Austin, Texas (Project SyndicateThe size of President Joe Biden’s American Rescue Plan (ARP) – spending $ 1 trillion for this year, another $ 900 billion after that, plus infrastructure and energy programs $ 3 trillion has been promised – already frighten many macro economists. Are their fears justified?
Banks and bond market economists, who once cried, may be looked down upon. A year ago, many of them warned that the $ 2.2 trillion Coronavirus Support, Relief and Economic Security Act (CARES) would ignite hyperinflation by increasing money supply. Massive. It didn’t happen.
What happened to inflation? The answer is almost, if not absolutely possible, summed up in a single word: China.
Defective Phillips curve
More notable among critics are the neo-Keynesians like Lawrence H. Summers of Harvard University and so much more. acolytes. Summers has another analysis. It was his uncle, Paul Samuelson, who along with future Nobel Prize winner Robert Solow launched Phillips curve in 1960. This simple model makes some of the most successful empirical predictions in economic history in its first decade, and has become a common economic rule ever since.
Once again, the huge financial spending in the United States issued warnings about inflation and caused dark memories of the 1970s. But these fears are based on a model from which it has been erased. blurred by economic realities – especially the rise of China, has fundamentally reshaped the US and global economy.
Based on data from late 19th-century Britain and the United States after the war, the Phillips curve implicitly recognized the inverse relationship between inflation and unemployment: when one fell, the other increased.
This is what seems to be bothering Summers today. The various federal aid and rescue packages are actually huge, the ARP alone takes up roughly 6% gross domestic product. The overall size of federal spending is even greater, reaching 13% of GDP by an estimate. By comparison, the usual “output gap”(The level of economic stagnation) is only a quarter of that, perhaps less.
Reality wiped out the Phillips curve. From the early 1980s – and unmistakably from the mid-1990s onward – inflation was not found, and lower unemployment rates did not tend to continue.
Moreover, the official unemployment rate is, at 6%, not too far from the 4% level that is often thought to represent “full employment”. The recipients of government bailout are concentrated at the bottom of the income distribution, and therefore should, in theory, spend more and save less than the cash disbursement, especially when more households already has some savings from the CARES Act. According to old-fashioned Phillips curve logic, the new “stimulus” could push the unemployment rate down to full employment and the inflation rate to rise from 0.6% in 2020 to at least 2% -3%.
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But the Phillips curve has a rough road since 1969. For about 25 years later, the dominant economic mindset held that it was not a steep downward curve but a vertical line, at least. “in the long term”. The implication is that any attempt to reduce the unemployment rate below the “natural rate” or “the unemployment rate that does not increase rapidly” (NAIRU) will create hyperinflation.
Since full employment was never the culprit, full employment in the late 1990s and before the COVID-19 pandemic did not raise inflation again.
I’m pretty sure Summers believes in American capitalism more than this; however, he always heeded this odd school of thought.
On the other hand, the fact has actually wiped out the Phillips curve. From the early 1980s – and unmistakably from the mid-1990s onward – inflation was not found, and lower unemployment rates did not tend to continue.
This relationship is not vertical or downhill but flat, meaning it doesn’t exist – if it ever existed. I pointed this out in a 1997 article titled “Time to quit NAIRU. Twenty-one years later, the famous new Keynesian Olivier Blanchard began to ask basically the same question in the same magazine: “Should we reject the hypothesis of natural proportions?“
China did that
What happened? The answer is almost, if not complete, to be summed up in a single word: China.
Since the early 1980s, the US dollar
began to rise, crushing America’s Midwestern industrial base and unions. The ensuing collapse in world commodity prices – and the Soviet Union with them – set the stage for China to become the world’s top supplier of manufactured consumer goods.
Meanwhile, the drivers of rising U.S. consumer prices after 1970 – included a depreciating dollar, spike in oil prices, and cost-of-living adjustments for production workers (which was adopted as price higher) – disappeared.
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Since full employment was never the culprit, full employment in the late 1990s and before the COVID-19 pandemic did not raise inflation again. Furthermore, there is no tendency for oil price volatility to affect wages and other prices, because American jobs are now predominantly in the service sector, where the labor price is the price you pay. .
But wouldn’t China now take advantage of high US demand to push prices up? No, because Chinese companies are afraid of losing market share to other countries, and because Economic characteristics of China the prize is not profit maximization but social stability, stable production growthand reduce costs through new learning and technology. Such companies wouldn’t alienate their customers by raising prices to exploit a little more demand.
There may be some backlog and delayed deliveries, and some orders increase due to higher shipping costs and higher wages in China. But the only real inflation risk comes from those who ignited the flames of war with China. War is always inflationary; A war with our greatest commodity supplier would be an inflation nightmare.
Lack of confidence and security, not stuff
Meanwhile, US households are not short of smartphones, dishwashers, and running shoes. What they lack is confidence and security. As a result, most of Biden’s money will not be transferred to China. It will be geared towards savings, to cover future rent, mortgage, utilities, and debt repayments.
Yes, some will be spent on services that were omitted over the past year, restoring jobs in those areas to some degree. Some will be used for housing maintenance, repairs or upgrades – expenses that are overlooked when people fear paying the extra cost to a plumber, electrician or painter. And some will move on to building new homes, as it happened.
As for the rest, a good portion will be spent buying stocks
and real estate – especially land, suburban housing, and rural resorts, became valuable during the pandemic. Here it is mainly the price that will increase, enriching those who already own those assets. The already huge gap between the rich and the poor will get bigger. Because stocks and bonds, existing homes, and land are not newly manufactured consumer goods, these price increases will not be taken into account in inflation measures. We’ll have to follow them in the S&P 500
and on the Zillow real estate platform, where soaring prices are considered a good thing.
The lesson is twice as big. First, the 1960s mainstream neo-Keynes macroeconomy is not a useful guide to understanding a US economy that has become fully integrated with the rest of the world and essentially reshaped by the rise of China. Second, the US issue of inequality and uncertainty is not really a matter of material scarcity. They reflect an unsustainable distribution of wealth and power.
James K. Galbraith is professor of government and president of government / business relations at the Lyndon B. Johnson School of Public Affairs at the University of Texas at Austin. From 1993-97, he was the principal technical advisor on macroeconomic reform to the China State Planning Commission. He is the author of “Inequality: What everyone needs to know“And “Welcome to the Toxic Grail: The Destruction of Greece and the Future of Europe. “