Antidotes to Samuelson’s Free-Floating Anxiety re Slack and Inflation

August 11th, 2014 at 8:22 am

Just a quick note re the Samuelson piece this AM suggesting that maybe the Fed should raise rates sooner than later. Or maybe not. Actually, all he seems to be saying here is: “maybe they should start fighting inflation now, or maybe they shouldn’t; we can’t really tell how much slack there is; but it would be terrible if inflation spirals out of control; but there’s still at least some slack; so we should just be nervous.”

Actually, that’s not as incoherent as it sounds. We should be nervous as there are good arguments about the extent of slack and the process by which inflationary expectations are “well-anchored” is not well understood. As Dean Baker points out, it’s awfully inconsistent for Samuelson to correctly note economists’ inability to accurately predict these key macro variables in the near term but then in another set of columns base his arguments for entitlement cuts on much longer term forecasts. Consistency does not allow you to believe forecasts when it’s ideologically convenient and reject them otherwise, particularly when the predicted results you choose to believe are decades away.

But what I’ve tried to point out in this space is that our nervousness can be reduced by thinking through two basic sets of points. First, the diminished relationship between slack and inflationary pressures (the flattening of the Phillips curve), and two, the mechanics by which wage growth feeds into price growth. (There’s a critical third reason to be nervous as well: that preemptive tightening kills long-delayed wage growth in its infancy.)

I will not go through these arguments in detail as I have done so in the recent past. On the first point, see here and links therein. I will note that this point re the changing empirics of slack and inflation and widely known and Samuelson should incorporate them. As David Mericle from Goldman Sachs recently put it: “…looking ahead, the flattening of the Phillips curve implies that the inflation costs of misjudging slack—however measured—are likely to be smaller than in the past.”

To be clear, that’s not zero—there is surely still a negative correlation between tightening capacity (reduced slack) and price pressures. But the fact that its magnitude is diminished should be known and incorporated in this type of analysis.

Second, and I’d argue that this point is more important right now, as we—hopefully!—will start seeing long-awaited wage gains as the job market tightens, Samuelson and others need to understand and appreciate at least three mechanisms by which wage gains would not be inflationary, as Baker and I explain here.

To understand why continued support from the Fed is unlikely to be inflationary, consider three factors: the current state of key variables, the mechanics of inflationary pressures and the sharp rise in profits as a share of national income in recent years, with its corollary, the fall in the compensation share.

I posted a chart on the first point over the weekend; the second point refers to the fact that given productivity growth, there’s room for a point-and-a-half faster wage growth without undue pressures on unit labor costs (compensation paid for out of productivity) or price growth; the third point is this:

…there has been a large shift within national income from wages to profits in recent years. In fact, corporate profits as a share of national income were higher in 2013 than in any year on record going back to 1929. The compensation share was the lowest since 1951. Wage growth paid for by a shift back toward to a more normal split between wages and profits is non-inflationary.

So while free-floating anxiety of the type Samuelson serves up today is understandable (though one wishes he’d apply the same appropriate skepticism to longer-term forecasts), it can and should be both informed and dampened by the understanding of the facts portrayed above.

And this argument isn’t just academic: millions of jobs and paychecks depend on it.

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15 comments in reply to "Antidotes to Samuelson’s Free-Floating Anxiety re Slack and Inflation"

  1. Peter K. says:

    I don’t think it’s understandable. Samuelson has always been pushing the policies desired by the one percent at the expense of the rest of the population, no matter the economic context. Unions are no longer as strong as they were in the 1970s. Volcker slammed on the brakes too hard.

    • Robert Buttons says:

      Look at the increasing wealth of the top tier since 2008. The 1% are the folks who benefit most from the current accomodative fed policy.

      • smith says:

        It may be true that the 1% benefit most from current Fed policy. However if Fed policy was the exact opposite (raising rates instead of keeping them near zero), the 1% would also benefit the most. This is not a paradox nor contradictory. The nature of the 1% is to have the ability and the resources to make maximal use of whatever economic environment occurs.
        The thing to keep in mind is that the 99% benefit vastly more from the present Fed policy than the alternative.
        If you have any actual data to contradict this, let us know. But keep in mind if the Fed raised rate now, that would only create conditions for even lower inflation, if not actual deflation.

        • Robert Buttons says:

          Notice the decline in wealth for the bottom 90% coincides with QE

          Notice the massive spike in inequality at the exact point Nixon abolished the gold standard.

