Don't expect too much from inflation
By Scott Sumner
I’m associated with the “pro-inflation” crowd because of my advocacy of monetary stimulus over the past 5 years. This is actually sort of ironic because I’m an inflation hawk who was trained at the University of Chicago in the late 1970s and haven’t significantly changed my views on monetary policy over the past 35 years. Thus the fact that I’m now viewed as a pro-inflation dove tells you more about the state of macroeconomics circa 2014 than it does about me. I’d be happy with even 4% nominal GDP growth, level targeting, which would result in roughly 2% inflation, on average.
People are becoming increasingly aware that NGDP growth in America since 2008 has been too low (lower than 4% on average), and that the problem in Europe has been even worse. That means monetary policy should have been more expansionary, even if it seemed highly expansionary to people who aren’t familiar with the fact that low interest rates and a big expansion of the monetary base don’t mean easy money.
I suppose there is a danger that things will eventually swing too far in the other direction, and people will begin advocating more inflation than is desirable. So let me point out one fallacy that seems to be increasingly common—the idea that the “Great Inflation” was both necessary and helpful. It was pure waste. Here’s a alternative view from Ryan Avent, discussing earlier posts by Steve Waldman:
This, as it happens, is basically the story that Steve Waldman tells about America in the 1970s, noting:
I don’t dispute that monetary contraction could have prevented the inflation of the 1970s. But under the demographic circumstances, the cost of monetary contraction in terms of unemployment and social stability would have been unacceptably high.
Mr Waldman brings with him another important piece of the puzzle: wage rigidities. Because wages were rigid, the adjustment needed to put everyone in the demographic bulge to work would have been long and painful.
I don’t think that’s correct. If the rate of inflation had been 5% points lower in the 1970s, I believe the rate of nominal wage growth would have also been about 5% points slower, and the unemployment rate would have been about the same. The actual inflation rate (about 8%) involved at least 5% points of pure waste—a wage-price spiral that discouraged saving and investment, and did not promote employment.
Take a look a the graph showing wage increases in the US. Things were unstable in the early 1950s, perhaps due to the Korean War, but then settled down to 3% to 4% wage gains in the late 1950s and first half of the 1960s. Then with the advent of the Great Inflation, wage growth increased sharply and stayed high until 1981. So wages were pretty flexible over a period of 16 years, even if one year wage changes are somewhat sticky.
PS. Much of Ryan’s post is excellent, particular the comments on the British labor market.