Even mild inflation should change how we think about policy

Even mild inflation should change how we think about policy

Efficiency and expanded labor supply are good; further stimulating demand? Maybe not so much

Matthew Yglesias

Sep 10

When Andy Stern, the influential former president of the Service Employees International Union, was promoting his book about universal basic income, his go-to example of looming technology-induced job losses was the impact of self-driving trucks on the trucking industry.

That was five years ago. Today we still don’t have self-driving trucks, but we do have 35,000 fewer truck drivers than we had at the beginning of 2020. And as people continue to order goods shipped by truck, the shortage of drivers is one of many factors disrupting global supply chains, causing shipping delays and higher prices, and potentially undermining the Biden/Powell push for highly stimulative macroeconomic policy.

In other words, we could really use some self-driving trucks. This would be a sad story for the impacted truck drivers in just the way that the invention of desktop publishing software was bad for my mom’s career as an analog-era magazine designer. And a decent country should have a more robust social safety net so that people are better insulated from these inevitable sources of income loss.

But macroeconomically speaking, brand new technology that lets us drive trucks without truck drivers would be a huge win. Shipping costs would fall, inflation concerns would moderate, retailers and restauranteurs would find it easier to expand employment in a lower-cost environment, and interest rates could remain lower for longer to spur private investment.

That was my reaction to the story, at least. But a lot of people had a different reaction, namely that the stingy companies should pay higher wages or offer better working conditions.

I, of course, want everyone to get higher pay. And five or 10 years ago, I would have been right there, too — “just pay more, you idiots.” The trucking industry is notorious for crying shortage (here’s a 2017 driver shortage story, and here’s one from 2012), so it’s natural for people to tune them out. But it’s important to understand that, in macroeconomic terms, 2021 is not 2012 or even 2017.

Inflation is not spiraling out of control, but it is undesirably high. And that changes the meaning and implications of “just pay more” as a mantra.

Real versus nominal wages in an inflationary world

Back in October of 2008, the main inflation index that the Fed tracks (the core personal consumption expenditure deflator, if you want to impress people at parties) fell below the 2% target. Over the next 147 months, it came in below target 138 times versus above target just nine times.

If you’re shooting at a target and you’re below the bullseye 138 times out of 147, there’s something wrong with your aim.

From April 2011 to February 2018, we didn’t have a single month of above-target inflation, just a grinding six-year span in which the economy was consistently understimulated. And it’s not just the direction; the magnitude is equally jarring. The largest upward deviation (0.12 percentage points in July 2018) was so much smaller than the largest downward deviation (1.37 percentage points in July 2009).

Under those circumstances, “just pay more” made sense not only as an emotional reaction to stingy bosses but as a macroeconomic prescription. Higher pay would have meant more spending power and thus more demand and a faster recovery. With inflation stuck below target, the Fed was at no risk of raising interest rates in response to marginal increases in wages or price pressure.

These days, a lot of people are still thinking along those lines: there is no shortage that can’t be solved with higher pay. As Rep. Pramila Jayapal says, “the real issue is that we aren’t paying people a living wage.”

Twitter avatar for @PramilaJayapal

Pramila Jayapal 

@PramilaJayapal

Can we finally put the conservative myth of a “labor shortage” to bed in this country?

The real issue is that we aren’t paying people a living wage. Period.

September 5th 2021

772 Retweets4,644 Likes

But is that the real issue? Real — i.e., inflation-adjusted — wages went down this summer, as strong nominal pay increases didn’t keep pace with rising prices. Some individual workers, particularly low-wage workers in the restaurant sector, benefitted. But in general, the thing you want to see going up is real wages. The distinction between nominal and real wages was easy to ignore when inflation was so low, but current conditions mean we shouldn’t continue to do so.

If higher pay for truck drivers is the result of general prosperity, that’s great. But if higher pay for truck drivers just means the price of everything goes up, that’s bad.

What you want to see is not just higher pay, but higher productivity as employers pair higher nominal compensation with innovation that lets them raise output. We have a mini-example of that in the restaurant industry with QR codes instead of paper menus, and I think there’s reason to believe that a tight labor market will reward businesses and customers who take risks on new technology, thus raising real wages.

But just saying “there is a shortage of employers willing to pay their workers a living wage” doesn’t address the underlying economics of an inflationary situation.

Twitter avatar for @RBReich

Robert Reich 

@RBReich

Let's get one thing straight: there is no labor shortage. There is a shortage of employers willing to pay their workers a living wage.

