[lbo-talk] Krugman: you can't have a wage/price spiral w/o wages

Michael Pollak mpollak at panix.com
Fri Jun 16 09:38:43 PDT 2006


The New York Times

June 16, 2006

Op-Ed Columnist

The Phantom Menace

By PAUL KRUGMAN

Over the last few weeks monetary officials have sounded increasingly

worried about rising prices. On Wednesday, Richard Fisher, the

president of the Federal Reserve Bank of Dallas, declared that

inflation "is running at a rate that is just too corrosive to be

accepted by a virtuous central banker."

I'm worried too -- but not about recent price increases. What worries

me, instead, is the Fed's overreaction to those increases. When it

comes to inflation, the main thing we have to fear is fear itself.

Discussions of inflation can be numbingly arcane -- are you a core

C.P.I. type or a trimmed-mean P.C.E. person? But the real issue is

whether there's a serious risk that inflation will become embedded in

the economy.

The classic example of embedded inflation is the wage-price spiral --

better described as wage-price leapfrogging -- of the 1970's. Back

then, whenever wage contracts came up for renewal, workers demanded

big raises, both to catch up with past inflation and to offset

expected future inflation. And whenever companies changed their

prices, they raised them by a lot, both to catch up with past wage

increases and to offset expected future increases.

The result of this leapfrogging process was that inflation became a

self-sustaining process, feeding on itself. And ending that

self-sustaining process proved very difficult. The Fed eventually

brought the inflation of the 1970's under control, but only by raising

interest rates so high that in the early 1980's the U.S. economy

suffered its worst slump since the Great Depression.

Fed officials now seem worried that we may be seeing the start of

another round of self-sustaining inflation. But is that a realistic

fear? Only if you think we can have a wage-price spiral without, you

know, the wages part.

The point is that wage increases can be a major driver of inflation

only if workers consistently receive raises that substantially exceed

productivity growth. And that just hasn't been happening.

In fact, the distinctive feature of the current economic expansion --

the reason most Americans are unhappy with the state of the economy,

in spite of good numbers for the gross domestic product and explosive

growth in corporate profits -- is the disconnect between rising worker

productivity and stagnant wages. Over the past five years

productivity, as measured by real G.D.P. per hour worked, has risen by

about 14 percent, but the real wages of nonmanagerial workers have

risen less than 2 percent.

Nor is there much sign that things are changing on that front. The

official unemployment rate is low by historical standards, but workers

still don't seem to have much bargaining power. (Does this mean that

the official unemployment rate makes the job situation look better

than it really is? Yes.) The Federal Reserve's Beige Book, an informal

survey of economic conditions across the country, reports that over

the last couple of months "wage pressures remained moderate over all,

with the exception being workers with hotly demanded skills."

But if wage pressures are so moderate, where's the inflation coming

from? The answer is soaring oil and commodity prices.

It's true that some widely used inflation measures, like so-called

core inflation, strip out the direct "first-round" effects of rising

energy prices. But there are still indirect effects, which usually

take some time to show up in the data. Much of the recent rise in core

inflation probably represents the delayed effect of the big run-up in

fuel prices a few months ago. And unless something else happens to

drive up oil prices -- like, to give a wild example, a military strike

on Iran -- inflation will probably subside in the months ahead.

And bear in mind that many economists, including Ben Bernanke, the

Federal Reserve chairman, have said that a little bit of inflation --

say, 2 percent a year on average -- is actually good for the economy.

It would be an exaggeration to say that there's no inflation threat at

all. I can think of ways in which inflation could become a problem.

But it's much easier to think of ways in which the Federal Reserve,

wrongly focused on the phantom menace of a new wage-price spiral,

could be slow to respond to bigger threats, like a rapidly deflating

housing bubble.

So I don't fear inflation nearly as much as I fear the fear of

inflation. And I wish the Fed would lighten up on the subject.



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