Why causality matters

Steve Waldman has responded to my recent post claiming that the inflation of the 1970s was a monetary phenomenon.  He still insists it’s more useful to think of it as a demographic phenomenon.  Let me try to explain my two objections in a different way.

Consider an unrelated issue.  Some have argued that hyperinflation is not a monetary phenomenon because the ultimate cause is deficit spending.   The inflation occurs because the government prints money to pay its bills.  There’s obviously some truth in that, but I think it makes more sense to view monetary expansion as the cause, and deficit spending a a reason for the monetary expansion.  Here’s why.  Suppose you learned in school that deficit spending was the cause of hyperinflation.  Then Reagan is elected in 1980 and starts running huge deficits.  What would you predict to happen to inflation?  And what actually happened?  Deficit spending is only a problem (for inflation) when governments finance the deficits by printing money, not when they finance the deficits by selling bonds.  That’s why it’s more useful to think of monetary policy as the cause of hyperinflation, and fiscal expansion as a reason for inflationary monetary policies.  [Of course even looking at the supply of money is not enough, the demand is also important, as we’ve seen since 2008.]

In the comment section to my post Mark Sadowski dug up a lot of data on demographics in other developed countries during the Great Inflation, and afterwards, and found that Waldman’s model doesn’t fit them very well at all.  Not even close.  I believe this shows that other paths were possible.  The Fed did not have to create high inflation to hold down unemployment; indeed they probably exceeded the peak of the “inflation Laffer Curve” and were actually increasing unemployment.  One of Lucas’s most famous papers showed essentially no relationship (across countries) between inflation and unemployment, and further research suggested the relationship might even be positive.

In this passage Steve seems to misunderstand my argument:

But reading his post, I don’t see any substantive inconsistency between his views and mine at all. He argues that the Fed overstimulated, because if it was trying to prevent unemployment, it would simply have stabilized nominal wage growth. Instead it tolerated “” or caused, depending how you tell the story “” wage inflation in excess of its long-term growth rate. My view is that stable nominal wages and full employment (under the Fed’s more robust 1970s definition of full employment) were simply inconsistent, so stabilizing nominal wages would not have been an effective strategy. Decent employment of a labor force growing faster than productive employment was only possible via a combination of falling real wages and a cross-subsidy from creditors, that is by high inflation.

I don’t understand why cross subsidy from creditors would affect unemployment, but the more important problem is the way he slides from my argument for stable nominal wage growth to his argument that falling real wages were needed.  That’s exactly the point of stable nominal wages!  It forces the Fed to do a monetary policy that delivers the appropriate decline in real wages, via higher inflation.  So yes, slightly higher inflation was appropriate, as I acknowledged.  My point was that the Fed went far beyond the extra inflation needed to stabilize nominal wages (and depress real wages), and indeed it sharply raised nominal wage growth.  That’s totally pointless inflation that doesn’t lower unemployment at all.  The countries that did not engage in that sort of reckless inflation did no worse than those that did.

We had 13% inflation in 1980.  Suppose instead that inflation had risen from 1.5% in 1964 to 6% in 1980. Does anyone seriously think the unemployment problem in 1980 would have been even worse with 6% than 13%? Surely nominal wages would have adjusted to that lower NGDP/person track by 1980.  I think the mistake people make is thinking too short term.  Yes, given the 12% inflation in 1979, a 6% rate in 1980 would have led to high unemployment, about 10% to be precise.  But not if the Great Inflation had never occurred.

I’m a pragmatist, and hence prefer definitions of causality that are useful for policymakers.  When Obama’s aides were sitting around a table deciding on fiscal stimulus it did no good for some aide to assert “Fiscal stimulus doesn’t work.  In the case usually cited (1940s) it was WWII that caused the rapid RGDP growth, not fiscal stimulus.”  The other aides would (rightly) say; “Well how did WWII cause RGDP to rise? Wasn’t it via fiscal stimulus?”  And if at an FOMC meeting someone says “Inflation is not a monetary phenomenon because the money supply changes for a reason, the policymakers are going to (rightly) wonder how that concept of “causality” helps them in their deliberations about the appropriate monetary policy.  The blogosphere is all about debating policy options.  We need proximate causes to do so coherently.

PS.  I also disagree with this claim:

To say that policymakers [in the 1970s] erred or even misestimated, you’d have to claim they did not understand that their employment-focused policies might bring inflation. I think it’s pretty clear that they did understand that.

Policymakers of that era had highly flawed models of the economy, just as they did in the 1930s, and just as they do today.  These bad models produced bad policies, everything from stop/go inflation cycles to price controls.  During the 1965-69 upsurge in inflation the rate of unemployment actually plummeted to 3.5%, far below the natural rate.   They tried to stop the inflation with income tax increases! (I kid you not.)  Then price controls.

The Keynesians went from claiming that Friedman was a crackpot, to saying; “well of course we always knew expansionary monetary policies cause inflation, the real issue is money supply targeting vs. fine tuning.”  As they absorbed one monetarist idea after another they began to redefine “Keynesianism” to make it look like they were right all along.

No, the central bankers of the 1970s were often clueless.  Go back and read the minutes if you don’t believe me.  Or save time by reading studies by people like Ed Nelson.


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53 Responses to “Why causality matters”

  1. Gravatar of Mark A. Sadowski Mark A. Sadowski
    7. September 2013 at 09:14

    Steve Randy Waldman:
    “To say that policymakers [in the 1970s] erred or even misestimated, you’d have to claim they did not understand that their employment-focused policies might bring inflation. I think it’s pretty clear that they did understand that.”

    Really?!?

    http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2126277

    Arthur Burns and Inflation
    Robert L. Hetzel
    Winter 1998

    Abstract:
    “Arthur Burns, Chairman of the Federal Open Market Committee of the Federal Reserve System from February 1970 until December 1977, was fiercely opposed to inflation. Yet, over his eight-year tenure, prices increased at an annualized rate of 6.5 percent. Why? One reason was Burns’s belief that inflation arose from a variety of special factors, each of which was largely out of the control of the Federal Reserve.”

    Page 22:

    “In November 1970, the minutes of the Board of Governors show Burns telling the Board (Board Minutes, 11/6/70, pp. 3115-17) that

    “…prospects were dim for any easing of the cost-push inflation generated by union demands. However, the Federal Reserve could not do anything about those influences except to impose monetary restraint, and he did not believe the country was willing to accept for any long period an unemployment rate in the area of 6 percent. Therefore, he believed that the Federal Reserve should not take on the responsibility for attempting to accomplish by itself, under its existing powers, a reduction in the rate of inflation to, say, 2 percent…he did not believe that the Federal Reserve should be expected to cope with inflation single-handedly. The only effective answer, in his opinion, lay in some form of incomes policy.”

    (The term “incomes policy” is a catchall expression for various forms of direct intervention by the government to control prices.) Those comments reflected a reading of the domestic situation that was particular to the time. Again, a different time would have yielded a different monetary policy.”

    Pages 36-37:

    “Both Burns and the economists in the Nixon Administration believed that the special factors that were exacerbating inflation in 1973 would dissipate in 1974 and, consequently, inflation would decline. Nevertheless, inflation remained in the low double digits throughout 1974. For that reason, Burns remained a strong advocate of incomes policies to control inflation (U.S. Congress, 7/30/74, p. 258). However, on April 30, 1974, the President’s authority to impose wage and price controls expired. The Cost of Living Council, which had administered the controls, disappeared at the same time. Even though Burns lobbied hard for reestablishment of an incomes policy, the price-controls program had become discredited in Congress. Also, the key economic policymakers in the incoming Ford Administration, in particular CEA chairman Alan Greenspan and Treasury Secretary William Simon, opposed incomes policies.”

  2. Gravatar of Roger Sparks Roger Sparks
    7. September 2013 at 10:12

    “The inflation occurs because the government prints money to pay its bills. There’s obviously some truth in that, but I think it makes more sense to view monetary expansion as the cause, and deficit spending a a reason for the monetary expansion.”

    Speaking as someone who lived and worked in that period, your arguments seem very narrowly focused with incorrect emphasis. I think your argument would be more accurate if you refocused on monetary expansion as ACCOMMODATION and deficit spending as the METHOD OF MONETARY DISTRIBUTION.

