Matthew Yglesias posting in Slate, also gave us a few words on Dylan Matthews’s post about Modern Monetary Theory (MMT). He starts with this thought:
”Is the inflation of the 1970s a myth? I don’t think it was, but something Dylan Matthews’ excellent overview of Modern Monetary Theory illustrates is that some people think it was. That to me is a mistake, and people should try to separate the merits of heterodox macroeconomic theory (which I think are considerable) from a handful of incidental political commitments that its adherents have. The core point of MMT is that if you have a freely floating fiat currency then the sovereign can’t “run out of money” and the point of taxes is to regulate demand not to finance government activities. But even though this is a “heterodox” view, I think few mainstream people would actually deny it. Instead they think that talking in these terms will lead to dangerous inflation. I think that fear is overblown, but not as overblown as Jamie Galbraith thinks it is.”
The 1970s Inflation
Reading this, I had the definite feeling that the old aphorism about people who fight new paradigms and ridicule/marginalize their adherents, and often opine later that there is nothing new there, is all too true. Matty ought to give everyone a break and admit that the mainstream has been beating the drums of insolvency terrorism since shortly after the Obama Administration began and still is. So, mainstream people have been saying that there can be an insolvency problem in very large numbers, and if they are doing so less now, it’s only because any fool can plainly see that austerity is failing all over the world, as MMT predicted when the austerity craze started, and also because many more people are reading MMT blogs than was the case two years ago, and they are beginning to pick up some of the core insights.
To say that “. . . few mainstream people would actually deny it. Instead they think that talking in these terms will lead to dangerous inflation” is to to imply that most mainstream people are elitist liars who have been engaged in deficit terrorism because they thought it was a more effective political tactic than using the inflation bogeyman.
That may, in fact, be true. But I wonder what the mainstream would have to say about Matty’s implication, that its economists haven’t really been being ignorant and dumb; just elitist, dishonest, and manipulative.
I lived through the inflation of the 70s, and I can attest to its reality, and severity for some people, but relatively mild impact for others. I also think that the causes of that inflation were not simply increases in nominal unit labor costs, but increases in interest costs caused by the Federal Reserve’s policies, the actions of the oil cartel, and particularly the Saudis, the activity of speculators, the constraining regulations on Natural Gas production, and the failure of the Carter Administration to employ price controls and rationing due to its neoliberal biases.
The other factors I’ve mentioned were much more important in causing the inflation than rising nominal labor costs, which were primarily reactive to the cost-push inflation caused by the other factors. Government deficit spending had almost no role in the 1970s inflation, which was due much more to cost-push than to demand-pull factors.
Types of Inflation
Matty next quotes Galbraith from Matthews’s article pointing out that we haven’t seen a serious demand-driven inflation since WWI and that one occurred under very unique circumstances unlikely to happen again.
”I think this contains some insight. Unfortunately the standard concept of “inflation” runs together two very different scenarios. In one kind of “inflation”, China abandons Maoist economic policies, its population gets richer, as it gets richer they start eating more meat, and this pushes the worldwide price of meat, dairy, and grains upward. That’s a real thing and it hurts real people in their pocket books, but these kind of global commodity price fluctuations aren’t effectively addressed by demand regulators. And one story some people have about the seventies is that it was just a global commodities issue. OPEC pushed up the price of oil, so we got “inflation” but this is nothing like the World War One case where dodgy government financial practices eroded the value of money.”
To me, this was really an “off the wall” response to Galbraith’s view, since Galbraith was clearly talking about the likelihood of demand-pull inflation inflation occurring in the United States, and was also implying that the Weimar and other WWI aftermath inflations had nothing to do with that policy. Also, in referring to “dodgy government financial practices” in the last sentence, Matty seems to be saying that the Weimar Government was guilty of such practices, but given the size of their Versailles-imposed reparations to be repaid only in goldmarks or foreign exchange, what could the German Government have done to recover from the War, except try the money-printing strategy to try to get the foreign exchange needed? If anybody was guilty of “dodgy financial practices” it was the Versailles peacemakers who, in imposing a Roman peace on Germany, insisted on payment conditions that the Germans could not possibly meet, especially since the French and Belgians seized control of the Ruhr and with it much of Germany’s industrial capacity in 1923.
But, that aside, Matty glosses over the fact that demand regulators can’t very well control worldwide demand-pull inflation in the international economic system from a legislative foundation in a single country, as long as they’re committed to maintaining a free market in the commodities that are the object of such inflation. That is, the China example basically says that when people in many nations other than the US and the previously developed nations get wealthy enough to create greater effective demand on certain commodities in a relatively free market, and that demand outruns supply, then price increases that hurt people will result.
But why is this a criticism or reflection on the MMT view, or what Galbraith had to say? Galbraith and the MMTers have clearly been talking about regulating demand-pull inflation in the United States caused by excessive deficit spending.