May 12th 2021

6,299 Retweets27,252 Likes

It’s also worth noting that this is not really how more egalitarian societies work. Danish, Swedish, and Finnish employers don’t conjure out of the ether a “living wage” that makes it easy for everyone to afford child care, health insurance, and whatever else. Instead, these countries have bigger and more generous welfare states that ensure your market income is less determinative of your standard of living.

The Fed is eyeing the exits now

The Fed’s preferred inflation index hit 3.1% in April, then went to 3.47% in May, 3.58% in June, and 3.61% in July.

Inflation of that scale is not the end of the world, and I think the line from the White House and the Fed that it’s likely to be transitory is probably correct. But the supply-side issues wreaking havoc with key segments of the economy don’t seem to be going away. Toyota held up better in the face of microchip shortfalls than most automakers since they had stockpiled supplies, but now they are talking about cutting production 40% in September. The current thinking is that auto production lines won’t be running at full capacity until 2023.

Meanwhile, the same factors are also curtailing the output of trucks and tractors, which may imperil the output of other goods and services down the chain. I don’t think these kinds of disruptions are a good reason to raise interest rates (“Toyota can’t make cars so we’re going to try to raise unemployment”). But they do, factually, constitute the inflationary background conditions that the Fed is dealing with.

When I read op-eds from folks like David Autor and Daniel Alpert hailing constrained labor supply as giving workers leverage, I think they’re sort of conflating two things:

One is the benefits of robust demand for labor, which forces employers to compete against each other to attract workers, and which I agree is quite beneficial.

The other is the idea that a constrained supply of labor (whether due to poorly designed welfare state programs, health fears, child care disruptions, or whatever else) is helpful because it increases bargaining power.

In the short term, these can look pretty similar. And in a severely depressed economy that in some sense “needs” more inflation, they can actually be the same. Gauti Eggertson argues that some of FDR’s supply-constraining policies helped lift the economy from the Great Depression because they altered expectations of falling prices.

But right now, prices are rising, not falling. The Fed is both promising that the rate of increase will slow soon (the inflation is transitory) and counting on the fact that this is what people expect will happen. If the rate of price increase escalates, that strategy won’t work and the Fed is going to feel compelled to raise interest rates and reduce labor demand. Staying the course on the current strong demand path requires improvements in the supply side of the economy.

The White House recognized that with their September 1 regulatory announcements on house building. I’ve advocated in the past for rolling back Trump’s tariffs. The Federal Trade Commission is hoping to play a part in this with some anti-trust actions. But I think the president is also implicitly counting on the expiration of Unemployment Insurance benefits, which is worrying some of his aides and many progressives in the media.

Unemployment Insurance in an inflationary world

Democrats have traditionally seen Unemployment Insurance as a balancing act.

On the one hand, giving people monetary payments that are conditional on not working seems bad for the supply side of the economy. But on the other hand, in a recession, giving money to people without labor income is very good for the demand side of the economy since they have such a high marginal propensity to spend. During 2020, when there were so few job openings, it made especially good sense to focus on stabilizing demand with generous UI. Research done during 2020 showed that bonus UI did reduce job search intensity among those who got it — it just didn’t raise overall unemployment because there were so many people on furlough that it was easy to fill the scarce vacancies.

Flash forward to the summer of 2021, and there are tons of job vacancies, so Republican governors start canceling bonus UI early. Academic research shows that these cancellations had a modest positive impact on speeding job matching. Except the actual headline of the piece I just linked to was “Cutoff of Jobless Benefits Is Found to Get Few Back to Work,” a more negative framing of the exact same finding.

Here’s the part that I think has really gone missing in the coverage: with inflation above the Fed’s long-term target, the reduced demand from people losing benefits is no longer a macroeconomic cost. The withdrawal of stimulus helps stabilize the economy on the demand side while expanding labor supply.

That’s not to say it isn’t a harsh cut. Here’s a New York Times story on the impact:

“To just cut people off, it’s ridiculous and it’s unethical and it’s evil,” said Travis Curry, 34, a freelance photographer who will lose all his assistance, about $482 a week. “If we can’t buy food or go to local businesses because we don’t have money to live in New York, how will New York come back?”

