Is the inflation of the 1970s a myth? I don’t think it was, but something Dylan Matthews’ excellent overview of Modern Monetary Theory illustrates is that some people think it was. That to me is a mistake, and people should try to separate the merits of heterodox macroeconomic theory (which I think are considerable) from a handful incidental political commitments that its adherents have. The core point of MMT is that if you have a freely floating fiat currency then the sovereign can’t “run out of money” and the point of taxes is to regulate demand not to finance government activities. But even though this is a “heterodox” view, I think few mainstream people would actually deny it. Instead they think that talking in these terms will lead to dangerous inflation. I think that fear is overblown, but not as overblown as Jamie Galbraith thinks it is:
“The last time we had what could be plausibly called a demand-driven, serious inflation problem was probably World War I,” Galbraith says. “It’s been a long time since this hypothetical possibility has actually been observed, and it was observed only under conditions that will never be repeated.
I think this contains some insight. Unfortunately the standard concept of “inflation” runs together two very different scenarios. In one kind of “inflation”, China abandons Maoist economic policies, its population gets richer, as it gets richer they start eating more meat, and this pushes the worldwide price of meat, dairy, and grains upward. That’s a real thing and it hurts real people in their pocket books, but these kind of global commodity price fluctuations aren’t effectively addressed by demand regulators. And one story some people have about the seventies is that it was just a global commodities issue. OPEC pushed up the price of oil, so we got “inflation” but this is nothing like the World War One case where dodgy government financial practices eroded the value of money.
That’s why my favorite indicator of inflation is “unit labor costs”:
Unit labor costs are basically wages divided productivity. It’s not the price of labor, in other words, but the price of labor output. If productivity is rising faster than wages, then even if wages themselves are rising unit labor costs are falling. Conversely, if wages rise faster than prodictivity than unit labor costs are going up. Clearly there’s nothing wrong with a little increase in unit labor costs here or there. But over the long term, growth in unit labor costs needs to be constrained or else it becomes impossible to employ anyone. And you can see that in the seventies it’s not just that gasoline got more expensive, we had an anomalous spate of high unit labor cost growth. That was inflation and it’s what led to the regime change that’s governed for the past thirty years.
In the wake of the Great Recession, I think we need another change in regime. We can’t continue with an approach that always delivers on price stability but frequent leads to prolonged spells of mass unemployment. But I think to push for that regime change credibly, people need to acknowledge what went wrong in the past and need to explain why it won’t happen again. I would say, for example, that one of the great virtues of the more globalized economy of 2012 rather than 1972 is that the freer flow of goods across borders makes inflation much less likely.