequality, and
makes a national policy that keeps ordinary Finns out of asset ownership look, in his words,
idiotic.

## Why this inflation, now

Vilén's account of the post-2008 puzzle is that the inflation was there all along, in asset prices
rather than in the textbooks' consumer goods. What changed in the pandemic was two things at once.

**Supply bottlenecks** multiplied — logistics failures, closed factories, inventories run down,
capacity mothballed — in supply chains already tightened to the limit, where a small disturbance
produces a large bullwhip effect. And stimulus took a step further: not only central banks pushing
up asset values but **states handing out helicopter money**, which is enormously effective at
producing demand precisely because giving the average person a thousand dollars means it gets
spent, where the same money in Amazon's share price reaches one per cent of people.

Both of those should, in principle, fade — capacity gets built where it is needed, and fiscal
stimulus tapers. The open question is what the inflation rate is afterwards.

Miettinen's addition is that a state consumer is a strange animal: it is planned economy, deciding
on your behalf what you want to consume, and it brings free resources into the demand pool because
the consumption is done on credit.

## Expectations, and the self-fulfilling forecast

Both men treat inflation expectations as the variable that matters and nobody can model. They
aggregate out of people's confidence in the economy; once they anchor at a high level, they drive
realised inflation there too.

Their point about forecasters is a good one and applies to more than inflation. Economics is
closer to religion than to mathematics, and forecasts are **self-fulfilling**: if a finance
ministry says the country is heading into recession, it will, because people react to the
statement. That is not a criticism of the ministry — it is a description of the position everyone
in the forecasting business occupies, including the IMF, which cannot really say anything other
than that inflation is temporary even when it believes it.

## Fiscal dominance

This is Miettinen's central concept and the episode's title.

Historically the tool against inflation was raising rates. The question is whether that tool is
still in the box in Europe, and his answer is that it is not. Euro-area central banks are held in
a headlock, and the party holding it is **over-indebted member states**. Italy carries debt at
around 150 per cent of GDP; a percentage point of extra interest cost feeds straight into the
deficit, and five per cent would take it to something no cash flow can service. Greece or Italy
would not survive a quarter of five per cent rates. So the threat runs the other way: raise rates
and we default, leave the euro and end our membership.

The United States does not have this problem, because there the indebtedness sits at federal
level. Texas does not go bankrupt, and California does not bail out Texas — a system deliberately
built not to rescue its own members.

His prediction follows from it. Rates cannot be raised; inflation runs; the debts erode. He notes
the proposals now appearing — France and Italy suggesting national debts be paid with EU debt
funded by EU taxes — and calls them economically absurd but politically viable, because nobody
wants an Italian default or a break-up. Vilén's counterpoint is the one lesson of the past decade
he considers proven: **do not underestimate decision-makers' willingness to keep this system
together.** Draghi's *whatever it takes* is alive and broad, and things now routine would have had
you committed fifteen years ago.

Vilén raises an economist colleague's idea as an example of how strange the solutions can get:
the ECB raises rates but simultaneously guarantees — locks — the rate levels of the problem
countries, building a firewall around them, so the higher rate is paid only by those who can. The
largest moral hazard imaginable, and not obviously impossible.

Miettinen's own view on the federal option is that it does not solve the problem it appears to
solve: if you know a federal structure will pay, the optimal strategy is to borrow six hundred
billion, set taxes to zero and enrich your citizens — so the arrangement collapses on the first
day through total moral hazard.

## The digital euro, from the banks' side

Leivo brings up the digital euro, and the answer is mechanical. If you had an unrestricted right
to move money from a commercial bank account into a central bank wallet, why would you not? Around
half of a roughly €40,000 billion European banking balance sheet is funded by **deposits**, and
removing a significant share of that funding channel would destroy the banks, because they have no
alternative source for it. Which is why the wallet, if it comes, comes with a cap — a few hundred
euros — and why it has not arrived despite being technically easy.

## What it does to markets, and who pays

Vilén's market reading has three layers. Historically **equities do well in inflationary
conditions**, because they are one of the asset classes that hold value. In the short run there
has been a correction, driven by rate expectations: a higher discount rate compresses valuation
multiples, and cash flows ten years out lose more of their present value than near-term ones —
which is the rotation from growth stocks into value. And at company level inflation sorts firms
sharply into winners and losers according to **pricing power**: if you can pass the input costs
on, you have no problem; if your position in the value chain will not allow it, you do.

Miettinen adds the third angle, and it is the one he considers most consequential. The old joke
that the risk-free rate had become the return-free risk is now out of date: it is a **guaranteed
loss**. A negative five per cent real return is a certain loss on every euro lent, and when the
curve rises, low-coupon bonds locked at low rates lose market value — a couple of percentage
points of rate rise can take twenty per cent off fixed income asset values.

And the holders are compelled. Pension funds across the Western world are regulated into an asset
class defined around government bonds as the risk-free asset, so they watch the value fall while
the regulator requires them to hold. Miettinen calls the Finnish solvency-capital rules a
peculiar forced asset allocation, notes that Finland's own state pension fund is not bound by them
and consequently carries a much higher equity weight and produces better returns, and suggests
watching what the unconstrained investors — Norway's oil fund — are doing with their fixed income
weights, because that carries information.

The distributional answer to Leivo's closing question is unanimous. If inflation runs hot for a
long time, the losers are **savers and ordinary people**: bank deposits lose value, wages do not
keep pace, and those who own hard assets — property, real estate, equities — do fine while the
gap to those who do not widens, and the first home moves further out of reach. Those who managed
to borrow at fixed low rates just before the wave win, as Finnish mortgage holders did in the
1970s; those who want to borrow afterwards cannot, because at a five per cent negative real rate
every loan is a political gift and lending becomes selective and arbitrary.

And the pension system is the quiet casualty. Finland's guarantee pension is roughly €2 billion
against €25 billion of pension contributions, so the state guarantee is a ten per cent problem —
but the €220 billion of pension assets falling in value is what makes paying the €25 billion
painful, and the burden shifts to the younger cohorts.

Original recording (Puheenaihe): https://www.youtube.com/watch?v=-e02sm4M_cU

---

Cite as: Sami Miettinen, guest on Puheenaihe 198 — Inflation and Fiscal Dominance — Sami Miettinen on Puheenaihe 198, 2022-01-21, https://www.youtube.com/watch?v=-e02sm4M_cU. Record: https://www.neuvottelija.com/media/puheenaihe-198-inflation-and-fiscal-dominance/.