Moving to Matty’s example, MMT would certainly predict that when an economic system has no common currency, but a relatively free market in certain commodities, and also limited supply, then increasing demand might well result in inflation. As for the ’70s oil inflation, that wasn’t the result of either a free market or increasing worldwide demand for oil, but rather of the factors I called out above being called into play by the Oil Cartel’s control of the world supply of oil. So, that inflation was an instance of cost-push, not demand-pull inflation, and requires different measures to control.
I hesitate to say what MMT might recommend in the two cases of increasing world-wide demand, highlighted by Matty, because I’m not sure that all of us would say the same thing, nor am I one of the economists developing the MMT approach. But, speaking as someone who’s been researching MMT for some time, in the ’70s case, I would have placed domestic price and wage controls on commodities except on foreign sales to oil exporting countries, where prices of exports would have been pegged to increases in the prices of their oil exports. I would have also recommended de-regulating natural gas, and oil rationing to cut demand for the cartel-restricted supply. I would not have implemented higher interest rates as the Fed did. Until the very end, when the economic system was driven into recession, that only “fed” the inflation fire, while creating “stagflation.” I think such measures, consistent with MMT as I understand it, would have “choked off” the ’70s inflation in a much shorter time than the policies followed in the 1970s and the early 1980s.
As for the present increasing demand on the world’s food supply, that’s certainly not being caused by deficit spending by an International currency issuer, since there is none. And the only remotely similar entity to that is the ECB which is gradually choking off economic activity in the Eurozone to save its financial elites. I think commodity inflation must be fought by Governments legislating and enforcing existing laws against speculation, preventing cost-push inflation of the kind we saw in the 70s using the measures outlined, and by allowing commodity markets to adjust to the need for more supply, or producers to create substitutes for commodities in short supply. I also think control of speculation and market forces will probably suffice to relieve the pressure we’ve been seeing in commodities.
If that fails, however, then Governments whose economies can produce abundant supplies will have to place export controls on commodities necessary for their own populations in order to contain domestic inflation. That will not be popular. But we do still live in a nation state system, and the first responsibility of national governments still is to the general welfare of their own populations. Of course, such measures will result in other nations placing their own export controls on abundant commodities, and nations will have to negotiate bilateral agreements to serve their respective populations.
Unit Labor Costs
Matty Yglesias continues with his remarks about inflation:
”That’s why my favorite indicator of inflation is “unit labor costs”:
“Unit labor costs are basically wages divided by productivity. It’s not the price of labor, in other words, but the price of labor output. If productivity is rising faster than wages, then even if wages themselves are rising, unit labor costs are falling. Conversely, if wages rise faster than productivity than unit labor costs are going up. Clearly there’s nothing wrong with a little increase in unit labor costs here or there. But over the long term, growth in unit labor costs needs to be constrained or else it becomes impossible to employ anyone. And you can see that in the seventies it’s not just that gasoline got more expensive, we had an anomalous spate of high unit labor cost growth. That was inflation and it’s what led to the regime change that’s governed for the past thirty years.”
Now that way of putting things is strange. Not that the general point is wrong, but if real unit labor costs exceed real labor productivity over the long term, that would create survival pressures for business. But, if there was an anomalous rise in labor costs in the 1970s, there was also an initial anomalous rise in the cost of oil before that rise, and later there was an anomalous pattern of interest increases implemented by the Fed that hasn’t been seen before or since, as well as anomalous rises in commodity prices. To read the quote above, one would think that the rise in unit labor costs was itself inflation, rather than just an adjustment of the cost of labor to all the price increases going on around it.
The truth, again, is that the inflation of the ’70s was caused by a complex of inter-related phenomena and the rise in unit labor costs was only one of these. It may have been the one that neoliberals focused on in the ’80s to avoid pinning the blame for what happened on the Cartel, the failures of the Carter Administration and the Fed’s policies, and to claim that the inflation was due to demand-pull factors, but that doesn’t mean that their analysis was correct.
Today, we know that Paul Volcker and Jimmy Carter handled the 1970s inflation incompetently, and we also recognize that the behavior of the Cartel, and the excessive regulations on natural gas made this a cost-push and not a demand-pull inflation, and that the Fed policy of targeting the unit cost of labor as a trigger for raising interest rates for the next 30 years or so was part of its low inflation at the cost of high unemployment policy that it illegally engaged in, in violation of the Humphrey-Hawkins Act. In his post, critiquing Matty’s missive, Steve Randy Waldman (SRW), had the following to say:
“. . . Yglesias has fallen into a trap. Unit labor costs are not “basically wages divided [by] productivity”. That’s not the right definition at all. [See update.] Unit labor costs are nominal wages per unit of output. With a little bit of math , it’s easy to show that
UNIT_LABOR_COSTS = PRICE_LEVEL × LABOR_SHARE_OF_OUTPUT
An increase in unit labor costs can mean one of two things. It can reflect an increase in the price level — inflation — or it can reflect an increase in labor’s share of output. The Federal Reserve is properly in the business of restraining the price level. It has no business whatsoever tilting the scales in the division of income between labor and capital.
