I was very disappointed to read the interview given by Charles Goodhart and Manoj Pradhan to James Pethokoukis on the topic of their book “The Great Demographic Reversal: Ageing Societies, Waning Inequality, and an Inflation Revival”, released last August. After all, Goodhart is a well known monetary economist and one of those that has a “law” attached to his name
First question: What is the current economic consensus on inflation? Why have we had low inflation over the past few decades?
Goodhart: People generally assume that the low, steady inflation that started in the 1990s is due to better monetary policy and the central bank’s ability to keep inflation down. We disagree.
Pradhan: Central banks have picked up so much credibility because there’s debate that the Phillips Curve is dead and, as a result, central banks only have to worry about growth, as opposed to inflation. It makes their job relatively easy: If growth goes down, you cut rates. And if growth looks like it’s overheating, you raise rates to slow things down. But we argue that it’s China that put the Phillips Curve in a coma — and that the pandemic and demography are going to revive it.
To them, low inflation in the past few decades was due to demographic forces.
Goodhart: At the same time, there was a huge influx of female workers and Baby Boomers into the workforce, which shocked the sector and led to weak bargaining power and lower inflation on wages and prices.
That´s interesting, because several years ago I read the argument that the Great Inflation was also due to demographics. You can read that here: “Not a monetary phenomenon.”
The root cause of the high-misery-index 1970s was demographics, plain and simple. The deep capital stock of the economy — including fixed capital, organizational capital, and what Arnold Kling describes as “patterns of sustainable specialization and trade” — was simply unprepared for the firehose of new workers.
The nation faced a simple choice: employ them, and accept a lower rate of production per worker, or insist on continued productivity growth and tolerate high unemployment. Wisely, I think, we prioritized employment.
But there was a bottleneck on the supply-side of the economy. Employed people expect to enjoy increased consumption for their labors, and so put pressure on demand in real terms. The result was high inflation, and would have been under any scenario that absorbed the men, and the women, of the baby boom in so short a period of time.
Note the inconsistency. While to one the robust growth in the labor force was responsible for the low/stable inflation, to the other the same forces were responsible for the strong increase in inflation!
It is disheartening to see that monetary policy is not mentioned, only to say that it was not relevant to the outcomes!
One problem is that monetary policy is viewed as interest rate policy, or that interest rates well define the stance of monetary policy. However, as Milton Friedman put it 50 years ago:
…In particular the approach provides an interpretation of the empirical generalization that high interest rates mean that money has been easy, in the sense of increasing rapidly, and low interest rates that money has been tight, in the sense of increasing slowly, rather than the reverse.
Not only interest rates do not define the stance of monetary policy, what is worse, it can be misleading!
For example, you may argue, as does the Fed, that monetary policy was “eased” significantly after August 2007, with the FF rate falling to the extremely low level of 2% by April 2008, and remained at that very low level for the next 6 months.
Sorry, but Bernanke himself long ago said that the level of interest rates is not an appropriate measure of the stance of monetary policy! Better look, he said, at what´s happening to aggregate nominal spending (NGDP). Unfortunately, he didn´t! He only looked at inflation and worse, only to the headline measure, contaminated by the oil price rise.
If you follow Bernanke´s suggestion and look at what´s happening to NGDP, you will see that monetary policy determined the high/rising inflation of the 1970s, the “switch” to low & stable inflation of the 1990s and the continuation of even “too low” inflation all the way to the present. The charts illustrate.
The fear of inflation following the pandemic is generalized. Larry Summers, who should know better even embraces the old “punch bowl” metaphor.
Larry Summers (at the 13 min mark):
Fed doctrine had been "to take away the punch bowl before the party gets out of hand. What we've now said is — we're not going to do anything until we see a bunch of drunk people staggering around."
Contrary to what Goodhart believes, inflation will not arise because of demographic factors. The Fed and monetary policy pin down the rate of inflation. After the monetary policy induced shock of the Great Recession, the Fed was too “conservative”, not allowing NGDP to climb nearer its previous trend level path. How it will act now will largely determine the path of inflation and real growth going forward.
The nature of the choices facing the Fed were discussed here.
The deceleration in AD, from the deceleration in Vt, is due to the impoundment and ensconcing of time deposits, interest bearing deposits, in the payment's system. The FED eliminated Reg. Q ceilings and the FDIC rose deposit insurance from $40,000 to $100,000. Then in 2008 the FDIC raised deposit insurance to unlimited and the FED remunerated IBDDs (a Romulan Cloaking device), inducing nonbank and E-$ disintermediation.
The July 2011 demarcation in E-$ liabilities was principally due to: (1) “the FDIC formally modified the assessment base in 2011 to include all bank liabilities”, which made foreign deposits, e.g., E-$ borrowings, more expensive (never before applied assessment fees), and Basel’s additive Liquidity Coverage Ratio (LCR).
re: "The root cause of the high-misery-index 1970s was demographics, plain and simple"
False. It was due to the acceleration in velocity as measured by demand deposit turnover. Vt rose because of the monetization of time deposits, the end of gate keeping restrictions, the transition from clerical processing to electronic processing.