I See No Stagflation Here...
Provoked by an interview with Simon Jarvis of the London Economist...
I See No Stagflation Here…
I confess that I really, really do not understand the fear of “stagflation” right now, The short-lived Korean War-era bottleneck inflation seems to be the most apposite historical model. Rejoining the highway at speed leaves rubber on the road. What we are seeing now is rubber left on the road. And that is expected, and desirable.
Stagflation: when both inflation and unemployment are increasing, or when they are both relatively high and, if one or two of them is decreasing, they are not decreasing very fast.
Starting in 1829, British polymath John Stuart Mill nailed what goes on with the business cycle. There can be too little cash money in the economy to grease all the transactions that people want to do. In that case you have idle factories, high unemployment, depression and recession. Or there can be too much money chasing too few goods, and you have inflation as people find themselves unable to buy the goods that they want to buy at the prices they expected they would have to pay. As John Maynard Keynes wrote in 1924, both of these are certainly bad and to be avoided. You want a point of balance, in the middle, where you have neither.
But you only are only supposed to have one of these at a time.
When you have high inflation but also high unemployment and idle factories, that is stagflation. Its appearance came as a great surprise to economists in the 1970s. The tradition of analysis dating back to John Stuart Mill in 1829. would say you should only have one or the other.
Pretty much only the 1970s, at least in the Global North, did we have both. Only then did we have episodes in which unemployment was relatively high and the economy was depressed, and yet also in which inflation stubbornly refused to fall back to normal or subnormal levels, even though the economy was clearly in a recession or a depression.
There are people there are smart people, there are intelligent people of whom I think an enormous amount, who think we might well be entering a period of stagnation. And I do not understand why they think this. After all, it took us nearly a decade—from 1966 to 1975—to get into the stagflation of the 1970s. And it then took a lot of bad luck, a lot of adverse shocks happening in rapid succession, a semi-perfect storm of bad things happening to keep us in stagflation from 1975 to 1983. A configuration in which unemployment is rising and factories are being idled and yet people are still expecting and counting on there being more money in the economy next year and so raising their prices and bargaining for higher wages—that is very unusual, hard to sustain. When it happened, we then failed to get out of it until 1984. But it had by that time been two decades building.
In other cases, we do not see anything like this. The episodes we see are more like the brief inflation during the Korean War, when there was a spike of inflation, a discrete rise in the price level, but then things went back to normal.
Once stagflation is entrenched, solving it pretty much requires having a régime change central bank—as Paul Volcker did in 1980, declaring that he did not care how high unemployment and interest rates went, he was going to make stopping inflation job #1. It succeeded. It took four years. It put lots and lots of people out of work. It generated the Rust Belt in America. It bankrupted Mexico.
We really do not want to do that again until we absolutely have to.
But, so far, there are absolutely no signs—I at least see no signs—of this at all. What I see is the world economy trying to rejoin the highway at speed, trying to get back to full employment. In the process we need to shift an awful lot of people out of one set of occupations into another set as we adjust to the conditions of our semi-post-COVID economy. Whenever you rejoin the highway at speed, you leave a bunch of rubber on the road. To complain about that reveals that you simply do not understand what “rejoin the highway at speed” means and entails.
And rubber on the road—not stagflation—is what we are seeing today. That is how I characterize the price rises in response to shortages and bottlenecks and supply chain disruptions. This is all a healthy part of the economic adjustment, and a necessary consequence of a rapid return to full employment—which is something we very much want to do.
I see no signs that this process will leave us with a configuration of high expected inflation and high unemployment, come 2, 3, or 5 years down the road. I do not understand why people, especially people whose usual intellectual position these days is one of great worry about “secular stagnation” and an economy with persistent deflationary pressures in which the natural interest rate keeps falling below the zero lower bound are worried about stagflation. It just does not fit.
And there are those who question whether we should prioritize return to full employment. Of course we should. An economy in which a lot of people are unemployed is an economy that is not working. Everyone who has a sustainable business model should be able to find customers with the money to provide healthy demand for their products. Everyone who wants a job should be able find one at the real wage that their work is worth in normal times, Getting the macroeconomy in balance so that unemployment comes down and comes down quickly to full employment levels is the lexicographically prior task of macroeconomic policy. Doing other things, including offsetting and repairing any adverse side effects of getting us to full employment, are secondary and tertiary goals to be postponed until after the primary goal of returning the economy to full employment has been accomplished.
I have never understood why policymakers thought different back in 2010—thought that their job was over after the financial crisis had passed. Perhaps there was a false assumption and presumption that the economy would rapidly return to full employment on its own? If so, it was never soundly based on any analysis of history or theory.
I would say that prioritizing full employment is what policymakers have normally done ever since Franklin Delano Roosevelt started his New Deal in 1933. At least, it is what smart policymakers have done. So from my perspective, it is not at all unusual to see policymakers prioritizing the return to full employment and postponing worries about what I see as a very remote possibility of “stagflation” to the future. I think that is a very normal, and proper, thing to do.