"We cannot, as a community, provide for future consumption by financial expedients but only by current physical output. In so far as our social and business organisation separates financial provision for the future from physical provision for the future so that efforts to secure the former do not necessarily carry the latter with them, financial prudence will be liable to diminish aggregate demand and thus impair well-being..."
   -- J.M. Keynes

"Expansion of Federal debt leads to expansion of private-sector debt, but private-sector debt is already so big and costly that it undermines the effectiveness of the "boost" provided by big new public spending. This problem cannot be solved by additional government spending. It can only be solved by reducing private-sector debt."
   -- Arthurian

Sunday, May 9, 2021

The role of wages in the 1955-57 inflation

The first result returned by my search for the creeping inflation of 1955-57 was Employment, Growth, and Price Levels: The effects of monopolistic and quasi-monopolistic practices, dated September 1959, from the Joint Economic Committee of Congress.

The text returned by the search:

But the major thesis of this paper is that the creeping inflation of 1955 – 57 is different in kind from such classical inflations , and that mild inflation may be expected in a dynamic economy whenever there occur rapid shifts in the mix of final ...

which turns out to be part of a statement by Charles L. Schultze, who we saw this past January in another publication of the Joint Economic Committee.

The inflation was "different in kind" from the classic demand-pull inflation, Schultze says. He gives me something to live for.

Schultze and Google Search open a door and leave it open for me and my thinking on the cost-push problem. And then Schultze says

Similarly there is no attempt here to prove that autonomous upward pressures of wage rates have had no impact on the price structure. Such pressures may have played a role in recent inflation.

And I suddenly wanted to show that wage rates played no role in that inflation. I don't know where this comes from, but my mind went instantly to Components of Corporate Cost, from 2010, where I show corporate compensation of employees falling as a share of corporate costs (as measured by corporate deductions) for the 1948-2007 period.

And then instantly to my list of FRED data that I usually use for labor productivity...


 ... and yes, the list has business sector compensation and business sector current dollar output. And if I look at the ratio of those two I can see the nominal cost of labor relative to the nominal price of output. And yes,

Graph #1

labor cost goes down from start to finish, so: No, wages have not been gaining on prices. And hey, that graph looks an awful lot like labor share.

Graph #2

Yes it does. Exactly like Labor Share.

The other components that make up the price of output are nonlabor cost, and profit. I found that data not long ago. I'll have to find it again.

But oh, there is a sharp down-and-up after the 1954 recession. That'll be involved in the 1955-57 inflation. Here, look at 1950-1962:

Graph #3

The plotted line drops down to a low point after 1954. That low point is First Quarter 1955, early in the year-long rise of the labor force. The line reaches its next high in second quarter 1956. Most of that increase occurs in 1956, the year after the year-long rise of labor force participation.

Checking compensation per hour:

Graph #4

The low point in the middle of the 1954 recession is 1954 Q1. The line drifts down to a low in 1955 Q4, then rises to a peak of more than 8% in 1956 Q4. So wages did go up, but not until 1956. This confirms what we saw on Graph #3.

Wages didn't go up until 1956. But prices were already going up early in 1955:

Graph #5: Three Measures of Inflation, 1950-1962


It wasn't wages that got the 1955-57 inflation going. It was the year-long increase in labor force participation that occurred in 1955. And the unusually large increase in employment in 1955 and '56 and into '57:

Graph #6

The large increase in new, unskilled workers. They came at a bargain price, but hiring them led to a fall in productivity that increased business costs and started the 1955-57 inflation.

Friday, May 7, 2021

High contrast

From Wikipedia:

Say's law has been one of the principal doctrines used to support the laissez-faire belief that a capitalist economy will naturally tend toward full employment and prosperity without government intervention... Say's law was generally accepted throughout the 19th century... John Maynard Keynes argued in 1936 that Say's law is simply not true...

From Milton Friedman's presidential address to the  AEA, 1967:

These theoretical developments ... did undermine Keynes' key theoretical proposition, namely, that even in a world of flexible prices, a position of equilibrium at full employment might not exist. Henceforth, unemployment had again to be explained by rigidities or imperfections, not as the natural outcome of a fully operative market process.

 

Consider the contrast between Keynes's rejection of

the laissez-faire belief that a capitalist economy will naturally tend toward full employment and prosperity

and Friedman's rejection of Keynes:

Henceforth, unemployment had again to be explained by rigidities or imperfections, not as the natural outcome of a fully operative market process.

