Current / Economics

The Significance of Shortages

After reading and commenting on Paul Krugman jumping onto the NAIRU/Greenspan/1990s bandwagon, I still have to respond to this:

The NAIRU is, I’d still argue, a useful concept, mainly because it’s a caution against expecting too much from monetary policy in the long run. Much as I want full employment, there is some lower bound on the unemployment rate, a rate that you just can’t achieve on a sustained basis with demand-side policies.

Krugman is channeling Dean Baker, who repeats his admiration for Greenspan’s authorship for the 1990s boom:

But there was a widely held view back in the 1990s, back up by a considerable amount of evidence, that the magic number was close to 6.0 percent. Alan Greenspan had the good sense to ignore this view and allowed the unemployment rate to continue to fall, eventually bottoming out at 3.8 percent in some months in 2000. The result was that millions of people had jobs who would not otherwise have been able to, and tens of millions saw pay increases. And, we had trillions of dollars in additional output.

The gains from lower unemployment contrasted with the risks of higher inflation seem so asymmetric that it is difficult to see why the Fed should move to dampen growth until there is real evidence of higher wage growth and accelerating inflation.

Gentlemen, you sell yourselves far too short. The economic consensus around the period that coincided with William Clinton’s second term in office seems to have congealed on the view that the NAIRU was far lower than previously estimated. I find the argument perplexing—sustained inflation has refused to rear its ugly head in the United States for more than 30 years. This is despite the fact that monetary policy hasn’t been particularly tight at any time since the 1982 recession. Will the economics field ever recognize that beginning in the early 1980s the Federal Reserve’s Open Market policies have become almost entirely supply focused?

The Channel

“Too much money chasing too few goods”—the essence of demand-pull inflation, right? Now consider that cost-push begins with essentially the same qualifier “when there is a decrease in the aggregate supply of goods and services…” Whether the argument is there aren’t enough goods or the supply is decreasing the same circumstance is present—a shortage. Inflation follows, and textbook economics calls for raising interest rates and choking the economy into a recession.

So, how has the Federal Reserve acted since 1985 or so to prevent shortages from occurring and thus prevent incipient inflation? Look past controlling interest rates—who benefits when the Fed engages in open market transactions? Whoever has access to treasury bills, which is another way of saying “the bond market.” Who, pray tell, has the largest stake in the markets? The Fed OMC’s policies flow into the economy through a channel …a channel that runs directly through the financial industry.

What the financial industry decides to do as the Fed’s middleman is key. It can finance and refinance municipal and state-level bonds and other debts. It can lend money at length for Americans to purchase smartphones, which it eschews in favor of loaning money to Americans that desire to purchase cars and housing.

But it has far more impact when it lends to producers. Land is bought and sold for commercial and industrial uses. Farms expand. Factories are built, bought, and eventually Boeing builds bombers to blow buildings up (preferably not on the North American continent or with nuclear weapons).

Late 1990s

Clinton’s second term was defined by a massive tech boom, which rather than just being a stock bubble also involved building an awful lot of buildings and other infrastructure. The effect was to move this graph to the right:


One important caveat: LRAS does not appear.  Aggregate supply rising almost vertically is short-run capacity constraints.

Moreover, this period was marked with less need for governmental financing. Social spending, beyond the self-funding design of the big-ticket items of Social Security and Medicare, wasn’t funded with debt as the federal deficit disappeared for a number of years. This money was free to be plowed back into the tech bubble, constructing infrastructure. The effect was to shift SRAS to the right again…

The hostility  American conservatives display at an increasing tempo currently, almost feverishly, toward loose Fed OMC policy is a little weird once one realizes that American monetary policy is wholly guided by supply-side economics. Contrast this with today’s basket cases. The basic message of NAIRU is monetary policy is responsible for this:

Three Argentine farm associations said their members will temporarily suspend grain and livestock trading to protest agriculture policies in the world’s third-largest soybean producer.