Yet throughout the Great Moderation, increases in unit labor costs were the standard alarm bell cited by Fed policy makers as an event that would call for more restrictive policy. And all through the Great Moderation, except for a brief surge during the tech boom, labor’s share of output was in secular decline. (More recently, the Great Recession has been accompanied by a stunning collapse in labor share. Record corporate profits!)”
SRW continues his discussion in this vein pointing out the Fed’s hawkishness on unit labor costs has had a heavy constraining influence on the presidency because Presidents have wanted to be very careful about economic policies that might increase unit labor costs and cause the Fed to activate contractionary reactions. He says further:
“. . . . In this environment, the decline of labor unions and their shift in focus from wage growth to working conditions was understandable. If workers won on wages, they would lose when the recession put them out of work. As long as wages were contained, monetary policy was “accommodative”, and workers could supplement their purchasing power with borrowings and asset appreciation. During the Great Moderation, wage growth was rendered obsolete. A superior means of middle class prosperity had been invented. Or so it seemed, until we experienced the toxic after-effects in 2008. Now we have grown skeptical of debt-fueled pseudoprosperity. But the covert hostility to wage growth that underpinned Great Moderation monetary policy remains unchallenged.
“I imagine some readers saying to themselves, “But still. If the labor cost of ’stuff’ is allowed to grow, how can that not be inflationary? It’s common sense.” And that’s true, as far as it goes. But if the capital cost of stuff grows, that must also be inflationary. Suppose we define the complement to unit labor costs, unit capital costs. Unit capital costs might be defined as “business profits per unit of output”. Would it be politically tolerable in the United States to have a central bank that prevented expansions of business profit per unit sold? Is restraining profitability of investment a proper role for a central bank? If suppressing returns to capital would be improper, why on Earth do we tolerate a central bank that opposes returns to labor?”
Very good questions. Why have we allowed the Fed aided by presidents to implement policies that increase returns to capital, but suppress returns to labor? Is this what Americans think has been going on and what they approve, or has this been made possible only because of “the independence” of the Fed, its systematic lack of transparency to the public, and the unwillingness of Presidents to contest the power and “independence” of the Fed either legally or informally?
Time for a Change in Regimes?
Even though Matty Yglesias seems convinced of the importance of increases in nominal unit labor costs as a primary cause of inflation needing to be constrained in the long run, he, nevertheless agrees with SRW and I that the approach to constraining such costs that the US has followed for the past 30 years and more cannot be continued. He says:
”In the wake of the Great Recession, I think we need another change in regime. We can’t continue with an approach that always delivers on price stability but frequently leads to prolonged spells of mass unemployment. But I think to push for that regime change credibly, people need to acknowledge what went wrong in the past and need to explain why it won’t happen again. I would say, for example, that one of the great virtues of the more globalized economy of 2012 rather than 1972 is that the freer flow of goods across borders makes inflation much less likely.”
I agree that the approach we’ve been following won’t do, and with SRW’s notion that Fed policy should not be biased in favor of returns to capital and against returns to labor. It is very plain to me that the severe economic inequality that has developed in the United States, and that now threatens our democracy, is in great part due to the Fed’s policies in past decades and to its fixation on inflation control. But I also think that changing these policies to ones that would be more neutral won’t work to redress the inequality that has already been created. What needs to be done instead, is to positively bias Fed policy toward returns to labor for some time to come, as part of a more comprehensive policy to lessen the levels of economic inequality that beset the American social, economic and political systems.
I also agree with Matty Yglesias’s call for people to acknowledge what went wrong in the past and to explain why it won’t happen again. But as I said earlier, my thinking about what went wrong in the ’70s, and also MMT thinking about it are both very different from his. As a result, I think corresponding explanations of why it won’t happen again are likely to be very different also. Again, I don’t think what we have to acknowledge is that increases in unit labor costs caused the ’70s inflation.
In fact, I think that is a very partial, and therefore false narrative of what happened then. And I’m afraid I also think that Matty ought to take his own advice and acknowledge the roles of 1) the Cartel, 2) the Federal Reserve, and 3) the Carter Administration as all being much more important in the severity of that cost-push inflation then the rise in unit labor costs was.
And, I think an explanation of why that is unlikely to happen again, will have to be conditional on the wisdom of future Federal Reserve Governors and Presidents in providing the right responses to any reconstitution of the Cartel, or aggressive moves by the Saudis and oil speculators to drive prices up. If the ’70s are not to happen again, it will not be enough to rely on the more globalized economy of 2012, with its cross-border competition among workers, creating a race to the bottom in wages, and untoward returns to capital.
The Federal Government will have to be much more aggressive in implementing a response, recognizing that an inflation like that in the 70s would be cost-push and not demand-pull. And that to manage it, policies that choke off government deficit spending, and tighten credit, will be much more costly than policies involving trade retaliation, price controls, rationing, substitution of commodities subject to cost-push, and above all continuous and very substantial investments in government programs developing alternative energy sources.
(Cross-posted from Correntewire.com