Journalists have to say something about the stock market correction. I get that. But it would be helpful if they didn’t drag old, discredited theories out from the trash bin of history in the process.
The news has been packed with fake economics for the weeks since the correction in stocks began. Story after story has claimed that rising wages could translate into higher inflation, setting off fear and trembling on Wall Street. These claims have caused anyone with contemporary economics knowledge to slap their heads with exasperation. This is precisely how fallacy lives on and on: it keeps being reported by journalists who don’t know better.
The cause and effect runs as follows. Unemployment drops because of better business conditions. In order to retain workers, companies have to boost wages. The workers, now flush with money, go out and spend on goods and services. Sensing higher demand, businesses start increasing prices. Those price increases become contagious across industries, thus generating higher inflation.
Milton Friedman tried to teach the world that inflation is always and everywhere a monetary phenomenon. The wisdom keeps not sticking. You can look as early as 1957, at the very height of Keynesian theory, and find Henry Hazlitt debunking the idea that wage increases cause inflation. He set the record straight: “Expansion of the money supply is both the necessary and the sufficient cause of inflation. Without such expansion, an excessive increase in wage rates would lead merely to unemployment.”
Or you can examine this comprehensive and patiently brilliant article by Dallas S. Batten published in 1981 by the St. Louis Federal Reserve.
The cost-push view of inflation is based on the notion that prices are set by the costs of production and that prices rise only when costs rise, regardless of demand. Inflation, in this framework, is the result of the sellers of productive inputs (including labor) persistently and unilaterally raising their selling prices, causing producers’ costs, and subsequently prices, to rise….
Such an hypothesis (1) confuses changes in relative prices with inflation, a continuously rising overall level of prices, and (2) neglects the role that the money supply plays in the determination of the overall price level. The idea that greedy businesses and/or labor unions can cause a continual rise in prices cannot be supported by either the conceptual development or the empirical evidence provided.
His two points bear repeating. Wage increases are not inflation. They are wage increases, period. Inflation deals with the price level in general at a very high level of aggregation. Relative price changes are completely different. The only way to cause all prices to increase together is through large increases in the money supply. No matter how you manipulate the numbers coming out of the Fed right now, it is impossible not to see that we’ve seen a falling rate of increase in the money supply over the past five years. This is not so much a result of Fed policy as such but rather consumer and bank behavior that has resulted in a notable decline in the velocity of money.
It is entirely possible that better economic conditions will increase market confidence in a way that will increase the velocity of money, in addition to activating more lending from banks. Both can cause adjustments in the equation of exchange that, at least according to the math, could fire up real inflation. But there are also a thousand other factors, both domestic and international, that could also change that outcome.
No matter how you look at it, zeroing in on higher wages as the cause of inflation is identifying the wrong source. There is also something strangely perverse about the theory of wage-push inflation. It blames business and workers for what is actually caused by the centrally managed banking system. This might not seem problematic right now but when inflation does truly become a problem, it becomes crucially important to understand its source. In the 1970s, bad theory led to price and wage controls that caused chaos in the markets.
Still, journalists in recent weeks have no problem dishing out bad theory by the pound.
“If wages continue to pick up, that could boost inflation,” says CNN. “Corporations could pass on rising wages to consumers by raising prices, and rising prices could feed inflation,” says The Nation. The Washington Post reports that “if the wage increase was heralding higher inflation ahead, then the Fed might accelerate its rate hikes out of concern that it needed to control inflation before it got out of hand.”
The last point is an interesting one. It subtly suggests that it doesn’t matter if the theory of wage-push inflation is right or wrong. It hints that it only matters that the Fed might believe it and increase interest rates in response. But I’m optimistic here. It has been decades since the wage-push theory has enjoyed any kind of status within the economic profession. It is highly doubtful that any top policy makers at the Fed really believe this stuff.
In any case, we are long past the time when the Fed could really control all the factors that go into monetary conditions, to say nothing about the macroeconomic environment. There is a reason there are so many ways to measure the money supply: since financial deregulation, the entire sector has become too complex to summarize in a single statistic. The structure of Fed control limits influence to short-term rates only. Lending today is no longer limited to the banking system. What’s more, the rise of cryptocurrency is starting to break even the Fed’s monopoly on the means of exchange itself.
Markets will continue to obsess about who is running the Fed and what they are planning to do. But that may reflect Wall Street’s insatiable hunger for any factors that hint at market conditions. Plus, in this world, people can come to believe something simply because they believe others believe it. Such is the case with this wage-push theory and the Fed’s response.
There is an additional irony about the fact that inflation fears have suddenly come to predominate discussion of economics in the press. For decades now, we’ve been witness to an overblown concern for deflation, as if falling prices is the worst thing that could ever befall us. Out of nowhere, and in response to what is truly a very small increase in wages, suddenly the whole narrative shifts. Google Trends reports an large uptick in searches on the term inflation.
Let’s add a final note on why precisely the mainstream press has been reporting with such focus bordering on fanaticism on the stock market, which, by the way, has only fallen to levels of early December 2017 (not exactly a disaster in the making). My own theory: this is all about politics. Any weapon will do to promote schadenfreude concerning Trump’s incessant bragging about financial conditions. So you guessed it: fake news (on all sides) is giving rise to fake economics.