Normally, I do a video on Fridays. But today, I felt compelled to put my thoughts to good old-fashioned paper (OK, digital paper).
Orthodoxy is collapsing fast.
You can see it in the recent talk about the pros and cons of federal government economic stimulus.
In one corner is about 75% of the American population, regardless of party affiliation, whom polls say support payouts to compensate for COVID-19’s damage to the economy.
Joining them are our top economic officials: Fed Chairman Jerome Powell and Treasury Secretary Janet Yellen. I never thought I’d live to see the day.
In the other corner are the usual suspects: mainstream economists, who are more concerned about inflation than anything else.
To an economic historian like me, this is a fascinating time.
Since the 1960s, Milton Friedman’s dictum has ruled. He said: “Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.”
Translated from econo-babble: If the government or the Fed adds more money to the economy, we’ll get inflation. Ergo, say followers of Friedman, stimulus payments will lead to inflation and must be cut substantially.
The problem is that this hasn’t been true for more than a generation.
After a big jump in the 1970s … and despite unprecedented money creation by the Fed … annual inflation has trended solidly downward and has rarely exceeded 2% in the last few years.
Given that undeniable fact, why does the inflation-phobic drumbeat against federal stimulus continue?
The answer will surprise you.
If We Want Jobs, We Need to Spend
In 1942, Polish economist Michal Kalecki gave a speech at Cambridge University entitled “Political Aspects of Full Employment.”
He started by saying that most economists believe…
Full employment may be secured by a Government spending program, provided there is in existence an adequate plant to employ all existing labor power.
He noted that it’s better to borrow money rather than raise taxes. That’s because taxes would reduce economic activity, and thus the impact of government spending.
Regarding inflation, he pointed out that debt-financed government spending was the same as any other spending. If there are enough resources in the economy to meet that additional demand, inflation won’t happen until those resources are exhausted.
Kalecki then posed a question that’s as pertinent today as it was in 1942: given this, why do we tolerate unemployment?
Optimal for Me, But Not for Thee
In Economics 101, back in 1985, our professors told us there was an “optimal” rate of unemployment. That was the rate at which joblessness and inflation were considered “acceptable.” They’re still teaching that.
Acceptable to whom, you might ask? Certainly not to folks without a job.
The optimal rate of unemployment has varied over the years, but until recently, policymakers reckoned it at 5% to 6%. Given the size of the U.S. labor force, that’s between 10.2 and 12.3 million workers.
That’s a lot of lost wages … and a lot of personal pain.
Workers Finally Benefit
Recently, the Fed showed the relative income growth of different segments of the labor force.
The Fed’s low interest rate programs kicked into high gear in 2013. From then until just before the pandemic, annual wage gains for the bottom 25% of the labor force grew from 1.5% to nearly 5%. And starting in 2018, wage growth for the middle 50% started to rise as well:
Inflation during that spurt of wage growth was under 2%. That means millions of Americans enjoyed increasing real incomes and spending power.
For those people and their families, the unemployment rate was getting more “optimal” all the time.
The Real Cause of Unemployment
The chart above shows that wage growth for the bottom 25% of the labor force broke away from everyone else starting in about 2016. Lo and behold, that’s the year the unemployment rate fell below 5%:
The relationship is clear. When unemployment falls below about 5% of the labor force, wages begin to grow.
Conversely, when unemployment is at 5% or more, wages stagnate.
So why doesn’t the government take steps to keep unemployment below 5%?
My economics professors taught us that the so-called optimal rate of unemployment reflected “friction” in the labor market. It was simply workers transitioning from one job to another.
That’s remained the official excuse ever since.
But Kalecki had a different answer.
He argued that employers prefer to keep unemployment at a level that prevents workers from bargaining for better wages by threatening to leave for another job.
That cuts into profits. It makes workers more likely to demand decent treatment. “Friction” is just the name economists give to strategies to avoid this outcome.
That’s why, whenever it looks like government policy is about to take a pro-wage earner turn, employers and their friends in media and academia begin to beat predictable drums.
They issue dire warnings about inflation.
They’re suddenly concerned about budget deficits that didn’t matter a whit when taxes were being cut.
They whisper darkly about declining business “confidence.”
Kalecki’s point was that the only reason we experience the agonies of large-scale unemployment is because it’s more profitable for business.
I agree with him. And I would encourage you to think about his argument the next time you see a headline warning of the horrors of inflation.
After all, for most people, unemployment is the biggest horror of all
Editor, The Bauman Letter