    Paul Volcker devised a policy that worked by increasing interest rates not in response, but faster than market forces could accommodate. As a result, the operating cash flow increases needed to perpetuate inflation in every part of the production chain could not be accommodated in logical business models. It did cause unemployment, yes, but it broke the repeating cycle that had become established and refocused the economy on a more sustainable path.

  3. Gravatar of Mark A. Sadowski Mark A. Sadowski
    7. September 2013 at 10:24

    Steve Roth:
    “You can argue about the answer, but this is sure: the rise in the labor force that Steve points out is crucial to thinking about The Great Inflation, and it’s been completely absent from the mainstream-storyline Great-Inflation explanations that I’ve wrestled with over the years.”

    http://angrybearblog.com/2013/09/did-the-baby-boom-labor-force-surge-cause-the-great-inflation.html#comment-309436

    Really?!?

    Katz and Krueger, 1999, Page 32:

    “A venerable macroeconomic tradition examines the extent to which changes in the age and sex composition of the labor force can explain secular movements in the unemployment rate. The much higher unemployment rates for teenagers and young adults than for adults of prime working age make it plausible that changes in the age structure of the work force can substantially affect the unemployment rate. Seminal studies by George Perry and by Robert Gordon provide strong evidence that changes in the age and sex composition of the work force (the labor market entry of the baby-boom cohorts and a rapid expansion of female labor force participation) contributed to an increase in the NAIRU in the 1960s and 1970s.39 The convergence in male and female unemployment rates since the early 1980s indicates that the direct effect of sex-composition changes on the unemployment rate is unlikely to have been important over the past two decades. But recent studies by Robert Shimer and by Robert Horn and Phillip Heap suggest that age-structure changes driven by the maturing of the baby-boom cohorts can account for a substantial part of the lower unemployment in the 1990s than in the 1970s and 1980s.40 In this section we reassess the role of age-structure changes and explore the possible consequences for the NAIRU of continuing secular increases in the educational attainment of the adult work force.”

    http://www.brookings.edu/~/media/Projects/BPEA/Spring%201999/1999a_bpea_katz.PDF

    Ball and Mankiw, 2002, Page 125:

    “The most obvious reason the labor force changes is demographics. In seeking to explain the evolution of the NAIRU, a number of authors point to a particular type of shift: the changing age structure as the baby boom generation has moved through the labor force. The proportion of the labor force aged 16 -24 rose from 17 percent in 1960 to 24 percent in 1978 as the baby boomers entered the labor force as young workers, and this percentage fell to 16 percent in 2000 as the boomers have aged. These trends are potentially important because young workers have higher unemployment rates than older workers: over 1960-2000, the average unemployment rate was 12.2 percent for workers 16-24 and 4.4 percent for workers 251. Gordon (1998) has argued that the increase in young workers accounts for much of the increase in the NAIRU before 1980, and Shimer (1999) argues that the recent decrease explains much of the NAIRU fall.

    The classic method for measuring the effects of demographic changes is to compute a “Perry-weighted” unemployment rate (Perry, 1970; Katz and Krueger, 1999). This is a weighted average of unemployment rates for different demographic groups with Ž fixed weights; by contrast, the usual aggregate unemployment rate has weights equal to labor-force shares, which change over time. A time series for Perry-weighted unemployment shows what would have happened to the unemployment rate given the evolution of each group’s unemployment if the sizes of groups did not change.”

    http://scholar.harvard.edu/files/mankiw/files/jep.ballmankiw.pdf

    Changing Labor Markets and Inflation
    George L. Perry
    1970

    [No Abstract]

    http://www.brookings.edu/about/projects/bpea/editions/~/media/Projects/BPEA/1970%203/1970c_bpea_perry_schultze_solow_gordon.PDF

    Inflation, Flexible Exchange Rates, and the Natural Rate of Unemployment
    Robert J. Gordon
    December 1982

    Abstract:
    “The most important conclusion of this paper is that the growth rate of the money supply influences the U.S. inflation rate more strongly and promptly than in most previous studies, because the flexible exchange rate system has introduced an additional channel of monetary impact, over and above the traditional channel operating through labor-market tightness. Lagged changes in the effective exchange rate of the dollar, through their influence on the prices of exports and import substitutes, help to explain why U.S. inflation was so low in 1976 and why it accelerated so rapidly in 1978. Granger causality tests indicate that lagged exchange rate changes influence inflation, but lagged inflation does not cause exchange rate changes. A policy of monetary restriction in the 1980s is shown to cut the inflation rate by five percentage points at about half the cost in lost output as compared with the consensus view from previous studies. The paper defines the “no shock natural rate of unemployment” as the unemployment rate consistent with a constant rate of inflation in a hypothetical state having no supply shocks and a constant exchange rate. A new estimate of this natural rate concept displays an increase from 5.1 percent in 1954 to 5.9 percent in 1980 that is entirely due to the much-discussed demographic shift in labor-force shares and relative unemployment rates. Other higher estimates of the natural unemployment rate, close to 7 percent in 1980, result from the use of a naive Phillips curve that relates inflation only to labor-market tightness and inertia variables. The paper contains extensive sensitivity tests that examine the behavior of the basic inflation equation over alternative sample periods; that enter the growth rate of money directly and track the behavior of a money- augmented equation in dynamic simulation experiments; and that test and reject the view that wage-setting behavior is dominated by “wage-wage inertia”, that is, the dependence of wage changes mainly on their own past values.”

    http://www.nber.org/papers/w708

    I must say this spectacle of Post Keynesians rewiting history (Arthur Burns) and reinventing the wheel (the demographic effects on the Time Varying NAIRU (TV-NAIRU)) has been utterly hilarious.

  4. Gravatar of Tom Brown Tom Brown
    7. September 2013 at 11:06

    @Mark Sadowski,

    O/T: Mark, I immediately thought of you when Nick Rowe posted this challenge:

    http://worthwhile.typepad.com/worthwhile_canadian_initi/2013/09/is-ngdplt-a-perfect-guard-dog-a-challenge.html?cid=6a00d83451688169e2019aff402c30970c#comment-form

  5. Gravatar of interfluidity » Agreeing in different languages interfluidity » Agreeing in different languages
    7. September 2013 at 11:15

    […] Update: Scott Sumner responds. […]

  6. Gravatar of Mark A. Sadowski Mark A. Sadowski
    7. September 2013 at 11:28

    Tom Brown,
    I’m insufficiently motivated to take up Nick’s challenge because I simply don’t believe there is a good counterexample.

    For example, if memory serves (I’m not sure about the exact cutoff), in every recession in the US since the end of WW II year on year NGDP growth dipped below 0.8% with the exception of the 1974-75 recession, and everytime it dipped below 0.8% there was a recession. So not only is NGDP a guard dog that has a near perfect record of recession barking, it doesn’t bark when there isn’t one.

    As for the 1974-75 recession, that was a giant negative AS shock related to the energy crisis that was further compounded by tight monetary policy. The recession certainly would have been less severe with NGDPLT even if it were it not completely avoided.

  7. Gravatar of Tom Brown Tom Brown
    7. September 2013 at 11:42

    “insufficiently motivated?!” … that’s not the Mark Sadowski I know! … or is that like asking the pope to get excited about proving that God doesn’t exist? 😀

    … but then if he doesn’t exist… he doesn’t exist. Perhaps it’d be fairer to compare it to asking Richard Dawkins to get excited about proving that God DOES exist? Lol

    You could think of it like being assigned a side at random on the debate team. No?

    Anyone else? It’s certainly WELL beyond me.

  8. Gravatar of Mike Sax Mike Sax
    7. September 2013 at 11:44

    Mark your quote of Burns seems to bolster Waldman’s point:

    “…prospects were dim for any easing of the cost-push inflation generated by union demands. However, the Federal Reserve could not do anything about those influences except to impose monetary restraint, and he did not believe the country was willing to accept for any long period an unemployment rate in the area of 6 percent. Therefore, he believed that the Federal Reserve should not take on the responsibility for attempting to accomplish by itself, under its existing powers, a reduction in the rate of inflation to, say, 2 percent…he did not believe that the Federal Reserve should be expected to cope with inflation single-handedly. The only effective answer, in his opinion, lay in some form of incomes policy.”