Farmers will halt sales nationwide from March 11-13 to protest government policies on inflation, taxes and export limits that have hurt competitiveness, according to Ruben Ferrero, president of the Argentine Rural Confederation. Two other groups, the Rural Society of Argentina and Coninagro, said they will support the stoppage.

“We need to take urgent measures,” Ferrero said in a phone interview Tuesday. “The government’s policies are wrong.”

…which is starving the Argentines…

As high inflation gnaws away at their purchasing power, many Argentines have altered their grocery shopping habits, changing not only what they buy but where they buy it.

For some, that means abandoning U.S.-style supermarkets (and even bigger hypermarkets) in favor of doing their shopping at smaller neighborhood stores. The changes haven’t escaped the attention of supermarket chains, which are trying to accomodate customers by morphing certain locations into smaller, more accessible estabishments.

“There is no customer who just shops in hypermarkets or supermarkets. The consumer chooses between an increasing number of channels,” says Pablo Lorenzo, head of new formats at the French-owned multinational market chain Carrefour.

…and generating feelings of desperation in Venezuela:

Waiting in line for hours to buy groceries at a supermarket in eastern Caracas, Helena Siso didn’t know or care who was to blame for the acute shortages of consumer goods plaguing Venezuela. She just wanted the government to do something about it.

“This is very frustrating,” said Siso, a 54-year-old doctor’s secretary. “Here I am on my lunch hour and I have to spend three hours in line to buy toilet paper. Tomorrow, I’ll have to come back to get corn flour. I don’t want the government to give me anything, just save me from submitting to these lines and this desperation.”

Siso’s comments were typical of the exasperation many Venezuelans’ expressed after President Nicolas Maduro’s state of the nation address this week in which he defended the socialist model of government but offered no immediate solutions for the country’s deepening economic crisis.

In addition to shortages that have consumers waiting in long lines for sugar, cooking oil, soaps, rice and other items, Venezuela is also in the grips of a sputtering economy and rising inflation that last year averaged 63%, the highest rate in Latin America.

Compare this with the United States, where inflation persistently refuses to reach the Fed’s 2.0% target. Do any economists actually fear that the financial industry won’t flood in should the American economy really take off and the dearth of investment opportunities recedes?

Needless NAIRU

I feel the need to reiterate:

The Econ 101 argument Hanauer contradicts blames (in the textbooks and other writings of freshwater economists) even the minutest wage increases for setting off inflationary storms. But the argument is dead wrong—capacity constriction, not excess demand leads to spiraling price increases. Even using terms like excess demand is at its heart a supply problem; demand is not in excess unless there is insufficient economic capacity to meet demand. Under the circumstances, why would it be more logical to crush down the demand side with wage restrictions (or stating there is a “pent-up demand for wage cuts”) rather than encourage supply expansion?

Just as in this light the normalized reaction to rising wages leads me to bloodletting comparisons, the common wisdom surrounding unemployment and inflation seems, well, unwise. If unemployment drops to such a low level SRAS can no longer expand, that’s still an issue with supply—throwing workers onto the unemployment rolls would be counterproductive after passing what increasingly appears to be the mythical NAIRU.

Can unemployment drop to a point that it pushes up inflation all by itself? Sure, it is theoretically possible, but inflation remains a supply issue regardless. Disruptions such as war, malfunctioning monetary channels, price controls, and resource constraints are much more likely to be the culprit when inflation rears its ugly head.

NAIRU ultimately is a resource constraint, a limit in manpower that is mitigated not only by the fact that there are 2.8 billion human beings living on less than $2 a day for businesses to exploit (if the price is right…say, $3 a day) but the productivity explosion that will accompany the automation/robotic revolution. At that point, the American economy will have a far more difficult challenge to try to surmount—the collapse of the consumer market. Currently, the United States appears to be experiencing a case of reverse demand-pull, “too little money chasing too many goods.” The pressure is definitely on to worsen this trend. More on this later.


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