China’s absence from the great inflation debate

After 1970, all the factors that drove inflation in the US disappeared. From the mid-1980s the dollar began to appreciate and crushed the industrial base and the unions in the central region of the country. The collapse in world commodity prices set the stage for China to emerge as a global supplier of consumer products.

AUSTIN – President Joe Biden’s American Rescue Plan (PER) scale – $ -1 trillion this year and $ 900 billion more in 2022, along with the promise of an additional $ 3 trillion in infrastructure and energy program. dollars – scared many macroeconomists. Are your fears justified?

We can dismiss the bank and bond market economists, who have already screamed that the wolf is coming. A year ago, many of them warned that spending $ 2.2 trillion under the Coronavirus Relief, Relief and Economic Security Act (CARES) would fuel inflation due to a massive increase in the money supply. .. it didn’t happen.

Critics include New Keynesians such as Harvard University’s Lawrence H. Summers and his many acolytes. Summers’s analysis is different. It was his uncle, Paul Samuelson, who, along with fellow Nobel Prize winner Robert Solow, introduced the Phillips curve in 1960. This simple model offered some of the most successful empirical predictions in economic history during its first decade and a half. it became, since then, a general rule.

The Phillips curve was based on late 19th century British and postwar American data; he postulated an inverse relationship between inflation and unemployment: if one went up, the other went down. Here’s what seems to bother Summers today: The various rescue and federal support packages are really huge; the PER alone represents about 6% of the US GDP. All federal spending is even higher and, by one estimate, reaches 13% of GDP. Compared to him, the “output gap” (the unused capacity of the economy) is only a quarter of that, maybe less.

On the other hand, the official unemployment rate, 6.2%, is not that far from 4%, a level that is usually considered “full employment”. Those who receive government assistance support are concentrated at the bottom of the income distribution and should then, in theory, spend more and save less than cash outlays, especially considering that many households already have savings from the CARES law. According to the traditional logic of the Phillips curve, the new “stimulus” could reduce the unemployment rate to full employment and increase inflation from 0.6% in 2020 to at least 2 or 3 percent.

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But the Phillips curve was not easy for five decades, starting in 1969. During those 25 years, the dominant economic thought held that it was not a curve with a negative slope, but a vertical line, at least “in the long term”. It follows that attempts to reduce unemployment beyond a “natural rate” or “non-accelerating inflation rate of unemployment” (NAIRU) would produce hyperinflation. I’m pretty sure Summers has more confidence in American capitalism than this conception implies, yet he always showed a penchant for this finicky school of thought.

Reality, on the other hand, wiped out the Phillips curve: from the early 1980s – and unmistakably from the mid-1990s onward – there was no inflation and reduced unemployment did not tend to create it. The relationship is neither negatively sloped nor vertical, but flat. This is equivalent to saying that it does not exist (if it ever did). I pointed this out in 1997, in an article titled “Time to leave the NAIRU.” Twenty-one years later, the distinguished New Keynesian Olivier Blanchard asked himself basically the same question in the same publication: “Should we reject the natural rate hypothesis?”

What happened? We can summarize the answer completely, or almost, in one word: China. Starting in the mid-1980s, the US dollar began to appreciate and crushed the industrial base and unions in the Midwest. The subsequent collapse in world commodity prices – and the Soviet Union with them – set the stage for China to emerge as the world‘s leading supplier of manufactured consumer goods.

Meanwhile, all the factors that drove higher prices for American consumers after 1970 – including dollar devaluations, oil rises, and cost-of-living adjustments for manufacturing workers (which were passed on through higher prices) – disappeared. Since full employment was never the culprit, full employment in the late 1990s and prior to the Covid-19 pandemic did not lead to inflation. On the other hand, the tendency for changes in the price of oil to be transmitted through wages and other prices disappeared, because American jobs are now mainly in the service sector, where the price of labor is what you pay. for him.

But won’t China take advantage of high US demand to raise prices? No, because Chinese companies fear losing their market share to other countries and because the Chinese economic spirit does not prioritize profit maximization but rather social stability, sustained production growth and cost reductions through learning and training. new technologies. These companies will not alienate their customers by raising prices to exploit a little extra demand. There may be some backorders and late deliveries, and some price increases from higher transportation costs and wages in China, but the only real inflationary danger comes from those fanning the flames of the war against China. War is always inflationary and a war against our largest supplier of goods would be an inflationary nightmare.

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Beyond that, American households do not suffer from a shortage of smartphones, dishwashers, and athletic shoes; what they lack is confidence and security. So much of Biden’s money will not go to China at all but into savings, to cover future rents, mortgages, utilities, and debt repayment.

Of course, a portion will be spent on services we missed over the past year, reviving employment in those sectors to some extent. Some of it will go to maintenance, repair, or home improvements (expenses that were neglected when people feared taking on the added cost of a plumber, electrician, or painter). And a part will go to the construction of new houses, as is already happening.

As for the rest, a good chunk will go toward buying stocks, bonds, and real estate – especially land, suburban homes, and shelters in the countryside, extremely valuable during the pandemic. It will be mainly in those sectors where prices will increase, further enriching those who already own those assets. The already huge wealth gap will widen. Because stocks, bonds, existing homes and land are not new consumer products, those price increases will not be part of the indexes that measure inflation, we will have to look for them in the S&P 500 index and in the real estate platform Zillow , where price hikes are, unsurprisingly, celebrated as a good thing.

The lesson in broader terms is twofold: First, the dominant Neo-Keynesian macroeconomics of the 1960s is not a useful guide to understanding an American economy completely entangled with the rest of the world and fundamentally altered by the rise of China. Second, America’s problems of inequality and precariousness are not actually problems of material scarcity, but rather reflect an inadequate and unsustainable distribution of wealth and power.

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The author

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 to 1997, he served as Senior Technical Advisor for Macroeconomic Reform to the China State Planning Commission. He is the author of Inequality: what everyone needs to know and Welcome to the poisoned chalice: the destruction of Greece and the future of Europe.

Copyright: Project Syndicate, 2020

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