Sunday, April 25, 2021

There was NO initial price increase ...

If you have cost-push inflation explained as a "wage-price spiral" it is easy to picture me and my boss, each in turn, getting an increase: first my wages, then his prices, then my wages again, and so on.

But how do we know the spiral started with my wages? The chicken, or the egg?

It is easy for me to accept the "spiral of increase" as a process in motion. But how does the spiral get started? That's the stumbling block.

So okay, I have to go to the boss for a raise because the cost of living is going up. But no: We're already mid-spiral at that point. The cost of living has already gone up. The process is already in motion. The cost-push doesn't start with me. The initial "push" is unexplained.

I think this is why the "oil shock of the 1970s" is so often used as an example of cost-push inflation. Not only was it a sudden "shock" to the economic system, and a massive one, but also it is easy to picture an external force imposing a cost on our domestic economy. It is easy to see this as the initial push that starts a cost-push inflation and a wage-price spiral.

Of course, the Great Inflation of 1965-1984 began in 1965, or possibly earlier, and the first oil shock didn't begin until late in 1973. So there is a possibility that even the oil shock was not the initial push of that inflation. More than a possibility: to my mind a certainty.

And, too, you have explanations like the one George Dorgan offers:

Economists commonly explain the rising oil price between 1998 and 2008 as due to the growth of emerging markets. They classify the resulting inflation as demand-pull inflation. We argue that the cost-push inflation of the 1970s was also a reflection of rising global demand. For us, oil prices had remained too low between 1950 and 1970. They had to catch up quickly to the reality: with rising deficits and wages in the U.S. The picture only changed with the outbreak of the Yom Kippur War in October 1973.

According to Dorgan, the problem goes back to the 1950s, and the rising price of oil was due to demand-pull, not cost-push. 

So the oil shock of the 1970s may be a good example of built-in inflation and how inflation continues, but it doesn't answer the question of how cost-push inflation gets started.


I have the same problem with built-in inflation and conflict inflation and inflation driven by expectations: These explain why inflation continues, not how it gets started.

This is what makes the inflation of 1955-57 so fascinating, or at least my April 13 explanation of it: It began with an unusual year-long increase in the Labor Force Participation Rate. The supply side was "unprepared for the firehose of new workers" (to use Waldman's phrase) and the effect of the year-long increase on "the returns to experience" (to use Vollrath's) caused a fall in the growth of productivity.

The fall in the growth of productivity meant that business was getting less output per hour, and less output per dollar of wage cost. The fall in productivity growth created rising cost in the business sector.

The initial push did not happen when some guy went to his boss and demanded a raise. The initial push arose from a fall in the growth of productivity. And the fall in the growth of productivity arose from the unusual increase in labor force participation. So we can look two causes back, and still not see increasing cost as the prime mover of the 1955-57 inflation. This is not just fascinating. It is significant. It should lead economists to revise their thinking and their explanations of cost-push inflation.

There was no initial price increase that created the cost increase that started the cost-push inflation of 1955-57.

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