IMF/Fed Economists: Fed May Have to Tolerate Inflation to Fix Labor Problem

File under: Keynesians in control

The Federal Reserve may have to push the unemployment rate beyond the point that it starts generating inflation if it wants to heal underlying labor-market weakness, according to a paper written by two economists working at the International Monetary Fund, reports WSJ.

This is the kind of thinking you get if you do not understand basic supply and demand.

Markets clear, including jobs markets, no inflation necessary, as I said in my speech at the New York Fed:

I scratch my head that somehow most of you on some academic level believe in the theory of supply and demand and how market setting prices result, but yet you deny them in your macro thinking about the economy.[...]


I ask you, with presidents actively conducting policies that attempt to defy supply and demand and prop up wages, are you really surprised that wages were sticky downward during the Great Depression?

In present day America, the government focus has changed a bit. In the new focus, the government  attempts much more to prop up the unemployed by extended payments for not working. Is it really a surprise that unemployment is so high when you pay people not to work.? The 2010 Nobel Prize was awarded to economists for their studies which showed that, and I quote from the Nobel press release announcing the award:

 One conclusion is that more generous unemployment benefits give rise to higher unemployment and longer search times.

Don’t you think it would make more sense to stop these policies which are a direct factor in causing unemployment, than to add to the mess and devalue the currency by printing more money?

 I scratch my head that somehow your conclusions about unemployment are so different than mine  and that you call for the printing of money to boost “demand”. A call, I add, that since the founding of the Federal Reserve has resulted in an increase of the money supply by 12,230%.

The paper’s authors are Christopher Erceg and Andrew Levin, Fed board economists on leave to work at the IMF.

WSJ in their report on the paper completely buys into this Keynesian notion of a trade off between price inflation and unemployment:

While there’s no precise estimate for what the natural rate is, economists generally believe that there’s a level for the jobless rate that once crossed will cause inflation to rise.

Well, I guess it depends how you define general. Here's Murray Rothbard, writing in April 1984, not exactly buying into the notion:

 Every time someone calls for the government to abandon its inflationary policies, establishment economists and politicians warn that the result can only be severe unemployment. We are trapped, therefore, into playing off inflation against high unemployment, and become persuaded that we must therefore accept some of both.

This doctrine is the fallback position for Keynesians. Originally, the Keynesians promised us that by manipulating and fine-tuning deficits and government spending, they could and would bring us permanent prosperity and full employment without inflation. Then, when inflation became chronic and ever-greater, they changed their tune to warn of the alleged tradeoff, so as to weaken any possible pressure upon the government to stop its inflationary creation of new money.

The tradeoff doctrine is based on the alleged "Phillips curve," a curve invented many years ago by the British economist A.W. Phillips. Phillips correlated wage rate increases with unemployment, and claimed that the two move inversely: the higher the increases in wage rates, the lower the unemployment. On its face, this is a peculiar doctrine, since it flies in the face of logical, commonsense theory. Theory tells us that the higher the wage rates, the greater the unemployment, and vice versa. If everyone went to their employer tomorrow and insisted on double or triple the wage rate, many of us would be promptly out of a job. Yet this bizarre finding was accepted as gospel by the Keynesian economic establishment.

By now, it should be clear that this statistical finding violates the facts as well as logical theory. For during the 1950s, inflation was only about one to two percent per year, and unemployment hovered around three or four percent, whereas later unemployment ranged between eight and 11%, and inflation between five and 13 %. In the last two or three decades, in short, both inflation and unemployment have increased sharply and severely. If anything, we have had a reverse Phillips curve. There has been anything but an inflation- unemployment tradeoff.

But ideologues seldom give way to the facts, even as they continually claim to "test" their theories by Facts. To save the concept, they have simply concluded that the Phillips curve still remains as an inflation-unemployment tradeoff, except that the curve has unaccountably "shifted" to a new set of alleged tradeoffs. On this sort of mind-set, of course, no one could ever refute any theory.