    It suggests that Burns thought it was politically unacceptable for the Fed to end higher inflation by itself. In his piece, Waldman suggests that in the 70s most economists thought that to take higher inflation in exchange for lower inflation was preferable to the alternative. In the Great Moderation it was the opposite-any amount of unemployment was seen as acceptable if it were the only way to achieve low inflation. In the 70s the economists believed ‘Low unemployment at any price’ and since the 70s its been ‘low inflation at any price’ more so in Europe even than the U.S. during the Great Recession.

  9. Gravatar of Tommy Dorsett Tommy Dorsett
    7. September 2013 at 12:54

    The labour force and productivity are supply side variables – they may change the composition of total spending, but not the level or growth rate absent the central bank’s policy actions. The argument that demographics caused the 70s inflation is similar to those arguing that zero NGDP growth during the last 20 years in Japan is due to structural/demographic considerations. No, both were the result central bank policy failure.

  10. Gravatar of Greg Hill Greg Hill
    7. September 2013 at 13:50

    Mark Sadowski,

    “I must say this spectacle of Post Keynesians rewiting history (Arthur Burns) and reinventing the wheel (the demographic effects on the Time Varying NAIRU (TV-NAIRU)) has been utterly hilarious.”

    I’m pretty sure the concepts of NAIRU and TV-NAIRU have no place in Post-Keynesian Economics (except perhaps as objects of criticism), if by “Post-Keynesian Economics,” you mean the sort of stuff found in JPKE or on the PKSG website.

  11. Gravatar of Mark A. Sadowski Mark A. Sadowski
    7. September 2013 at 13:57

    Mike Sax,
    Ah, but Steve’s leaving out the best parts.

    Burns had a credit view of monetary policy in that it worked through its influence on the credit market. And monetary policy was only one factor affecting credit markets. Thus monetary policy could be overwhelmed by other factors. He had a “real” or nonmonetary view of inflation in that inflation could arise from a variety of sources other than just money. He believed that a central bank could cause inflation by monetizing government deficits but did not attribute inflation to that source in the early 1970s, but instead, he attributed it to the exercise of monopoly power by unions and large corporations

    Pages 34-35:

    “Burns did not consider money to be a major independent influence on economic activity or inflation. For Burns, the fundamental determinant of economic activity was the confidence of businessmen. As a result, Burns emphasized not the rate of growth of money but its short-run velocity, which he believed reflected that confidence. At the December 1974 FOMC meeting, Burns stated (FOMC Minutes, 12/17/74, pp. 1312-14 and 1338):

    “The willingness to use money””that is, the rate at which money turned over, or its velocity””underwent tremendous fluctuations; velocity was a much more dynamic variable than the stock of money, and when no account was taken of it, any judgment about the growth rate of M1 was likely to be highly incomplete. . . . Fundamentally, velocity depended on confidence in economic prospects. When confidence was weak, a large addition to the money stock might lie idle, but when confidence strengthened, the existing stock of money could finance an enormous expansion in economic activity.”

    Money was important, but only as it affected interest rates. Burns saw monetary policy through the optic of credit markets. With interest rates being the measure of monetary ease or tightness, monetary policy could be restrictive even if money growth was rapid. Burns testified to Congress (U.S. Congress, 6/27/73, p. 185):

    “We began applying monetary restraint as early as March of 1972. This is reflected in interest rates. . . . I do not want to leave you with the impression that . . . we went much too far in the growth of the aggregates [in 1972]. I do not think we did.”

    In 1973 and 1974, as inflation rose sharply, Burns became sensitive to monetarist criticism of the Fed for allowing high rates of M1 growth. In 1973 and the first half of 1974, the FOMC, with Burns’s encouragement, moderated the M1 growth. However, while acknowledging that inflation could not continue without rapid money growth, Burns challenged the monetarists by arguing that rapid money growth had followed inflation, rather than preceding it. Burns testified (U.S. Congress, 7/30/74, p. 257):

    “The current inflationary problem emerged in the middle 1960s when our government was pursuing a dangerously expansive fiscal policy. Massive tax reductions occurred in 1964 and the first half of 1965, and they were immediately followed by an explosion of Federal spending. . . . Our underlying inflationary problem, I believe, stems in very large part from loose fiscal policies, but it has been greatly aggravated during the past year or two by . . . special factors. . . . From a purely theoretical point of view, it would have been possible for monetary policy to offset the influence that lax fiscal policies and the special factors have exerted on the general level of prices. One may, therefore, argue that relatively high rates of monetary expansion may have been a permissive factor in the accelerated pace of inflation. I have no quarrel with this view. But an effort to use harsh policies of monetary restraint to offset the exceptionally powerful inflationary forces of recent years would have caused serious financial disorder and dislocation.

    When Burns became Chairman of the FOMC in February 1970, economic activity had fallen for two months from its December 1969 cyclical peak. During the recession of 1970, inflation failed to decline. Burns drew the conclusion that the contemporaneous inflation arose primarily from a rise in wages due to the exercise of monopoly power by labor unions. In a speech before the American Economics Association, Burns ([12/29/72] 1978, pp. 143-54) stated:

    “The hard fact is that market forces no longer can be counted on to check the upward course of wages and prices even when the aggregate demand for goods and services declines in the course of a business recession. During the recession of 1970 and the weak recovery of early 1971, the pace of wage increases did not at all abate as unemployment rose. . . . The rate of inflation was almost as high in the first half of 1971, when unemployment averaged 6 percent of the labor force, as it was in 1969, when the unemployment rate averaged 3 1/2 percent. . . . Cost-push inflation, while a comparatively new phenomenon on the American scene, has been altering the economic environment in fundamental ways. . . . If some form of effective control over wages and prices were not retained in 1973, major collective bargaining settlements and business efforts to increase profits could reinforce the pressures on costs and prices that normally come into play when the economy is advancing briskly, and thus generate a new wave of inflation. If monetary and fiscal policy became sufficiently restrictive to deal with the situation by choking off growth in aggregate demand, the cost in terms of rising unemployment, lost output, and shattered confidence would be enormous.”

    President Nixon imposed wage and price controls on August 15, 1971. This offered a tailor-made experiment of Burns’ views. The controls worked as intended in that they held down wage growth and the price increases of large corporations. Nevertheless, inflation rose to double digits by the end of 1973.

    Page 36:

    “Burns attributed the inflation that began in 1973 to a variety of special factors (U.S. Congress, 2/1/74, pp. 669-70):

    “In retrospect, it might be argued that monetary and fiscal policies should have been somewhat less expansive during 1972, but it is my considered judgment that possible excesses of this sort were swamped by powerful special factors that added a new dimension to our inflationary problem. . . . A major source of the inflationary problem last year was the coincidence of booming economic activity in the United States and in other countries. . . . Another complicating factor was the devaluation of the dollar. . . . disappointing harvests in 1972″”both here and abroad””caused a sharp run-up in prices. . . . In short, the character of inflation in 1973 was very different from the inflation that troubled us in different years. A worldwide boom was in process; the dollar was again devalued; agricultural products, basic industrial materials, and oil were all in short supply.”

    So then Burns attributed inflation to special factors, such as increases in food prices due to poor harvests and in oil prices due to the restriction of oil production. However, special factors are by nature one-time events. In 1974, inflation should have fallen as the effect of these one-time events dissipated, but it remained at double-digit levels that year.

    Page 37:

    “In the last half of 1974, with an incomes policy no longer viable and with inflation continuing unabated, Burns returned to the themes of government spending and deficits as the primary cause of inflation. He testified to Congress
    8/21/74, p. 213), “The current inflation began in the middle 1960s when our government embarked on a highly expansive fiscal policy.” And again, Burns testified (U.S. Congress, 9/25/74, p. 119):

    “. . . special factors have played a prominent role of late, but they do not account for all of our inflation. For many years, our economy and that of most other nations has been subject to an underlying inflationary bias. . . . The roots of that bias . . . lie in the rising expectations of people everywhere. . . . individuals and business firms have in recent times come to depend more and more on government, and less and less on their own initiative, to achieve their economic objectives. In responding to the insistent demands for economic and social improvement, governments have often lost control of their budgets, and deficit spending has become a habitual practice. Deficit spending . . . becomes a source of economic instability . . . during a period of exuberant activity.”

