Politics & Policy

Irrational Exuberance Is Not Inflationary

Here's hoping the Fed recognizes this reality.

The Wall Street Journal’s Mark Whitehouse and Kemba Dunham say that too much employment growth causes inflation. In advance of last Friday’s jobs report, they wrote that a really good jobs number could “fuel fears of higher inflation and cause bond prices to fall and interest rates to rise.”

In fairness to both writers, Federal Reserve chairman Alan Greenspan has in the past similarly worried about the economy growing too fast. He noted in a 1999 speech that if GDP continued to rise “in excess of trends of potential, the economy could be expected to eventually overheat, with inflation and interest rates moving up.” Greenspan went on to argue in the same speech that job growth would have to moderate “if inflationary forces are to continue to be contained.”

To any American who lived through the ’70s and early ’80s, the above assumptions would presumably be confusing. In the aforementioned timeframe inflation was sharply higher alongside rising unemployment; the latter hitting a high of 11 percent in 1982. Arthur Laffer has pointed out that unemployment ranged between 14 percent and 25 percent from 1933 to 1937 and, contrary to the present conventional wisdom that would suggest falling prices, inflation averaged 7 percent during the time in question.

As opposed to too much economic or employment growth, what caused the inflationary ’30s and ’70s, not to mention Germany’s inflation after World War I and Latin America’s in the ’80s, was too much money chasing too few goods. Inflation is and always will be a monetary phenomenon in which money creation outpaces demand. As the value of the local currency fell in each instance, wages and prices rose not as a result of too much growth or demand, but due to a weakening currency. That’s inflation.

But even if there were some kind of correlation between employment growth and inflation, there is still no evidence that the Fed should hike interest rates to fix this “problem.” Indeed, the comments of Whitehouse and Dunham last week, and Greenspan nearly six years ago, falsely assume that the labor force is static and that people don’t adjust to the changing economics of the workplace.

In truth, the labor force is very dynamic, and it grows in response to the rising demand for workers. As wage pressures rise, as they did in the late ’90s and early part of this decade, so too does labor-force participation. David Malpass, NRO financial writer and chief economist at Bear Stearns, documented this phenomenon in a report on February 4: Though the present 65.8 percent level of labor-force participation is high by historical standards, it is down from its peak of 67.3 percent in 2000. When demand for labor outstrips “supply,” more people enter the workforce, and in doing so, wage pressures are moderated.

Even if labor-force participation were in fact static, there’s still nothing saying the Fed should use interest-rate hikes to “cool” the economy. To see why, one need only buy gasoline, movie tickets, or airplane tickets. In each case, innovation has made it possible for purchasers of all three to do so without transacting with a live human being.

Wal-Mart now offers self-checkout aisles in which customers can scan their items themselves, at which point they swipe debit or credit cards to complete the transaction. In short, businesses will continue to innovate around labor shortages. Fed involvement in this process is at best superfluous and, as the 2001 recession indicated, can very often be harmful to the economy.

In a 2000 report for the Hudson Institute, economist Alan Reynolds analyzed periods of economic growth and found that “the United States has never experienced high inflation and rapid real growth at the same time.” Here’s hoping the Fed recognizes this reality and avoids strangling the jobs recovery based on the discredited notion that too many people working is somehow inflationary.

John Tamny is a writer in Washington, D.C. He can be contacted at jtamny@yahoo.com.

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