"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

Tuesday, April 13, 2021

Answering an old question

What caused the creeping inflation of 1955-57?


  • LFPR = Labor Force Participation Rate

  • Rising LFPR as a cause of falling productivity

    1. Dietrich Vollrath:
      "The late 1960s/early 1970s coincide with the flood of Baby Boomers into the labor market. Are the returns to experience much more severe than we think from Mincer regressions, and so their entry lowered productivity growth before creating a spike in the late 90s as they really reached their peak?"
    2. Steve Randy Waldman:

      "The crucial economic fact of the 1970s is an incredible rush into the labor force... What was stagnant in the 1970s was productivity, which puts hours worked beneath GDP in the denominator. Boomers’ headlong rush into the labor force created a strong arithmetic headwind for productivity stats."
  • Falling productivity as a cause of inflation

    1. Janet Yellen:
      "My reading of the evidence suggests that the predominant medium-term effect of a slowdown in trend productivity growth would likely be higher inflation."
    2. Tejvan Pettinger:
      "If firms become less productive and allow costs to rise, this invariably leads to higher prices."

  • Rising LFPR => Falling Productivity => Rising Inflation

    1. Hank M. Gracchus, Jr.:
      "A change occurred in the late 1960s / early 1970s, however, as labor productivity slowed. Under the then-current regime, labor income continued to grow in line with the economy, maintaining its share of total income. Because productivity was no longer rising as much as previously, though, the return on capital consistent with a constant share of total income could not deliver an adequate rate of return – a profit squeeze ensued. This drove firms to increase prices, leading to larger wage demands and cost-push inflation."
    2. Waldman's "Not a monetary phenomenon":
      The root cause of the high-misery-index 1970s was demographics, plain and simple... The nation faced a simple choice: employ them, and accept a lower rate of production per worker, or insist on continued productivity growth and tolerate high unemployment... The result was high inflation, and would have been under any scenario that absorbed the men, and the women, of the baby boom in so short a period of time.
  • Comments at Waldman's

    1. slotowner writes: "I am concerned..."

    2. Unanimous writes: "As slotowner says, the history of a single episode is not really proof."

    3. Steve Randy Waldman writes: "slotowner — Unfortunately, stats for the civilian labor force begin in 1948. We have just one big boom to look at."

    4. And, importantly, Steve Randy Waldman writes: "Unanimous — I agree that one episode is not a proof of anything, but despite that, the episode in question provoked massive and in my opinion unwarranted and very destructive changes in the views of macroeconomists. I’m trying to counter those changes here. I think the evidence for a demographic explanation is at least as strong as any evidence of misguided policy, and that post-Volcker triumphalism may well just be the fundamental attribution error in action."

There was a short-lived but extremely rapid increase in the Labor Force Participation Rate in 1955:

Graph #1a: Labor Force Participation Rate

Graph #1b: Percent Change from Year Ago, LFPR

Graph #1c: Detail Showing the Extraordinary 1955 Increase

I do not know why this anomalous increase occurred, so the thoughts that follow could be ridiculous.

There was a drop in the labor productivity growth rate that appears to be related to (and perhaps even caused by) the LFPR increase. The productivity drop does not appear to extend beyond the 1958 recession, but I couldn't say:

Graph #2: Labor Productivity, quarterly, 1950-1962

Using the initial "bounce" of growth, which typically follows recessions, as start- and stop-points for short-period comparison, Real GDP growth between bounces of the 1954 and 1958 recessions was noticeably low, relative to earlier and later periods:

Graph #3: Average of Annual RGDP Growth Rates, Including Bounces

Omitting the fore- and aft-bounces from the calculations, the average of annual growth rates shows an undeniable low between the 1954 and 1958 recessions:

Graph #4: Average of Annual RGDP Growth Rates, Excluding Bounces

In evaluating RGDP growth in the 1950s, keep in mind the high growth rates that were common in the early post-WWII period. This graph highlights RGDP growth during and after the 1955 LFPR increase:

Graph #5: Real GDP Growth, 1950-1962

There was, despite the slow economy, an unexplained "creeping inflation" during 1955-57. I want to say that, acting through a decline in productivity, the 1955 increase in the Labor Force Participation Rate was responsible for this inflation:

Graph #6: Three Measures of Inflation, 1950-1962

The deflator starts rising a bit early, but the PCE price index bottoms out in 1955:Q1, just where you might expect, and the CPI rise starts after June 1955.

Writing of Samuelson and Solow's 1960 paper, James Forder said:

The question they were addressing was that of the explanation of the inflation of the 1950s – particularly the period 1955-57 – and the implications it had for macroeconomics.

Nearing the end of their paper, Samuelson and Solow wrote:

We have concluded that it is not possible on the basis of a priori reasoning to reject either the demand-pull or cost-push hypothesis, or the variants of the latter such as demand-shift.

If they couldn't distinguish what type the inflation was, it's got to be safe to say they could not identify the cause of the inflation. 

They wrote in 1960. It's been a long time. Far as I know, which isn't far, I admit, the cause of the 1955-57 inflation was never discovered. It is still an open question: What caused the creeping inflation of 1955-57?

The cause of that inflation was the 1955 increase in the Labor Force Participation Rate. 

So that makes twice that an increase in LFPR created cost-push inflation by causing a fall in productivity. Twice in the US data.


The link to the Excel file with the "bounce" graphs

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