    Burns told the FOMC, “While the U.S. inflation was attributable to many causes, a large share of the responsibility could be assigned to the loose fiscal policy of recent years” (FOMC Minutes, 5/21/74, p. 669).”

    Pages 37-38:

    “Ultimately, Burns attributed the effect of the deficit on inflation to its influence on the psychology of businessmen. Because the deficit symbolized a lack of government discipline, it lessened the willingness of businessmen to exert the discipline required to hold down wages and, as a consequence, prices. The importance that Burns placed on the psychological effects of the deficit are evident in his comments both at FOMC meetings and at congressional hearings. At one FOMC meeting, Burns made his point by taking a shot at the Keynesianism of the Board staff (Board Minutes, 12/16/74, p. 1261):

    “The Chairman then asked what the staff thought the net effect would be of a simultaneous decrease of, say, $20 billion in both Federal expenditures and business taxes. In response, Mr. Pierce said the econometric model would indicate that such a policy was deflationary, on balance, because it wouldresult in a rise in savings. Chairman Burns observed that in his opinion the effects would be strongly expansionary rather than deflationary; a $20 billion tax cut would create a wholly new environment for business enterprise, and businessmen would react by putting their brains, their resources, and the credit facilities to work. His disagreement with the staff on that point reflected a basic difference in interpretation of how the economy functioned and how fiscal stimulants and deterrents worked their way through the system. According to Burns, a reduction in the deficit would both stimulate economic activity and reduce inflation. He testified to Congress (8/6/74, pp. 225-26 and 229):

    “If the Congress . . . proceeded to cut the budget . . . then confidence of business people, and of heads of our households, that the inflation problem will be brought under control would be greatly enhanced. In this new psychological environment, our trade unions may not push quite so hard for a large increase in wage rates, since they would no longer be anticipating a higher inflation rate. And in this new psychological environment, our business people would not agree to large wage increases quite so quickly. Therefore, these indirect effects of a cut in the Federal budget of $5 [billion] or $10 billion can in such an environment be vastly larger than what the mathematical models . . . suggest. . . . If this Congress were to vote this day . . . a cut of $10 billion in spending, the stock market would revive promptly, the bond market would revive promptly, and short-term interest rates would move down promptly. . . . Forces . . . would be released within the private sector that would in time make more jobs for our people.”

    So Burns then blamed inflation on government deficits. But according to Hetzel, as a percentage of GNP, the government (federal, state, and local) surplus or deficit was 1.1 in 1969, 1.0 in 1970, 1.7 in 1971, 0.3 in 1972, 0.5 in 1973, and 0.2 in 1974. The deficits of 1970 and 1971 reflected the recession.

    Steve Randy Waldman (in his comments thread):
    “We only have one dramatic disinflation experiment, and despite the self-congratulation of some economists ex post, Burns’ view of inflation an multi-causal remains current and wins on parsimony.”

    Actually we have dozens and dozens of such experiments and not all contemporaneous. Some countries such as Japan started to disinflate as early as 1974. Other countries such as Australia didn’t start until as late as 1990. But disinflation is now a near global phenomenon and every country that did it, did it through less expansionary monetary policy.

  12. Gravatar of Eureka! The Great Inflation was the result of demographic trends | Historinhas Eureka! The Great Inflation was the result of demographic trends | Historinhas
    7. September 2013 at 14:07

    […] Sumner has weighed in (here and here). In the comments section of Scotts first comment on SRW Mark Sadowski shows that a bunch of […]

  13. Gravatar of Mark A. Sadowski Mark A. Sadowski
    7. September 2013 at 14:19

    Greg Hill,
    “I’m pretty sure the concepts of NAIRU and TV-NAIRU have no place in Post-Keynesian Economics (except perhaps as objects of criticism), if by “Post-Keynesian Economics,” you mean the sort of stuff found in JPKE or on the PKSG website.”

    Yes, it’s a pretty insular world there.

    Post Keynesians complain all the time that nobody is familiar with their research, but it’s pretty clear that Steve Randy Waldman is largely unfamiliar with the research of such unknowns as Perry, Gordon, Katz, Krueger, Ball and Mankiw.

    If you read those journals you’d even come away believing that Post Keynesians are the only ones to have ever applied Sims-Granger causality tests to monetary policy. (That’s “Sims” as in Chris Sims.)

  14. Gravatar of Doug M Doug M
    7. September 2013 at 14:38

    They tried to stop the inflation with income tax increases! (I kid you not.)

    and today inflation targeting central banks tighten money to offset the inflationary impact of tax increases.

  15. Gravatar of Negation of Ideology Negation of Ideology
    7. September 2013 at 14:57

    “Some have argued that hyperinflation is not a monetary phenomenon because the ultimate cause is deficit spending. The inflation occurs because the government prints money to pay its bills.”

    The question is what is the necessary and sufficient cause of hyperinflation(or any inflation for that matter). I’d cut the end of that sentence to “The inflation occurs because the government prints money.” The “to pay its bills” is superfluous.

  16. Gravatar of Mark A. Sadowski Mark A. Sadowski
    7. September 2013 at 16:25

    Steve:
    “I’ve put together a correlation table using the single-prices all-prices monthly HICP data available from FRED. It’s 1996 to the present, prominently missing Japan. (I’m not sure why.)

    You’ll notice that most of the correlations are approximately 1. The minimum correlation is 0.707. The minimum correlation of the US with any country is 0.835.

    This is biased to some degree by European integration and its recency.”

    Seventeen of those 31 countries are eurozone members. Another 3 are pegged to the euro. Before they were euro members most were pegged to the European Currency Unit (ECU), which effectively meant being pegged to the German mark. Some have been pegged to each other for a very long time. For example prior to the formation of the euro the Dutch guilder was essentially pegged to the German mark since 1983. It would be very surprising if there wasn’t a high degree of correlation.

    Moreover, with few exceptions these countries have been targeting a low inflation rate since 1996. Thus most of the variation will be from food and energy prices, which are global in nature, further increasing the cross correlation. Finally, and probably most importantly, you are taking the cross correlation of data series that are all increasing over time. Thus they are bound to display a high degree of correlation, but the correlations are spurious and not very informative.

    Steve:
    “It’s less trivial to find comparable old data, but you’ve pointed out yourself the curious simultaneity of the Great Inflation. Regardless, I’d gladly wage that the point would stand with older data, that crosscountry inflation correlation coefficientss were strong and significant throughout the period.”

    They same delusions concerning the role of monetary policy with respect to inflation was global and the knowledge of how to contain it spread nearly simultaneously, but not completely. As I just pointed out, 16 years separate Japan’s and Australia’s disinflation, and I only mention those because I spent some time studying those events recently. Were I to do a more systematic analysis I’m sure I can find a greater span of time between first and most recent incident of disinflation.

    Steve:
    “This is also the problem with your claim in the previous post that demography and the Great Inflation don’t match elsewhere. No, they all basically match the demography of the country at the heart of the global monetary system. Hmm!”

    This doesn’t disprove that inflation is primarily a monetary phenomenon, it proves it. Under Bretton Woods we essentially had a system of fixed exchange rates where all of the world’s economies were pegged to the dollar. When the US inflated its economy in 1966-73 it took the rest of the planet with it. This close correlation broke down with the demise of Bretton Woods and you can see that with the fact that some countries started to disinflate before others.

    Also I think it’s a bit simplistic to explain the US Great Inflation purely on an increased NAIRU due to demographics. There were of course other factors at work.

    Steve:
    “We might be able to draw useful lessons from differences cross country experiences. But it will be hard, and require careful econometrics to try to tease a little independence out of a lot of contamination.”

    Certainly, but it’s much better than leaping to conclusions based on observing a single nation.

    Steve:
    “Still, the only people who would find Burns’ views as a corpus self-discrediting are those who’ve latched onto a very monocausal view of inflation and consider any alternatives to be laughable.”

