Tuesday, October 12, 2004

"Stagflation" is suddenly all the rage.

Case in point. A simple Lexis-Nexis search shows that from August 1999 through July 2004 the word "stagflation" appeared prominently (in the headline or lead paragraphs) in the Financial Times a mere 13 times. That comes out to an average of one appearance every 4.6 months. Since August 1, however, the word has appeared prominently nine times, on average one appearance every eight days. Today, in fact, the nasty word shows up twice. Clearly folks are gazing back to the 1970s and they don't like the comparisons.

From Joachim Fels in today's FT (sub. only):
I see five main parallels between the current situation and that of the 1970s. First, the world economy must again digest a sharp increase in oil prices. . . .

Second, just as in the 1970s, monetary policy has been highly expansionary . . .

Third, then and now, government budget deficits rose . . .

Fourth, the established industrialised nations in Europe and North America faced new competitors in world markets . . . [leading to] a big structural crisis . . .

Finally, just as global productivity growth slowed in the 1970s from its heady pace of the 1960s, we may now be at the tail-end of the information-technology-induced productivity growth cycle that began in the mid-1990s.
All very good observations. However, Fels omits the most important difference between the 1970s and the 2000s from his lineup, saving it for the final paragraph:
Yet, there is a big difference between now and the 1970s: workers now have less bargaining power. Back then, unemployment was lower, competition from emerging markets was less intense and the political climate following the student revolts of the late 1960s was more conducive to redistribution from capital to labour. Today, while wages are still likely to follow inflation with a lag, aggressive "autonomous" pay increases as in the 1970s are unlikely. Wage-induced cost-push inflation is not on the cards.
This is a very important difference. In the 1970s workers had the economic and the political capacity to drive up wages and thus demand and prices. Today things are quite different. As real wages have stagnated and even begun falling in the US, consumption in the US has been buoyed only through a rolling wealth effect, first rooted in equities and then housing. All of this, both in the US as well as in China, has been supported by extremely loose monetary policy which both countries are now in the process of tightening, however slowly and tentatively. Producers can try to raise prices, and on some goods and services (e.g. transportation) they will, but overall it seems unlikely that real 70s-style inflation will return precisely because of the prostrate position of labor today.

I wrote a couple of posts back in June on stagflation (here and here), based especially on some great work by Jonathan Nitzan at York University in Toronto. Jonathan emailed me back then with some of his more recent work, and I'll try my best to update my thinking in light of these mounting arguments for stagflation.

Nonetheless, I still remain committed to a basic deflationary scenario. After all, you wouldn't want me to start sending you "mixed messages," would you?

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