          If there was any beneficial relation between wages and inflation, real wages wouldn’t decline, EVER.

          • smith says:

            The first graph is income not growth, and what I notice is a sharp uptick in the share going to the top 10% at the start of Reagan revolution, who with that paragon of liberal virtue, Bill Bradley, the same who helped elect Bush II by challenging Gore, lowered tax rates on the rich and made the rate structure much less progressive. There’s also the misfortune of those in the 90% who were affected by great recession starting in 2007 (it’s more than an understatement to say the downturn in fortunes there had more to do with massive bank failures and millions of jobs lost and not QE ). Do you not know anyone who lost there jobs because of the recession?

            The spike in inequality in 1970 is unlikely related to Bretton Woods. We were off the gold standard since the 1933, Bretton Woods related to foreign exchange, an international gold standard of sorts, more oriented towards trade policy than controlling the domestic money supply. The 70’s rise is more likely a function of volatility in markets, greater swings in the economy, guess who has the advantage?

          • smith says:

            Darn, ‘their’ not ‘there”

  2. Larry Signor says:

    @ Peter K…I agree, Jared is being very kind to Mr. Samuelson. Samuelsons’ opposition to a full-employment policy is hard to understand, since it would mitigate or solve most of the problems he claims exist in our economy, both today and in the future. (I think it is safe to assume the inflation mongers oppose a full-employment policy).

    • Peter K. says:

      Yes unlike some of those of us on the left, I don’t hold it against high profile economists like Bernstein or Krugman when they give the benefit of the doubt to people like Samuelson. It makes for a more civil public conversation and frankly I think it’s admirable.

      But as Baker has pointed out for years, Samuelson is really for bad policies. He wants to cut Social Security and Medicare benefits for middle class and poor elderly. He doesn’t want any wage inflation at any time. He wants wages to continue to stagnate and for inequality to continue to increase.

      • Larry Signor says:

        We all know the Sams story. Our advantage is not to be centrists, but to allow the validity of an opposition argument, and refute it within the bounds of logic. I believe Jared has done this and Dean has put the hammer down, so to speak. Full-employment is certainly the answer…from a LTE’d point of view.

  3. smith says:

    I would very much like to see a stark explanation of the implied logic delineated above. There is a strong argument for 3.5% inflation, a natural 2% base rate that feeds on nominal increases to satisfy pre existing expectations, plus the 1.5% productivity increase that both labor and business owners chase and fight over.

    What is still seems left unaddressed is my argument that businesses have so much control over prices that they refuse to yield even token amounts of productivity growth to labor. Even if labor power was legally stronger, and the job market slack was smaller, not solving this pricing problem would only lead to actual (at least small scale) spirals. Then inflationistas would say “I told you so.” the Fed would act, and we’re back where we started from. Is there anyone anywhere working on this?

    • Jared Bernstein says:

      Hmmm…I think we’re saying a similar thing, though not sure. We need the Fed to recognize the wage/pricing problem much as you described it, understand the mechanisms that absorb wage growth without undue price pressures, tolerate some price pressures as not spiraling, and accommodate real wage growth. I mean, if G-span could do it…!

      • Peter K. says:

        Yes. In the late 90s, Greenspan allowed unemployment to reach 4 percent and labor shared in productivity gains. Candidate Obama mentioned this in a BusinessWeek interview.

        But Greenspan was also a Randian and didn’t believe in regulation. We got a tech stock bubble (which was solvable like the 87 dip) but the 2000s didn’t see great job growth and the stock bubble morphed into the housing bubble.

      • smith says:

        We are saying something similar but with some important distinctions.

        We both agree that it would be acceptable for inflation to run above 2% if this was caused by real wage increases. The higher inflation would be caused by a natural race between labor and capital to grab a larger share of increased productivity.

        Trouble comes from this scenario: Labor in a more friendly regulatory environment and tighter job market asks for raises of 3%, higher than 2% because 2% is the expected low inflation rate. Capital then raises prices to recover part of the increased costs of labor. If capital raises prices a mere 3% labor actually gets nothing, inflation rises, labor asks for raises above 3% eventually and capital says stop, you’re going to create runaway inflation. Meanwhile capital has pocketed the entire 1.5% increase in productivity. This is much easier for capital to do in a low inflation environment, because the trick is hardly noticed.

        The lack of price competition, the propensity to inflation spirals in a healthy labor market, are what I fear is not being addressed. The conservatives answer is just to keep labor down.