    In the short run inflation is the result of shifts in AD (NGDP) and short run AS (SRAS). In the long run its determined by AD and long run AS (LRAS). Since AD is largely a matter of monetary policy inflation is mostly determined by monetary policy in the short run and almost entirely determined by monetary policy in the long run. Call that “monocausal” if you like.

  17. Gravatar of ssumner ssumner
    7. September 2013 at 16:30

    Mark, As usual your comment makes my case better than I can.

    Roger, In real terms the deficits were actually fairly small during the Great Inflation.

    Mark, And I’d add that in 1974 inflation was distorted by the removal of price controls.

  18. Gravatar of Mike Sax Mike Sax
    7. September 2013 at 17:11

    Sumner vs. Waldman on the 70s

    http://diaryofarepublicanhater.blogspot.com/2013/09/sumner-vs-waldman-on-great-inflation.html

  19. Gravatar of benjamin cole benjamin cole
    7. September 2013 at 17:17

    Yes, the Fed was too expansive in the 1970s. We also had a 20 percent real increase in GDP the last four years of the 1970s, following the 1974-5 recession.

    And what real growth have we had following the 2008 recession?

    This debate shows the lamentable skewing of the econ profession in the last few decades. The topic is always inflation and not real growth.

    Call me irresponsible, but I think real growth is worth considering.

    H

  20. Gravatar of Mike Sax Mike Sax
    7. September 2013 at 17:19

    Thanks for the great quotes and info Mark. I’m sifting going through it now. Right off the bat however in the first paragraph-doesn’t Bernanke have a credit view of monetary policy too?

    http://www.calstatela.edu/faculty/rcastil/ECON_435/Bernanke.pdf

    In addition, I think there were nonmonetary causes behind at least some of the early 70s inflation-the supply side shocks of oil and the food shortage.

    Ok. I know ideally I should read the whole thing before commenting. I’ll get back to it.

  21. Gravatar of Mike Sax Mike Sax
    7. September 2013 at 17:38

    Mark you wrote:

    “President Nixon imposed wage and price controls on August 15, 1971. This offered a tailor-made experiment of Burns’ views. The controls worked as intended in that they held down wage growth and the price increases of large corporations. Nevertheless, inflation rose to double digits by the end of 1973.”

    Stilnol, this is the question of whether it was possible to lower inflation without severe monetary tightening. Waldman’s argument is that policymakers considered higher inflation preferrable to low unemployment.

    During the Great Moderation high unemployment was seen as preferable to high inflation. What Waldman is saying is how do you show that the policymakers who believe in low inflation at any price like those in the EU today are right? This is his point. Saying that Burns attempts to lower inflation doesn’t meet Waldman’s point on head on.

    Let me try to ask the question as simply as possible. Why is high unemployment always and everywhere preferable to high inflation? Now that view it seems to me has been the view of many policymakers since the 70s-certainly in the EU still today.

  22. Gravatar of Mike Sax Mike Sax
    7. September 2013 at 17:39

    I meant so say ‘Still, this remains the question “of whether it was possible to lower inflation without severe monetary tightening. Waldman’s argument is that policymakers considered higher inflation preferrable to low unemployment.’

  23. Gravatar of Mike Sax Mike Sax
    7. September 2013 at 17:42

    Indeed, Mark take what Burns himself said: “If monetary and fiscal policy became sufficiently restrictive to deal with the situation by choking off growth in aggregate demand, the cost in terms of rising unemployment, lost output, and shattered confidence would be enormous.”

    Do you think the pain would have been enormous? If so why was it still worth doing in your mind? Waldman argues that we couldn’t have ‘done a Volcker’ in 1972.

  24. Gravatar of Mark A. Sadowski Mark A. Sadowski
    7. September 2013 at 17:46

    Mike,
    “Right off the bat however in the first paragraph-doesn’t Bernanke have a credit view of monetary policy too?”

    In my opinion Bernanke’s views on monetary policy are considerably more advanced than Burns.

    But in my opinion Bernanke places far too much emphasis on the Bank Lending Channel and the Balance Sheet Effects Channel of the Monetary Transmission Mechanism (MTM). In fact this is why I think he was so focused on shoring up the financial sector (it was crucial to the MTM in his view) rather than shoring up NGDP.

    “In addition, I think there were nonmonetary causes behind at least some of the early 70s inflation-the supply side shocks of oil and the food shortage.”

    Aggregate Supply shocks (AS) can affect inflation in the short run. But they cannot determine the rate of change in NGDP. Since the rate of change in NGDP is mostly determined by monetary policy, it almost entirely determines the rate of inflation in the long run. (See the last paragraph of my last comment for another way of stating this.)

  25. Gravatar of Mark A. Sadowski Mark A. Sadowski
    7. September 2013 at 18:01

    Mike,
    “Do you think the pain would have been enormous? If so why was it still worth doing in your mind? Waldman argues that we couldn’t have ‘done a Volcker’ in 1972.”

    No, I don’t think it would have been enourmous. NAIRU was already near its peak level (6.3%) in 1972 (6.2%). So the demographic effects were already largely played out.

    The factors that Burns thought were crucial, such as monopoly power of unions and corporations, were not substantially different in 1982 than in 1972. The effect of commodity prices is transient, and in fact food and energy were a drag on overall inflation in 1975-76.

    And deficits corrected for the business cycle were fairly constant during the 1970s unlike the 1960s, or indeed, any decade since. In fact they were quite small with the cyclically adjusted Federal budget deficit staying within the narrow range of 1.3% to 2.7% of potential GDP. In any case this was just another in a long line of bogus excuses why Burns couldn’t do anything about inflation.

    Burns thought the costs of reducing inflation with monetary policy would have been enormous precisely because he didn’t really think inflation was a monetary phenomenon.

  26. Gravatar of Mark A. Sadowski Mark A. Sadowski
    7. September 2013 at 18:05

    Scott,
    In the econoblogosphere you constantly hear from Post Keynesians and MMTers that just about everything causes inflation except money. The usual explanations are demographics, commodity prices and war. (Thank God this is something the Austrians have right, even if they do think hyperinflation is lurking under every bed and around every corner.)

    And I’ve heard it so many times and in so many ways it has become a pet peeve of mine, so Steve Randy Waldman’s post perked my radars, and his second post, where he simply dug in rather than admit his mistakes, just brought out the snark in me.

    But fortunately as a result of combating this unrelenting campaign of misinformation I have developed a deep trove of facts and resources. For example one of the favorite myths of Post Keynesians and MMTers concerns the “hyperinflation” in the Confederacy during the American Civil War.

    First of all, according to Eugene Lerner (1955) the maximum documentable month of inflation was 40.4% in March 1864 (Table 2):

    http://www.jstor.org/discover/10.2307/1826773?uid=3739592&uid=2129&uid=2&uid=70&uid=4&uid=3739256&sid=21102578468467

    So it does not satisfy the Phillip Cagan definition of hyperinflation of 50% inflation per month. Also according to Eugene Lerner (1954), a total of about $1.55 billion Confederate notes were issued between May 1861 and February 1864 (page 518):

    http://www.jstor.org/discover/10.2307/1827106?uid=3739592&uid=2129&uid=2&uid=70&uid=4&uid=3739256&sid=21102578360897

    To put that in perspective the nominal GDP (NGDP) of the entire U.S. was about $4.4 billion. Since the states that comprised the C.S.A. had about 29% of U.S. population in 1860, and income per capita in those states has been estimated to be about 73% of the rest of the country in 1860, this means the nominal GDP of the Confederate states was approximately $1.0 billion.

    Thus the total amount of currency issued during the war was about 155% of NGDP at the start of the war. By comparison, currency in circulation is equal to about 7.2% of NGDP in the U.S. today under circumstances with considerably lower domestic velocity of money. So a lot of money was in fact issued.

    The Confederacy offers an interesting experiment to test the hypothesis that the supply of money affects the rate of inflation. The Currency Reform Act of February 1864 effectively repudiated approximately one third of the existing Confederate money supply:

    “[Once] the currency reform took hold…the general price index dropped…in spite of invading Union armies, the impending military defeat, the reduction in foreign trade, the disorganized government, and the low morale of the Confederate army. Reducing the stocks of money had a more significant effect on prices than these powerful forces.”