Keynes rejected the view that "full employment" is the economy's natural state. Friedman rejected the view that it isn't.

Wednesday, May 5, 2021

David Hume did not assume full employment.

Inflation and Disinflation in Turkey, edited by Faruk Selcuk, Libby Rittenberg, Aykut Kibritcioglu:

O'Brien (1975) argues that there are some differences between transmission mechanisms in classical and neoclassical versions of QTM. The neoclassical model is based on the assumption of full employment, and is characterized by a dichotomy between the real and monetary sectors. Real wages will be determined in the real sector (labor market) while nominal prices are a function of the money supply. Therefore, increases in the money supply increase the general price level by leaving the volumes of goods demanded and supplied, and hence, real output unchanged. 
On the other hand, O'Brien writes, some classical economists like David Hume do not assume full employment and there is no room for a dichotomy. According to Hume, an increase in the money supply does not increase the general price level through a different transmission mechanism. The increase in nominal cash balances of economic units initially results in higher expenditures for goods, and hence, in higher production. Then, under the assumption of underemployment, prices start to adjust to risen money supply. As a result, money is not neutral as in the neoclassical model; it has also some real effects in the short run.

 
David Hume did not assume full employment. 

Milton Friedman did. Friedman in The Counter-Revolution in Monetary Theory, page 8:

If the government gets the funds by borrowing from the public, then those people who lend the funds to the government have less to spend or to lend to others.


Those who lend to government have less to lend to others.


Q: At what time in history (since Charlemagne, say) would lending to others have reached its "full employment" stage?

A: It would have to be the time that Keynes referred to in Chapter 23 as "the greatest age of the inducement to investment" and in Chapter 21 as "a period of almost one hundred and fifty years" when "rates of interest were modest enough to encourage a rate of investment " that was "consistent with an average of employment which was not intolerably low."

"[N]othing short of the exuberance of the greatest age of the inducement to investment could have made it possible to lose sight of the theoretical possibility of its insufficiency."
-- J.M. Keynes

At such a time, it would have seemed that "full employment" had been achieved.

When, exactly? I'd say from the publication of The Wealth of Nations to the First World War: the 138 years from 1776 to 1914.

During that time, it seemed reasonable and natural to think full employment had been achieved. Investment was viewed with an optimism that now seems unnatural. It seemed self-evident that "supply creates its own demand". And economists lost sight of the theoretical possibility that investment could be insufficient.

However, economists this side of the first World War have no such ready justification for assuming full employment.


If you think of civilization as a massive business cycle some 2000 years in length, the 150 years of the "greatest age" make a nice high point. This coincidentally puts Charlemagne just at the bottom, where he was busy starting the upswing of the cycle.

This is why the economy changes: It is part of a massive cyclical phenomenon. Economic forces change and sometimes fade; and other driving forces (religious, political,  military, and irrational) may also each have a dominant phase. But the cycle is a handy framework for thinking about the economy.

And if you think of economic forces as among the forces that drive the cycle, you can see why David Hume (1711-1776) did not assume full employment, and perhaps why J.B. Say, just a little later, did.

It also becomes obvious that Milton Friedman shouldn't have. Nor should we.

Monday, May 3, 2021

And Friedman would be wrong.

 

"Friedman rejected cost-push as a credible source of sustained inflationary pressure."

 

If you reject the possibility of cost-push, only government remains as the cause of inflation.

 


But if the problem is cost-push, the focus on inflation is the wrong focus.

Saturday, May 1, 2021

Labor force growth and labor productivity

The relation between labor force growth and labor productivity? I don't know. So I went looking.


Crazy Explanations for the Productivity Slowdown (PDF, 40 pages) by Paul M. Romer

For the explanation of the productivity puzzle, the key implication of this revised interpretation of growth accounting is that an increase in the rate of growth of labor will be accompanied by a fall in the rate of growth of labor productivity. This may explain the productivity slowdown in the United States since the 1960s...

 

Determinants of Labor Productivity: An Empirical Investigation of Productivity Divergence, by Misbah Tanveer Choudhry, University of Groningen, The Netherlands

We  analyzed  the  determinants  of  labor  productivity  for  the  group  of  40  countries,  representing   four   different   income   groups   in   the   world.   This   study   confirms   the   diminishing return to labor force participation rate both in short run as well as in the long run. We find that negative impact of increased  labor  force  participation is high in lower and lower middle income economies compared to high income and upper middle income economies.


