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.