    Lerner, Eugene M. “Inflation in the Confederacy,
    1861-65,” in Milton Friedman, ed., Studies in
    the quantity theory of money. Chicago: University
    of Chicago Press, 1956, pp. 172.

    And in 1864 there were two separate Confederate economies. Following the fall of Vicksburg in July 1863, the loss of communications across the Mississippi isolated the western portion of the Confederacy from Richmond so that this region no longer had ready access to the money being printed in the East. And while the Currency Reform Act took effect on April 1, 1864 east of the Mississippi, it was not implemented at that time west of the Mississippi. The implementation of the Act in the west was officially delayed until July 1, 1864 and, as a practical matter, was delayed even further by extreme difficulties in getting the new currency across the enemy occupied Mississippi. Accordingly, this episode provides a natural experiment with which to test the relative importance the quantity of money in circulation.

    Here is what Richard C. K. Burdekin and Marc D. Weidenmier (2001) conclude about the incident:

    “Contrary to the view espoused in much recent Civil War research, we believe that Friedman (1992) is right to refer to the 1864 Confederate experience as a textbook case of drastic money supply changes causing drastic price changes. But it is more than that: the Currency Reform Act is a unique natural experiment by which one can compare the effects of applying monetary reform in the East to the effects of not applying monetary reform in the West. After April 1864, continued depreciation in the West runs counter to the sudden strengthening of the gold value of Confederate currency in the East. This strengthening seems largely attributable to the currency reform and the concomitant nearovernight one-third reduction in the money supply.

    Our analysis implies that standard gold price series from the eastern markets cannot possibly give an accurate picture of the effects of war news in the postreform period. The measured rate of currency depreciation in eastern markets in 1864-1865 conflates the effects of war news with the artificial boost arising from the currency reform. Even if Mitchell’s (1903) war news hypothesis fits the northern case, it manifestly is not an adequate explanation for the post-1864 Confederate experience. Money really does matter.”

    http://www.jstor.org/discover/10.2307/2677945?uid=3739592&uid=2&uid=4&uid=3739256&sid=21102592194401

    Interesting story isn’t it?

    (And not at all like how the Post Keynesians and MMTers tell it.)

  27. Gravatar of Vince Vince
    7. September 2013 at 22:10

    “Thus the total amount of currency issued during the war was about 155% of NGDP at the start of the war.”

    This is interesting. To make hyperinflation you seem to need debt over 80% of GNP, government spending nearly twice what it gets in taxes, and then a positive feedback loop where the more the central bank monetizes bonds the less people want to hold them, but the less people hold them the more the central bank monetizes so the government has cash to spend. This feedback loop rapidly turns debt over 80% of GNP to currency over 80% of GNP.

    WordPress has decided I use my full name too much and link to my blog too much and so would block this post if I do it now, but Google “Hyperinflation FAQ” to see exactly how hyperinflation works.

  28. Gravatar of Lorenzo from Oz Lorenzo from Oz
    7. September 2013 at 23:10

    Some of what I wanted to say in response to Waldman’s original argument has been said by others at his site. (And I seem to have trouble commenting there, not sure why.) But a couple points which strike me are:

    If the US has still been on the gold standard, as it was after 1873 during the US’s late C19th population boom, would there have been “demographic-caused” inflation in the 1970s? Clearly not. Indeed, that late C19th population boom coincided with the 1873-1896 deflationary period. Trying to say some labour force surges count for inflation and others don’t seems somewhat like using one’s conclusion to set the ambit of your premises.

    Waldman’s cancer analogy rests on there being only one likely effective response. But what if that is not the case? Why is not the sensible response to a flood of new labour be to make sure that blockages to use of labour are removed? I.e. supply-side policies. Even if you want to ramp up inflation a bit to get falls in real wages, is not how much you need to do that a trade-off with such supply-side policies? The great inflation then becomes a monetary phenomenon due to under-utilisation of supply side reforms.

  29. Gravatar of Benjamin Cole Benjamin Cole
    7. September 2013 at 23:52

    Mark S.

    A Senator and then Treasury Secy named John Sherman wrote an autobiography, much of it on the Civil War years, and the expansion of the money supply (in the north).

    The North had an economic boom during the Civil War.

    And Sherman considered it clearly a Congressional prerogative to control the money supply, and the Treasury was to do as it was told by Congress. Sherman anticipated the need for a single currency and national bank.

    The book is free on Kindle.

  30. Gravatar of lxdr1f7 lxdr1f7
    8. September 2013 at 01:26

    It seems to me the 70’s inflation was an monetary phenomenom but done on purpose to get around sticky wages. Otherwise the labour market wouldnt of cleared.

  31. Gravatar of Saturos Saturos
    8. September 2013 at 01:37

    This is a great Twitter account (“livetweeting” the crash of September ’08) https://twitter.com/TBTFLive

  32. Gravatar of interfluidity » Demographics and inflation: international graphs interfluidity » Demographics and inflation: international graphs
    8. September 2013 at 03:21

    […] Sandowski (in comments here and here) and Scott Sumner challenge me to support my thesis that inflation is related to demographics in international data. […]

  33. Gravatar of Enric Blanco Enric Blanco
    8. September 2013 at 04:19

    Scott,

    I’m a loyal reader from Spain. You wrote something that caught my attention:

    “That’s exactly the point of stable nominal wages! It forces the Fed to do a monetary policy that delivers the appropriate decline in real wages, via higher inflation.”

    My question is: what would happen in a nominal wages or NGDP targeting regime if wages were linked to CPI? That’s precisely the case of the Spanish labour market, where the core of collective bargaining is the CPI-linked annual wage increase.

    My intuition is that CPI wage linking would offset the benefits of nominal wages or NGDP targeting and just lead to higher inflation. If that’s the case, then reforming the monetary regime would be useless without reforming the labour market as well. Sadly, for countries like the PIGS that seems to be a dual challenge: 1) convince the northern countries (i.e., Germany) to shift to a monetary regime that would sometimes allow higher inflation, and 2) convince the powerful unions (and the protected workers as well) in the southern countries to shift to a nominal wage increase regime that would sometimes allow real wages to fall.

    What are your thoughts on this?

    I’m no optimist in the short run given the European reform track record on recent years…

    Regards,

    Enric

  34. Gravatar of Tom Tom
    8. September 2013 at 04:20

    about debating policy options. We need proximate causes to do so coherently.

    The problem with “targeting NGDP” at 6% (or x%), combined with a futures market, is that this doesn’t quite answer what the Fed should do. I agree with Scott that the Fed should target 6% NGDP growth, and have a futures market.

    I don’t think such would have fully avoided the mal-investment in housing based financial products (and the semi-secret huge increase in “money” based on excessive valuations of those fin products). Worse, I think that changing the Fed to be NDGP oriented will still result in low growth, unless other things happen.

  35. Gravatar of ssumner ssumner
    8. September 2013 at 05:29

    Mark, Very interesting comments on the Civil War.

    Enric, If wages were 100% indexed to prices there is nothing the central bank could do (other than via the sticky price channel) More likely, they are less than 100% indexed, so monetary policy has some effect.

    Here’s an example. Suppose the ECB boosted Spain’s NGDP by 20%, Spain’s CPI by 12%, and Spain’s wages by 12%. Then Spain’s wages as a share of NGDP would fall. Which is expansionary–via sticky prices.

    Tom, I don’t actually favor a 6% target.

  36. Gravatar of Enric Blanco Enric Blanco
    8. September 2013 at 06:49

    Scott,

    I supose that you’re assuming that that imaginary NGDP boost from the ECB would be to some extent unexpected by the public and thus prices would remain sticky. Am I right? In that case I would fully agree that it will be expansionary, even with CPI-linked wages.

    But what would happen if there was a high degree of upward price flexibility on top of CPI-linked wages, so that the public could adjust fast to unexpected NGDP boosts? As it was for a very long time in Latam and Southern Europe.

    What I’m just wondering about is this: is labour market reform (i.e., breaking wage CPI-linking) a prerequisite for an effective (and efficient) NGDP targeting regime? In countries like Spain, I mean.