Macroeconomic policy isn’t just about what’s good for this one guy; it’s about what’s good for the overall economy, and in a depressed, deflationary economy, I’d be saying he’s right. But the current economy is not depressed. Aggregate consumer spending is strong, and we are groaning against supply-side limits. Losing the $482 a week is horrible for Travis Curry, who is now going to need to go get a job in the foodservice sector (where wages have been rising because workers are scarce) or driving an Uber (where prices have been rising because drivers are scarce) or some other job he might not really want to do. But in broad economic terms, it’s fine. Even if it only boosts the job-finding rate by a modest amount, it’s a clear macro-positive. It’s just also kind of harsh.

Happier forms of supply-side change

We started with something happier, though — technology and productivity enhancements.

The long slump years were marred by the very powerful anti-progress idea that every initiative should be judged in terms of its impact on “jobs.” Jim Clifton wrote a book called “The Coming Jobs War” in 2011 and Daniel Alpert’s “The Age of Oversupply” came out in 2013. The premise of these books (and much of Trumponomics) is that everything is a zero-sum fight for jobs in a world where employment opportunities are scarce but everything else is abundant. So if they’re making cheap washing machines in Korea, that’s poaching our jobs and we need to tax the Korean washers. If a Mexican woman is cleaning rooms in the hotel, that’s poaching our jobs and we need to build the wall. Heck, even an Indian engineer could be stealing a job from a hard-working American. Technology also fell under suspicion — a 2018 Vox article denounced self-checkout machines in part because they’re annoying, but also because they kill jobs.

Self-checkout machines are annoying. But Amazon’s Just Walk Out technology is a delight. And if we shift to a future where grocery stores don’t require so much labor, we can have more stores and lower prices, and the people who used to work at the cash registers can shift into sectors like restaurants, where they are desperate for workers.

Ultimately, of course, the labor shortage enthusiasts are right, and what most people want is something better than a low-paid service sector job with no career ladder. But to get to that world in a sustainable way, you need not just strong demand (which we have now) but to backfill the positions so the demand can actually be met rather than just having prices rise.

Immigration and trade factor in, too. We’ve seen this summer that there’s just no universe in which cleaning rooms at a hotel becomes a glamorous and high-paid job. Hotels do react to a scarcity of labor by paying moderately more, but they are also hiring way fewer people; most guests don’t want to pay through the nose for the privilege of daily housekeeping, so the rooms just get cleaned less. That’s not a disaster. But it is sad to think that there are millions of people around the world who would strongly prefer to move to the United States and clean hotel rooms. If we recreated some wider legal pathways for people to move here and do this work, it would be a win-win-win:

The immigrants get higher wages and living standards.

The hotel guests get cleaner rooms.

And because it’s now more feasible to open hotels, we all get a richer, deeper, more competitive hotel market, complete with more management jobs, construction positions, etc.

And for durable goods, the same is true of trade. A brand new semiconductor factory in the United States would be great news for the economy. But so would a brand new semiconductor factory in Taiwan or Japan or Mexico. We need more semiconductors, and making them anywhere in the world is a positive-sum interaction for everyone.

The revenge of Econ 101

Between 2007 and 2019, a lot of people came to understand the limits of really basic economic thinking about supply and demand and how efficiency is good.

I don’t think anyone ever truly believed that the most simplistic charts perfectly described reality. But in a severely depressed economy with persistently inadequate demand, they’re not even approximately correct. If you go back and read Milton Friedman’s popular writing, he includes a lot of caveats about full employment. He just thought it would be simple to maintain full employment all the time by ensuring steady growth in the money supply. But we’ve seen that macroeconomic stabilization policy is much harder than he believed and that things can go pretty badly awry.

And when the macroeconomic policy is bad, all kinds of weird stuff happens to your microeconomic thinking. Efficiency can be bad because it’s deflationary. Expanding supply can be pointless because there’s no demand.

But precisely because more unconventional thinkers won the macroeconomic battle, we now need to return to some more orthodox thinking. We want to have a flexible, dynamic economy in which labor-saving technology is used and efficient companies outcompete less efficient ones. And to make that tolerable, just, and humane, we want a welfare state that gives parents the extra money they need and takes care of people’s health. We want high-quality mass transit and well-managed schools.

But we don’t want to literally pay people more money to not work than to work — that’s a kludgy emergency measure that’s outlived its time.

Countries with more robust welfare states actually have higher prime-age labor force participation rates these days than the United States does. It’s not that the supply side of the economy doesn’t matter, it’s that supporting a healthy, well-educated workforce with access to child care and good transportation is good supply-side policy.

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