May 7, 2011


If You Have the Answers, Tell Me (N. GREGORY MANKIW, 5/07/11, NY Times)

How long will inflation expectations remain anchored?

In 1967, Milton Friedman gave an address to the American Economic Association with this simple but profound message: The inflation rate that the economy gets is, in large measure, based on the inflation rate that people expect. When everyone expects high inflation, workers bargain hard for wage increases, and companies push prices higher to keep up with the projected cost increases. When everyone expects inflation to be benign, workers and companies are less aggressive. In short, the perception of inflation — or of the lack of it — creates the reality.

Although novel when Professor Friedman proposed it, his theory is now textbook economics, and is at the heart of Federal Reserve policy. Fed policy makers are keeping interest rates low, despite soaring commodity prices. Why? Inflation expectations are “well anchored,” we are told, so there is no continuing problem with inflation. Rising gasoline prices are just a transitory blip.

They are probably right, but there is still reason to wonder.

Females, blacks and people over 65 are all considered worthy of employment domestically, while "Made in ...." is no longer a slur but reflects the advent of cheaper labor abroad for American-designed products. In such an economic milieu, employees have no power to ask for higher wages. Thus the realistic expectation of inflation is deflation.

Consider just one, relatively unnoticed, current event: the most important result of the Arab Spring is a labor force of 60 million people becoming available to the West.

Posted by at May 7, 2011 8:06 PM

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