  37. Gravatar of John John
    8. September 2013 at 07:14

    I’ve seen economics defined as the study of supply and demand. What’s wrong with applying the ideas of supply and demand to the medium of exchange (or account if you prefer). Changes in the purchasing power (i.e. inflation and deflation) of money come about through changes in the supply and demand for money. Saying that changes in the value of money are caused by things like labor unions or deficit spending is to discard the use of basic economic reasoning.

    In the case of the 1970s, it is very clear that Federal Reserve increased the supply of money at a rate that was too rapid and consequently the demand to hold money fell as people realized what was going on. When supply increases and demand decreases, the price will go down. In this case the price was simply the purchasing power of the dollar.

    Once that is clear, debating why the Fed pursued such policies is the task of history not economics.

  38. Gravatar of Mark A. Sadowski Mark A. Sadowski
    8. September 2013 at 08:47

    Lorenzo from Oz,
    “If the US has still been on the gold standard, as it was after 1873 during the US’s late C19th population boom, would there have been “demographic-caused” inflation in the 1970s? Clearly not.”

    Excellent point. For labor force estimates from before 1890 I turned to the following:

    http://www.sciencedirect.com/science/article/pii/0164070494900086

    For civilian labor force estimates after 1890 the Millenial edition of the US Statistical Abstract is probably the most authoritative. Between the two it appears ten year labor force growth rates in the US exceeded the 1969-79 level in 1869-79 through 1887-97. The peak level during this period is 1870-80 when labor force increased by 38.2%.

    According to MeasuringWorth the CPI and the GDP implict price deflator both declined at an average rate of 2.41% from 1870-80.

    In short the period of maximum US labor force growth coincides with a period of extreme deflation.

    Now, was there a depression during the 1870s? Sort of.

    There was a very long recession from 1873-78 and according to J. R. Vernon’s estimates national unemployment more than doubled from 4.0% to 8.3% in a time when the country was still very agrarian. But he also estimates that the unemployment rate was only 4.5% in 1880 compared to 3.5% in 1870.

    Now, mind you, I think labor markets were much more flexible in those days so deflation did far less harm. But if your story is that demographics drives inflation rates and not monetary policy, surely this fact alone would cause you to reexamine your beliefs. (But knowing the Post Keynesians very well, almost certainly not.)

  39. Gravatar of Mark A. Sadowski Mark A. Sadowski
    8. September 2013 at 08:51

    Right away I see two enormous problems with Steve Randy Waldman’s latest post (other than the fact that he initially misspelled my name):

    http://www.interfluidity.com/v2/4624.html

    1) Lagged population growth is a very poor proxy for labor force growth.

    This is especially evident in the case of Spain and the UK where bursts in labor force growth in from the late 1990s to late 2000s have been driven by foreigners. This is also especially true of two other of my counterexamples: Ireland and Luxembourg. In short lagged population growth is a very poor proxy for labor force growth for these countries.

    2) The Penn World Tables consumer price inflation data appears to be hugely flawed.

    Remember a burst of double digit inflation across the advanced world in the oughts? Of course not.

    According to the Penn World Tables the average consumer price inflation rates from 2002-07 for Australia, Austria, France, Spain, Sweden and the UK were 13.7%, 10.0%, 11.2%, 12.1%, 9.0% and 9.7% respectively. According to the OECD the actual average CPI inflation rates from 2002-07 for Australia, Austria, France, Spain, Sweden and the UK were only 2.3%, 1.5%, 1.6%, 2.6%, 0.6% and 1.4% respectively.

    This is even more ridiculous in the case of Japan. The Penn Tables claim Japan’s average inflation rate from 2006 to 2011 was 6.0%. The actual CPI inflation rate was of course (-0.5%).

  40. Gravatar of Mark A. Sadowski Mark A. Sadowski
    8. September 2013 at 09:54

    On closer examination I think I see what the problem with the Penn World Table data that Steve Randy Waldman is using is.

    The consumer price data he is using is measured relative to the US GDP implicit price deflator. That’s why you see such wild gyrations. Exchange rate fluctuations are causing this effect. Offhand I don’t see how to convert this into useful inflation data.

    I would recommend using civilian labor force data from the OECD (available all the way back to 1955/56). One can get CPI (national) at AMECO for all of these countries back to 1960.

  41. Gravatar of Everything You Thought You Knew About The 1970s, Inflation And The US Economy Is Wrong | TokNok Multi Social Blogging Solutions Everything You Thought You Knew About The 1970s, Inflation And The US Economy Is Wrong | TokNok Multi Social Blogging Solutions
    8. September 2013 at 11:51

    […] and that’s where things really got crazy. I should add that all this was inspired by the Scott Sumner = Steve Waldman debate over the […]

  42. Gravatar of Tom Tom
    8. September 2013 at 15:51

    It’s great that you comment on comments, but sometimes quite frustrating:
    I don’t actually favor a 6% target.
    Well, what x% DO you favor?

  43. Gravatar of Mark A. Sadowski Mark A. Sadowski
    8. September 2013 at 16:29

    Tom,

    He favors 5%:

    https://www.themoneyillusion.com/?page_id=3447

  44. Gravatar of Mark A. Sadowski Mark A. Sadowski
    8. September 2013 at 18:09

    I took Steve Randy Waldman’s set of eight nations in his latest post plus the four from my original set of counterexamples that he excluded (West Germany, Ireland, Luxembourg and the Netherlands), combined civilian labor force data from the OECD with CPI from AMECO, and computed 5-year compounded average civilian labor force growth rates and CPI inflation rates. The time periods ran from 1960-65 through 2007-12.

    Then I regressed the average CPI inflation rates upon the average labor force growth rates. Five of the twelve were statistically significant, and all at the 1% level. The average civilian labor force growth rate and average CPI inflation rate were positively correlated in the U.S. and Japan, and negatively correlated in Spain, the Netherlands and Luxembourg.

    Next I conducted Granger causality tests using the Toda and Yamamato method on the level data over 1960-2012 for the U.S., Japan, Spain, the Netherlands and Luxembourg.

    The U.S. data is cointegrated, so although the majority of lag length criteria suggested using only one lag, since Granger causality in both directions was rejected at a length of one, I went to two lags based on the other criteria. The results are that CPI Granger causes civilian labor force at the 10% significance level but civilian labor force does not Granger cause CPI.

    In Japan’s case civilian labor force Granger causes CPI at the 1% significance level but CPI does not Granger cause civilian labor force.

    Granger causality was rejected in both directions for the other three countries.

    In short, out of the 12 countries I looked at, only five have a significant correlation between average civilian labor force growth and average CPI inflation, and only two of the five have a positive correlation. Of the five, only the two with positive correlation demonstrate Granger causality. But in the US case the direction of causality is in the opposite direction to that which Steve predicts. Only Japan seems to support the kind of story he is trying to tell.

  45. Gravatar of ssumner ssumner
    9. September 2013 at 05:23

    Enric, Labor market reform would help ANY monetary policy work better, but I’d guess there’s enough price flexibility and wage stickiness that more NGDP would help right now.

    John, I agree.

    Tom, It depends what other policies are in effect.

    Mark, Thanks for all that data.

  46. Gravatar of Mark A. Sadowski Mark A. Sadowski
    9. September 2013 at 14:32

    Scott,
    Steve Randy Waldman has fixed the errors in his latest post and eliminated some countries but added seven additional countries.

    I added his set of seven new nations (Canada, Finland, Greece, Italy, New Zealand, Switzerland and Turkey) plus seven additional nations (Belgium, Denmark, Iceland, Korea, Norway, Poland and Portugal) to the set of 12 that I commented on last time. I did the same analysis as I did last time for this new set of 14, that is I combined civilian labor force data from the OECD with CPI from AMECO, and computed 5-year compounded average civilian labor force growth rates and CPI inflation rates. The time periods ran from 1960-65 through 2007-12 with the exception of Korea which started with 1967-72. I regressed the average CPI inflation rates upon the average labor force growth rates. Ten of the fourteen were statistically significant, and all at the 1% level with the exception of Poland which was at the 10% significance level. The average civilian labor force growth rate and average CPI inflation rate were positively correlated in Canada, Denmark, Finland, Greece, Iceland, Italy, Korea, New Zealand and Norway and negatively correlated in Poland.

