Inflation and unemployment, was: "Sweat Shops"

Topics: Theory
12 Dec 1994

From: "DG Ervan Darnell"

> Really from: Vincent E. Kargatis
> > Dan Dees
> > "full employment" level of 5.8% (a SUPPOSED point were were is is ASSUMED
> > that competetion for a shrinking labor pool increases wages and creates
> > inflationary pressure).
> So this is not an observed effect? I was aware of this explanation;
> perhaps I was silly in assuming it was...

I'm not sure which way you are asking this question. Let me answer it,
whichever way it is though ;-) In the middle of writing this, I see
that Clive gave the moderate's answer, so I'm free to stick with the
monetarists' answer :-)

The vulgar Keynesianism that one can trade off inflation for unemployment
is false. Only in the short run can higher employment be bought with
inflation. The simple reason is that labor appears cheaper than it
really is and so people expand into markets that don't exist once all
prices ratchet up to adjust. Employment then falls back at least as
low as it was before inflation started and everyone is worse off (for
employment and other factors).

In the long run, inflation is *always* a monetary phenomenon and never
a cost-push one. Consider that the U.S. experienced 150 years of
growth with only negligible inflation (I don't mean per year, I mean
total). That all came to end when the government monopolized money in
1918 via the creation of the federal reserve. Then, inflation
started. Short term cost-push inflation can exist until things
equalize. And, of course, your particular living choices can become
permanently more expensive. Since even many libertarians would miss
the point, let me repeat it, no individual price hike can cause
inflation. It doesn't matter if the unions could somehow get double
the wages or if the Arabs start another oil embargo. These things do
*not* cause inflation. Other goods would have to drop in price. The
argument rests on counting dollars in circulation and not anything to do
with producitvity or the changing scarcity of particular goods.

With that as prelude, I want to return to Dan's remarks:

> Thus, we have a "secret society" in the government working to ensure that
> at least 6% of the poplulation seeking work (underestimated by the "employment
> rate" figure statistic, since those who have "given up" are not included,
> along with several other catagories), does not have that work available.

Let me say that for my part, I would abolish the fed, make private
money legal again (meaning currency competition), and put the
government itself on a commodity (e.g. gold) standard. The fed has
made incredible blunders, from greatly aggravating (if not probably
causing) the great depression, to many periods of inflation including
stagflation of the 70's. Clinton is still wanting to appoint more
inflation doves (meaning he doesn't realize Keynes is dead). The urge
to abuse is to great. It should simply be gone.

Having said that, I don't think Dan's comments are a fair reading of
what the fed did. Greenspan is doing a good job. If we could have him
forever, there might even be arguments to keep the fed (for instance,
the California gold rush caused inflation (*)). I conjecture that
Greenspan is operating on the theory that low unemployment is a
necessary harbinger of inflation and that the long term damage would be
greater than less employment now. If the economy changed structurally
in favor of more employment, the short-term correlation factors of
unemployment and inflation would change and the fed would act
appropriately, letting unemployment go even lower.

This is compatible with the monetarist view as well as the cost-push
view. The cost-push view is obvious. The monetarist view is that
lower unemployment may be acting as a leading indicator (though not
causal agent) of real monetary inflation (for example increasing
velocity may be first felt as more hiring). I'm conjecturing this
latter only as a possible mechanism, not one that has been clearly shown
to operate.

(*) Presumably true free market currencies would be based on a basket
of goods, not merely a single commodity. In the past, there were
practical difficulties with using anything other than a single metal to
represent money. Technologically that is no longer true. Banks could
easily create certificates redeemable for (oh say) one barrel of oil,
10 bushels of corn, 1M-hour of electricity, and three votes on the
local city council ;-) Such products would compete and the market
would sort out those currencies which could reasonably be backed and
proved to be the most stable.