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Evan Soltas and the Inflation Hawks

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Wednesday, 12 March 2014 04:31

Evan Soltas has responded to me and others who don't quite see us as bumping up against full employment and capacity constraints any time soon. Fortunately, he clearly lays out his argument so it is easy to see the error in his ways. He notes the unemployment rate has fallen by 0.8 percentage points annually the last three years and assumes that we will continue on this path.

That one doesn't seem very likely unless Evan is either way more optimistic about growth than almost anyone else or way more pessimistic about productivity. The basic story is that unemployment has fallen more than most economists (including me) expected in the last three years. The reason is that productivity growth has slowed to a crawl. The average rate of productivity growth over this period has been less than 0.9 percent.

There is considerable debate about what sort of rate of productivity growth we should see going forward, but you won't find many estimates under 1.5 percent, and most would be around 2.0 percent. The average from 1995 to 2007 was 2.7 percent. If we use a 2.0 percent productivity number and assume 0.4 percent annual growth in the labor force (600,000 jobs a year), that gets 2.4 percent growth in potential GDP.

Most forecasts put GDP growth at the next three years around 3.0 percent. If we get productivity growth rebounding to its normal pace then we would be exceeding potential GDP growth by around 0.6 percentage points. Using historic relationships, this translates into a drop in the unemployment rate of roughly 0.3 percentage points a year. If our target is 5.0 percent unemployment (I'd shoot for lower, remembering the good old days of 2000 and 4.0 percent unemployment), we would get there in 2019.

This is why I and others are not anxious to see the Fed slam on the brakes any time soon. For what it's worth, any movement toward tightening any time soon would be seriously out of line with what the Fed did following the last downturn. It left the federal funds rate at 1.0 percent until the summer of 2004 when the unemployment rate was 5.6 percent and the economy was growing at almost a 4.0 percent annual rate. (Yes, they deserve to be strung up for allowing the housing bubble to grow to such dangerous levels, but that was a question of regulatory policy and targeting the bubble, not interest rates that were too low.)

Comments (6)Add Comment
U6
written by jonny bakho, March 12, 2014 5:20
U6 is much higher. When there are more jobs, many in lower paying jobs will upgrade to higher pay higher skill jobs and unemployed will move into low paying jobs.

Plus the labor market is global. Unemployment went significantly below 6% in the 90s without large wage inflation. Some wage inflation would be good for the economy.
.......
written by djb, March 12, 2014 5:44
Just wondering if there is such a thing as "productivty growth in the financial sector...... and if so what exactly are they producing
three card monte
written by Peter K., March 12, 2014 8:31
@djb - as Johnny Lee Miller's Sherlock put it on the TV show Elementary, the financial sector is basically three card monte.

"Yes, they deserve to be strung up for allowing the housing bubble to grow to such dangerous levels, but that was a question of regulatory policy and targeting the bubble, not interest rates that were too low.)"

This seems to be a fundamental point about which the inflation hawks are dishonest. Regulation is bad but slack labor markets are good for them. But the result of course is a bubble/ house of card, lower demand levels and slow growth.
Evan's Bass Ackward Theory
written by Paul Mathis, March 12, 2014 9:59
The myth that Evan believes is that wages "cost push" inflation, when any Keynesian knows that demand pulls up prices in response to a shortage of supply.

So unless there is excess demand in the world economy relative to overall supply of goods and services, there won't be generalized inflation. (Of course "bottlenecks" of shortage can develop in select areas of supply, but that is not a general supply shortage that is cause for concern.)

Where does Evan see this excess demand for goods and services? A rational person does not see any supply shortages anywhere, so Evan is seeing ghosts.
...
written by urban legend, March 12, 2014 3:44
The idea that we are remotely close to seeing full employment is a sick joke, not something to be treated with a respectful response. Look at the employment-to-population ratio among 25-54 age, which eliminates the "baby boomer retirements" excuse. In 2000, it reached almost 82%. In 2007 it was over 80%. Now it's between 76% and 77%, and it's considerably worse than in other industrial countries other than the EU periphery.

When that rate approaches 80%, we can start talking seriously.
...
written by urban legend, March 12, 2014 3:55
In the second quarter of 2007, the employment-to-population rate in the 25 - 54 age group was 80%. By the second quarter of 2010, it had dropped to 75%. That is huge, and quick, and it isn't some sudden change in the nature of the labor force or one of Casey Mulligan's "Great Vacations" caused by overly generous unemployment insurance.

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.

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