    Next I conducted Granger causality tests using the Toda and Yamamato method on the level data over 1960-2012 (except for Korea which was over 1967-2012) for the ten countries which had statistically significant correlations.

    In Finland, Poland and Korea civilian labor force Granger causes CPI at the 5% significance level but CPI does not Granger cause civilian labor force. In Greece CPI Granger causes civilian labor force at the 1% significance level but civilian labor force does not Granger cause CPI. In Iceland CPI Granger causes civilian labor force at the 10% significance level but civilian labor force does not Granger cause CPI.

    So out of the 26 countries I have looked at, fifteen have a significant correlation between average civilian labor force growth and average CPI inflation with eleven of the fifteen having a positive correlation. Of the eleven with positive correlation six demonstrate Granger causality with three showing one way causality from civilian labor force to CPI and three showing one way causality from CPI to civilian labor force. Of the four with negative correlation one demonstrates Granger causality from civilian labor force to CPI.

    Only three countries (Japan, Korea and Finland) out of the 26 support the kind of story Steve is trying to tell.

  47. Gravatar of Larry Larry
    10. September 2013 at 05:22

    “If I had a hammer, I’d hammer in the morning. I’d hammer in the evening. All over this land…. ”

    I think Waldman’s arguments are a useful corrective to those who think monetary policy is always the answer. Other events in the real world really do influence the economy.

    Waldman has argued that the growth after WWII was due to, among other things, the removal of all the entrenched interests that existed prior to the war. Removing the entrenched interests leveled the playing field and allowed the growth to occur.

    Maybe similar problems exist today or other real world problems like the high cost of energy, but if you are only focused on monetary policy solutions, you will never see it or solve it.

  48. Gravatar of interfluidity » Terminal demographics interfluidity » Terminal demographics
    10. September 2013 at 05:40

    […] Nunes [1, 2], Steve Roth [1,2], Mike Sax, Karl Smith [1, 2, 3], Evan Soltas, and Scott Sumner [1, 2], as well as a related post by Tyler Cowen. I love the first post by Karl Smith. My title would […]

  49. Gravatar of Angry Bear » Links to debate on full employment/inflation Angry Bear » Links to debate on full employment/inflation
    10. September 2013 at 06:47

    […] Scott Sumner responds. […]

  50. Gravatar of ssumner ssumner
    10. September 2013 at 08:43

    Mark, That seems pretty convincing to me.

    Larry, You said;

    I think Waldman’s arguments are a useful corrective to those who think monetary policy is always the answer. Other events in the real world really do influence the economy.”

    You misunderstood him. He is saying that monetary policy is what caused the inflation which accommodated the growth in the labor force. he is saying that w/o a highly inflationary monetary policy there would have been high unemployment. That’s wrong.

    And you can’t have a “useful corrective” when it is based on data that is totally wrong. If you are persuaded by him then you aren’t engaged in critical thinking. His data was wrong. You need to readjust your priors when you find that out.

    In any case, no one here is saying monetary policy is more important that real factors, obviously it isn’t in the long run.

  51. Gravatar of Mark A. Sadowski Mark A. Sadowski
    11. September 2013 at 10:13

    http://angrybearblog.com/2013/09/links-to-debate-on-full-employmentinflation.html

    September 10, 2013

    Links to debate on full employment/inflation
    By Dan Crawford

    Commenter Mike McOsker claims:
    “I would argue that 70″²s inflation was caused by oil prices…”

    Which causes me to probe even deeper into why people still believe in this zombie myth.

    World nominal crude oil prices can be found here:

    http://econ.worldbank.org/WBSITE/EXTERNAL/EXTDEC/EXTDECPROSPECTS/0,,contentMDK:21574907~menuPK:7859231~pagePK:64165401~piPK:64165026~theSitePK:476883,00.html

    The US GDP implicit price deflator can be found here:

    http://research.stlouisfed.org/fred2/series/A191RD3A086NBEA

    Real world crude oil prices (in 2009 dollars) fell from $7.59 a barrel in 1965 to $5.31 a barrel in 1970, or by 30.0%, and then rose to $82.99 a barrel in 1980, or an increase by a factor of 15.62. For comparison real world crude oil prices rose from $16.54 a barrel in 1998 to $97.74 a barrel in 2008, or an increase by a factor of 5.90.

    However let’s look at expenditures on petroleum. Expenditures by energy source can be found here:

    http://www.eia.gov/totalenergy/data/annual/pdf/sec3_11.pdf

    Combine that with the GDP figures from this:

    http://www.eia.gov/totalenergy/data/annual/pdf/sec1_13.pdf

    And what you’ll find is the following.

    Expenditures on petroleum rose from 4.6% of GDP in 1970 to 8.5% of GDP in both 1980 and 1981, or an increase of 3.9 points. For comparison expenditures on petroleum rose from 2.6% of GDP in 1998 to 6.1% of GDP in 2008, or an increase of 3.5 points.

    Core inflation rose from 1.3% in 1965 to 4.7% in 1970 to 9.2% in 1980:

    http://research.stlouisfed.org/fred2/graph/?graph_id=109579&category_id=0

    But core inflation only rose from 1.2% in 1998 to 2.3% in 2008.

    So the increases in the proportions of GDP spent on oil are virtually identical and yet core inflation did not soar in the 2000s. Thus the idea that oil prices caused the Great Inflation makes little sense to me.

    Now, this raises a legitimate question, how is it that real world crude oil prices can go up nearly 16 fold and the amount spent on petroleum *less* than doubles in the 1970s, and the real world crude oil price goes up nearly 6 fold in the 2000s and the amount spent on petroleum *more* than doubles?

    One issue is that *US* crude oil prices did not rise anywhere near that much in the 1970s. The real US price of oil was $14.35 a barrel in 1965, $13.52 in 1970 and $77.39 in 1980, so US crude oil prices only rose by 5.72 fold in the 1970s:

    http://research.stlouisfed.org/fred2/graph/?graph_id=136738&category_id=0

    Until 1979 US crude oil prices were significantly higher than world crude oil prices, and as of 1965 and 1970 imported oil represented only 19.8% and 20.7% of total oil consumption respectively:

    http://www.eia.gov/totalenergy/data/annual/pdf/sec5_6.pdf

    Furthermore the price of crude oil relative to the consumption price was a lot lower in 1970 than it was later.

    If you take the average daily consumption figures from the link just above and multiply them by 365 you can convert them to annual averages. Then take the annual expenditures and divide them by the consumption amounts you’ll get the average consumption price of petroleum products. Then finally convert them to real prices using the GDP implicit price deflator and this is what you will find.

    The real consumption price of a barrel of oil rose from $35.98 in 1970 to $85.64 in 1980 or by 138.0%. For comparison the real consumption price of a barrel of oil rose from $33.56 in 1998 to $122.34 in 2008 or by 264.5%. Thus the impact of the oil price increases on the price of a barrel of oil to the consumer was actually far worse in the 2000s than in the 1970s.

    It’s interesting to note that US crude oil prices were 37.6% of the consumption price of a barrel of oil in 1970, 90.4% in 1980, 49.9% in 1998 and 75.4% in 2008. Furthermore world crude oil prices were only 14.8% of the consumption price of a barrel of oil in 1970. A weighted averaged of domestic and world crude oil prices suggests that in 1970 crude oil prices were only about one third of the consumption price of a barrel of oil in 1970.

  52. Gravatar of More on Population Growth as a Cause of Inflation: Mark Sadowski and Steve Waldman | Last Men and OverMen More on Population Growth as a Cause of Inflation: Mark Sadowski and Steve Waldman | Last Men and OverMen
    17. March 2017 at 06:41

    […] Roth [1,2], Mike Sax, Karl Smith [1, 2, 3], Evan Soltas, and Scott Sumner [1,2], as well as a related post by Tyler Cowen. I love the first post by Karl […]

  53. Gravatar of Sumner vs. Waldman on the Great Inflation: Was it a Monetary Phenomenon | Last Men and OverMen Sumner vs. Waldman on the Great Inflation: Was it a Monetary Phenomenon | Last Men and OverMen
    17. March 2017 at 06:41

    […]      https://www.themoneyillusion.com/?p=23432 […]

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