David R. Henderson  

Chapman on Inflation

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One thing I've always liked about Chicago Tribune columnist Steve Chapman's writing is its high degree of sophistication in economics relative to the usual in regional and even national newspapers. Exhibit A is his column today on inflation. He brings together a lot of strands that bloggers like Scott Sumner and Paul Krugman have been blogging about and does it tersely and accurately. Although I think his bottom line is very slightly overstated, the whole piece is an excellent polemic. And if you think I'm using the word wrong, check the dictionary. Many people use the word "polemic" to include the connotation of bias. That's not what it means.

The two best paragraphs:

But gold prices were also on a rocket during the previous eight years. And they were not a portent of raging inflation. During the administration of President George W. Bush, the consumer price index rose at an average rate of less than 3 percent per year -- while gold was tripling in value.

Oil and other commodities, believe it or not, can be affected by events that don't occur in the United States. Bentley University economist Scott Sumner, who sees no chance of an inflation outbreak, attributes rising prices for oil and other goods to strong demand in developing countries, particularly China.


One other excerpt:
Investors wouldn't be snapping up three-year Treasury notes at 1 percent if they were expecting their purchasing power to be ravaged by wolves any moment now.


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COMMENTS (20 to date)
Tom writes:
The spike in commodity prices has raised fears of a '70s-like wage-price spiral: Prices climb, so workers demand pay raises, which causes their employers to raise prices again, which sparks another round of wage increases.

But you can't have a ham sandwich without ham, and you can't have a wage-price spiral when unemployment is high, workers have little bargaining power and pay is stagnant.

This would be meaningful if it weren't for the numerous bouts of high -> hyper inflation accompanied by high UE (above the natural rate). The simple fact is that the high inflation rate of the 1970s- that he cites- occurred in concert with, wait for it, high UE! If I recall correctly the UE rate was >5% from the beginning of 1974 through the early 1980s with spikes hitting >10%.

In fact are there ANY examples of high inflation that don't coincide with UE above the "natural rate"?


The major flaw in this lazy approach is that is assumes that UE is spread equally across all sectors and not concerntraded as many (including your co-blogger A. Kling) have shown. Concerntrated UE means the bargining power of a small subset is harmed but doesn't imply that areas in which there is little UE- education, health care- will suddenly see competition due to large numbers of construction workers with no credentials trying to get a job.

Effem writes:

Do you make no distinction between different types of inflation? The word "inflation" by itself means almost nothing to me. If wages fall 20% and oil rises an offsetting amount to leave the overall CPI at +1% are we really in a simple "low inflation" environment that requires more of the same policies?

Granted, we are not in that extreme position today but we are also not in an ordinary inflation environment. Wages and homes are falling while commodities, health, and education are rising. Is this really benign? Doesn't feel that way to me.

David R. Henderson writes:

@Tom,
You missed the point. The point is not that you can't have high inflation with high unemployment. You can, as we did in the early 1970s. The point is that you can't have a wage-price spiral with falling or constant nominal wages.
@Effem,
I wasn't talking about policy should be. Nor was Steve. We're talking about future inflation. Actually, though, if nominal wages fall, that will help get us out of this high unemployment situation.

Costard writes:

Like Krugman, this author has a blind spot the size of China. The sequestration of dollars by our trading partners - and the increasing imbalance in forex - has had a DIRECT impact on "core" inflation. Capital markets have been the true measure of the dollar, and their message is as clear now as it was during the housing bubble. Is it any surprise that those who ignored asset bubbles five years ago, continue to ignore them? Was the crisis any less real on account of CPI's gentle ride?

This blind spot somehow does not extend to deficit spending, where Krugman and the rest are quick to point out that there is no "crowding out" of private investment, on account of foreign buyers of the extra debt.

With that being said, speculators are going a bridge too far. The watched pot will not boil until forex rebalances, which (despite their rhetoric) the export nations will avoid as long as they can. Until then, deflationary forces rule the day. QE will only pump this thing so far. Krugman will be right before he is catastrophically wrong, and his "I told you so" will probably be the blackest part of this whole escapade.

Badger writes:
But you can't have a ham sandwich without ham, and you can't have a wage-price spiral when unemployment is high, workers have little bargaining power and pay is stagnant.
It's shocking to me to realize how fast economists have forgotten the 70s. Is it complacency or denial?

Inflation can arise even if unemployment is high. Usually, it will come before wages rise, and wages rise as workers that remain employed and have some bargaining power try to recover their losses. They never do it fully, naturally.

Economists that believe that stagflation doesn't exist should take a crash course in Latin-American economics. The ones in the Fed need it right now.

Eric Larson writes:

Costard=Cogent

David R. Henderson writes:

@Badger,
I haven't forgotten. Read my response to Tom above.

David Pearson writes:

One implication of the "flat wage" scenario is that there will be little inflation pressure beyond commodity price pass-through. This means the Fed is heavily dependent on commodity price increases when it comes to maintaining 2%+ inflation expectations. In other words, the Fed effectively ends up targeting commodity prices as long as employment growth is less than robust. This has distributive effects: the broad, over-levered middle class suffers from declining real wages and house prices; meanwhile, the rich get the lion's share of the benefit from higher financial asset prices. Unfortunately, we don't see much evidence of a "Tobin's Q" effect (and follow-on employment) resulting from those same high asset prices. No wonder: government-induced price distortions are hardly a foundation for long term investments.