WHY HAS THE EMPLOYMENT-PRODUCTIVITY TRADEOFF AMONG INDUSTRIALIZED COUNTRIES BEEN SO STRONG? by Paul Beaudry & Fabrice Collard. Working Paper 8754

Neoclassical growth theory predicts that, along a transitional path, countries with higher rates of labor force growth should exhibit less labor productivity growth due to the need to use scarce capital to equip new workers.

Thursday, April 29, 2021

Separating the cost-push from the inflation

Mine of the 27th is about how the growth of one sector of the economy (relative to the rest of the economy) can create cost pressure that tends to cause cost-push inflation... One sector, like "government" or like my favorite target, "finance".

Mine of the 25th is part of a series about how a decline of labor productivity (caused by labor force growth) may create cost pressure that tends to cause cost-push inflation.

Both posts are about cost-push inflation arising from some source other than rising prices (like the price of labor). In neither post does the cost pressure initially arise from rising prices that must be paid.

  • Sectoral growth can create pressure simply because there are more transactions -- more people paying taxes, for example, or more people borrowing money. The cost pressure can arise even without increases in tax rates or interest rates. I say this all the time about interest rates versus the amount of debt on which interest must be paid.

  • Falling labor productivity creates pressure not because it increases wage rates, but because it reduces the output that labor creates. The cost is generated internally, within the business itself, and passed on from there. 

I'm tempted to say that in *no* case does the cost pressure initially arise from rising prices that must be paid. But I can't imagine that's 100% true.

 

I notice that, more and more, I am separating the "cost-push" problem from the "inflation" problem in "cost-push inflation".

The "cost-push" problem -- the cost problem -- may arise from unusual circumstances like extremely rapid increase in the Labor Force Participation Rate for a year, say, or persistent, long-term growth of the financial sector, or perhaps from other causes.

The "inflation" problem arises when some change in "money" makes possible an increase in spending and aggregate demand, perhaps as a solution to a cost problem or to the "slow growth" problem that arises therefrom.

But we must never forget that of the two, cost and inflation, it is cost that is the greater problem. Cost reduces economic growth. Sustained cost -- which economists have defined out of existence, by the way -- is how civilizations die from suicide.

Inflation may postpone this but does not prevent it.

Tuesday, April 27, 2021

Starry-eyed and hopeful: Unbalanced sector growth as a source of cost pressure

Inflation & the Rise of the Government Sector: An Analytical Survey (1979) by John H. Hotson


Hotson's opening:

That the rise of the government sector in recent decades is the root cause of the inflation which has plagued these same decades is not a thought which has occurred forcefully to many economists.

Hotson's observation, reinforced by the title of his article, offers support for my running argument that cost-push inflation is driven by the growth of finance:
  • Each sector of the economy is a cost to the rest of the economy.

  • The growth of one sector, relative to the rest of the economy, creates cost-push pressure.

  • Unless the central bank relieves the cost pressure by allowing inflation, cost pressure slows economic growth.

  • Sector growth is liable to be a long-term phenomenon, so that the containment of inflation is likely to create long-term slowing of the economy, as the developed world has seen over the past 60 years.

Hotson reinforces his observation with a quote from Robert Heilbroner:

When we look at the historical picture, the root cause of the recent inflationary phenomenon suggests itself immediately. It is a change that profoundly distinguishes modern capitalism from the capitalism of the prewar era - the presence of a government sector vastly larger and far more intimately enmeshed in the process of capitalist growth than can be discovered anywhere prior to World War II ...
I would change two of Heilbroner's words to one:

... the presence of any sector vastly larger and far more intimately enmeshed in the process of capitalist growth than can be discovered anywhere prior to World War II ...

and that about sums it up.

One measure of size, commonly used as a measure of problems related to government, is the size of the debt. Here's an old graph of total debt, and five components of it, shown relative to GDP:

From my blog post of 23 January 2010
Original Graph by CONTRAHOUR at Seeking Alpha, 28 Jan 2009

 

The graph doesn't show where we are now. But it does show what happened during the time the economy went from "good" to "bad". I'll paraphrase what I said about it before: 

The topmost plotted line shows total debt. On the right-hand side of the graph, the next line down from the top is "Domestic Financial" debt.

