Sunday, July 17, 2022

The inflation fallacy redux

 Peter Dorman had a post on this topic here a while back.  The inflation fallacy says that inflation doesn't affect real income, since aggregate nominal income increases at the same rate as prices. 

But today you can't shake a stick without hitting someone, economist or lay-person alike,  talking about the harm that the current inflation is doing to real income.

So: what is going on?  If the inflation fallacy is correct then a fall in real wages  would imply an increase in real non-labor income. Is that happening?

But the larger point of the fallacy is that changes in real income have real, not monetary, causes.  If, for example, an increase in labor supply reduces the equilibrium real wage, this may well manifest itself in an inflation rate in excess of wage growth, and the blame for lower real wages might be placed, fallaciously, on high inflation.

So why are real wages falling? One explanation, given by Jason Furman, is that the demand-induced expansion of employment is the cause--real wages behaving, as is typical, counter-cyclically.

But something about that doesn't sit right with me. Lately, I have been thinking back, way back, to Bob Rowthorn's "conflict theory of inflation."  One implication is that the stagnation of real income, or a reduction in its growth rate --  and hasn't the pandemic been responsible for such a stagnation? -- can lead to inflation as everyone, capitalist and worker alike, tries to maintain their real incomes.  This is consistent with the inflation fallacy: we want to treat the consequence, higher inflation, as the cause, pandemic-induced lower real income.

I'm really asking for help here, and would love to hear what Peter, Barkley and Tom think.

(BTW, I have the same puzzlement when I read descriptions of the great inflation related to the influx of New World gold as a cause of lower real wages and capital accumulation.)


kevin quinn said...

I should have said, instead of "if the inflation fallacy is correct", "if the inflation fallacy is indeed a fallacy." And for "consistent with the inflation fallacy", substitute "consistent with the idea that changes in real income have real causes."

Peter Dorman said...

Thanks for the mention, Kevin. What a number of people (no references here, off the top of my head) have been saying is that it's primarily a composition effect. Specifically, the claim is that, as society shrugs off the pandemic, low-paid service jobs are coming back.

This should be empirically testable, but I haven't seen any work that either contradicts or supports it.

Of course, at a deeper level, there's the question of why "low-paid service work" is so low-paid, but if the composition argument is correct, that disparity should have remained roughly constant.

nobody said...

Globally, what is the causal chain between the pandemic and reduced productive capacity and/or reduced real income? There doesn't seem to be one. Only the Chinese are doing large-scale curfews anymore and very few countries have lost enough working-age people to the pandemic to appreciably impact labor availability.

It seems to me that declining real income and rising inflation, as two sides of the same coin, have very little to do with the pandemic at this point. As I see it, the underlying causes are:

The US-Chinese great power economic sanctions pissing match, which has cut off Chinese exports of electronic parts to the west, triggering shortages of everything that contains chips.

Russian oil export issues related to their invasion and genocide in Ukraine.

Saudi Arabian oil supply cuts intended to influence the outcome of the next few US elections.

Food export issues from Ukraine due to the Russian invasion and blockade.

Global-warming related crop failures.

Businesses in highly consolidated sectors raising prices to retain the profit margins they were able to extract when there were pandemic-related curfews in effect.

Large-scale political-economic mismanagement (including the recent interest rate hikes scalping anyone who invested in productive capital goods over the past few years) leading to the dismantling of productive capacity in favor of mechanisms intended to derive profits through financialization or fraud.

The pandemic isn't the major issue anymore. Instead, the pandemic shock simply exposed much deeper faults in global society.

kevin quinn said...

Peter: yes, the composition effect is certainly part of it, with lower wage workers disproportionately represented in new employment post-ppandemic; not sure how much quantitatively that might account for.

Anon: agree with all of your amendments, thanks. I would just want to argue that -- with respect to the two sides of the coin--it is the real income shocks causing the inflation, not vice-versa.

(Of course, there is a monetary background as well.)

kevin quinn said...

Whoops: I was replying to "nobody," not "Anon." Sorry- I hope "nobody" was not offended.

Peggy said...

Guys, guys, please,
When you say "productive capacity", does that still refer to fixed capital that increases the productivity of labor? And does "increasing productivity of labor" still refer to increasing units [of what ever labor is producing] per man-hour? I guess I should ask when did the measure of "productivity" shift from measuring units/manhour to US$$s out/US$$s in. Isn't the latter just ROI? And isn't Return On Investment different from Productivity? Maybe my real question is

Do economists concern yourselves with the productivity of labor or of capital? of humans or money?

I know that in the 1970s I still lugged heavy volumes published by some UN affiliated agency or another off the shelves onto library tables to find comparisons between the US and the USSR [and other sovereign states less relevant to my burning question) on tons of coal, I beams of steel produced per man-hour.
Is 'man-hours' still a variable of economic analysis?
I never agitated for, and I'm sure I'd have notice if the term had changed to person-hours.

kevin quinn said...

Peggy: (Labor)Productivity: the numerator is the value of output measured in "constant dollars" --the value of output divided by a price index to correct for inflation. The denominator is labor hours. I don't think the term "manhours" is commonly used. There is also the concept of "multifactor productivity" the change in which is measured as that part of the change in labor productivity that can't be explained by changes in capital per worker. The idea is that labor productivity grows either because we equip the average worker with more capital (by saving more of output) or because technological improvement makes capital and labor more productive (that's the multi-factor productivity bit.) The former is "perspiration"; the latter, "inspiration."

Tel U said...

one of you many brilliant posts