Badger writes:

@David
Flat or decreasing nominal wages won't stop inflation in a true stagflation scenario. Typically, stagflation is caused by a supply shock outside of the wage chain that will shutdown economic activity and lead to higher prices of e.g. commodities. Fight for jobs will lead initially to stagnation of wages for a few years. It's when the new NAIRU sets in at a higher level, and the central bank keeps making the mistake of fighting supply shocks with monetary expansion, that inflation will finally appear. It takes a few years by the way for inflation to set in.
Now, because of inflation, organized labor and professional/technical/white collar staff will start fighting for nominal wage increases to recover wage losses. And normally they get some of what they ask for (see the old literature on labor bargaining under high inflation).
Want proof? You don't hear "recover price losses" complaints during stagflation episodes in deregulated sectors, the complaint is always about "recovering wage losses."
This that I describe is exactly what happened in the 70s and 80s in Latin America.

Badger writes:

To make it simpler, what I mean is that "wage recovery" bargaining can happen even under high unemployment and low growth because the segments of the labor force that remain employed usually have enough bargaining power to obtain nominal wage increases under a lax monetary policy. That's exactly what defines a sustained stagflation scenario, and it has happened many times in the past in many different nations.

Effem writes:

@David

I think the evidence is proving this notion wrong...

"...if nominal wages fall, that will help get us out of this high unemployment situation."

Isn't the logic as follows - wages that are "too high" hurt profits and therefore prevent job creation? Therefore if wages fall profits are restored and hiring will ensue. Well, we are now at record corporate profitability with little in the way of hiring. What is the argument for further declines in nominal wages? Is there another mechanism besides increasing profits? I doubt it.

Tom writes:

David-

He specifically states

The spike in commodity prices has raised fears of a '70s-like wage-price spiral

And then refutes it with

But you can't have a ham sandwich without ham, and you can't have a wage-price spiral when unemployment is high

So either he thinks that the 1970s DOES represent a wage-price spiral, in which case his assertion that a W-P spiral can't happen with high UE is flatly wrong

OR

The 1970s does not represent a W-P spiral- in which case he does not address what caused inflation in the 1970s and has not refuted concerns that 1970s style inflation could be coming- and he is a horrible writer since the wording directly leads one to believe that the 1970s was a case of a W-P spiral.

Its pretty cut and dry one of those two has to be the case.

David R. Henderson writes:

@Effem,
No. That's not the reasoning. The reasoning isn't about profitability. It's about thinking on the margin and the law of demand. At a lower real wage, ceteris paribus, more people will be employed.
@Tom,
If Steve Chapman had said only what you quoted him as saying, then I would agree with your criticism. But you truncated the quote. Here's what he wrote:

you can't have a wage-price spiral when unemployment is high, workers have little bargaining power and pay is stagnant.

It's the stagnant pay factor that is most relevant.

Tom writes:

David,

I still fail to see the point.

A- Chapman specifically refers to the 1970s as a period of inflation caused by a wage price spiral.

B- He also states that a Wage price spiral cannot happen with high UE

But the 1970s had both high inflation- which he attributes to a wage price spiral- and high UE. It doesn't matter the reasons that he gives for it being impossible since the example he gives cleary shows that it is possible.

This leaves one with the conclusion that either his approach is wrong and that a W-P sprial CAN happen with high UE or that the inflation in the 1970s was not caused by a W-P spiral.

David R. Henderson writes:

@Tom,
I did my best. Sorry if it's not clear.

David Pearson writes:

David,

If stagnant pay growth constrains a wage-price spiral, it also constrains the effect of monetary stimulus on RGDP. In other words, you cannot argue, "don't worry, the Fed's stimulus will not cause high inflation", without also conceding, "the Fed stimulus will also not drive a strong recovery."

My conclusion: eventually Badger will be right. The Fed will go through iterations of failed stimulus ("start-stop growth") before it finally targets nominal wage growth. At that point, a wage price spiral could occur along with high unemployment.

Costard writes:

Badger - it depends upon labor mobility in any given nation. Anywhere where the barriers to job entry are high could see such a situation. It would not surprise me if this is the case in Latin America, where the governments have their hand in everything and many workers don't have the means or connections to change location or chase jobs. You'd have a hard time arguing for this in the US, though, outside of the peculiar world of municipal, state and federal employees who are rarely, and often cannot easily be, fired.

David P - how would the Fed target nominal wage growth? What tool could they employ to force consumption spending, core inflation and the rest? Stimulus legislation might do this, but not liquidity injected into capital markets, which will only pour into capital assets or into the cracks in banks' damaged asset bases. In a normal market we would see a trickle-down into consumption and wage rates, but we have seen less of this the past few cycles, and it seems like that we will see none of it in the near future. Debt-for-consumption is simply maxed, and cash isn't going into business creation but into balance sheets and commodity markets. Higher commodities will raise prices, but to whose benefit, and at what political cost?

Effem writes:

Why must labor bear the brunt of unemployment via lower wages? Couldn't we just as easily say that corporate profit expectations are too high and that is where the adjustment needs to be made? I find it disconcerting that labor has been steadily devalued for decades while corporate profits have steadily increased for decades - yet when now faced with record profits and high unemployment we once again go back to the same solution - devalue labor to the benefit of corporate profits. I can understand why the average person is losing faith in the system (and economists).

Tom writes:

Someone recently wrote that those complaining about high inflation and hyper-inflation is like someone yelling fire during Noah's flood. Well we may not be in Noah's flood anymore, but it just stopped raining and the flood water have just receded. With QE2 ending, inflation should be less of a concern and the greater concern should be on anemic economic growth and high unemployment.

David R. Henderson writes:

@Effem,
You ask, "Why must labor bear the brunt of unemployment via lower wages?" That's not what's going on. The way not to bear the brunt of unemployment, that is, the way to be employed, is to take a wage cut.

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