On the right-hand side, the most recent numbers show domestic financial debt is the largest component of the debt. On the left-hand side, the graph shows domestic financial debt was the smallest component in the 1960s.

Clearly, domestic financial debt has been the fastest-growing component of our debt.

The growth of one sector, relative to the rest of the economy, creates cost-push pressure. If the sector's growth is natural, it may not be a problem. But if the growth arises from an unnatural cause such as economic policy that consistently favors the growth of finance, it could very easily be a problem, and one most difficult to solve.

Let me paraphrase Hotson's Heilbroner quote:

The graph shows the presence of a financial sector vastly larger and far more intimately enmeshed in the economy than can be discovered anywhere prior to World War II ... When we look at this historical picture, the root cause of the recent inflationary phenomenon suggests itself immediately.

These days, inflation is among the least of our economic problems. Forgive Hotson and Heilbroner their focus on inflation. Hotson was writing in 1979, Heilbroner in 1978. 

Me, I have a somewhat different concern.

Do keep in mind two things. First, economists' diagrams of inflation show that 

  • Demand-pull inflation works itself out through faster economic growth
  • Cost-push inflation works itself out through slower economic growth

Economist Frederic Mishkin explains:

[D]emand-pull inflation will be associated with periods when output is above the natural rate level, while cost-push inflation is associated with periods when output is below the  natural rate level.

The growth of finance creates cost-push inflation, not demand-pull. So we can simplify the Mishkin quote by omitting the "demand-pull" part: Mishkin says "cost-push inflation is associated with periods when output is below the natural rate level." Output "below the natural rate level" means economic growth is slow. Mishkin is saying that cost-push inflation makes the economy slow. 

The economists' diagrams tell us the same thing: cost-push inflation makes the economy slow.

I prefer to think that cost pressure makes the economy slow, and that if they let some inflation occur, the central bank relieves some of that pressure and the economy slows less. But we can go with it Mishkin's way for now, if you prefer.

Mishkin's statement makes sense if we assume cost-push inflation is temporary: We get a few years of slow growth, and then things return to normal. Economic performance returns to the natural rate level.

But if the inflation is sustained, the economy will seem to be permanently below the old natural rate level. Economists will say the natural rate has fallen, and they will lower their estimate of the natural rate. At least, that's what happens with potential output.

The new estimate may bring the natural rate down to the actual growth level. We can, however, expect the cost pressure to continue driving actual economic growth down until it is again below the estimated natural rate. But this doesn't happen because "cost-push inflation is associated with periods when output is below the natural rate level." It happens because cost pressure reduces economic growth.

Maybe we should look at the natural rate as a best-case estimate of growth, an estimate that arises from actual economic performance. The economy doesn't grow slowly because the natural rate is low. It's the other way around: The natural rate is low because the economy is growing slowly.

Furthermore, if cost pressure has made the economy slow but the cost pressure still exists, the economy will slow more.

This is what happens when the inflation is cost-push. It continues to happen as long as the cost problem continues to exist, and it happens whether the central bank allows inflation or not. Do what you will -- abandon Keynesian theory, come up with supply-side policies to boost economic growth, deregulate finance, whatever -- the decline of growth continues regardless, until the cost problem is resolved, one way or another, for better or worse, rising again or falling to ruin.

"And on the pedestal these words appear:
'My name is Ozymandias, king of kings:
Look on my works, ye Mighty, and despair!'
Nothing beside remains..."

Scott Sumner said

I am not denying that growth in US living standards slowed after 1973, rather I am arguing that it would have slowed more had we not reformed our economy.

Yes, the economy slowed. Yes, the reforms helped. But the reforms did not solve the problem. They did not solve the cost problem. And after Paul Volcker solved the inflation problem in the early 1980s, economists quit looking for a cost problem. Instead, they defined "cost-push" out of existence.

And since the reforms did not address the underlying cause of slow growth -- the cost problem created by the continuing growth of finance --  the economy continued slowing despite being boosted by reforms. Things grew worse, and here we are today, starry-eyed and hopeful that the post-pandemic economy will grow enough to somehow justify the inflation we are now being told to expect.

And that's how cost pressure works. Inflation is not the problem we must focus on.


The second thing to keep in mind is the slowdown of economic growth. And that the solution is to reduce the size of finance, the overgrown sector that is the source of the cost pressure. We must also eliminate the policies that induce excessive growth in that sector.