Here’s a statement that I don’t think will be too contentious, across the ideological spectrum:

The American way is to draw sharp distinctions between winners and losers, in order to encourage people to hustle.

People on the political left might rephrase this in stronger, more derogatory language. People on the political right would mostly celebrate the statement. But as a description of the American status quo, I think it is fairly uncontroversial. It expresses the barely tacit rationale behind a whole panoply of American institutions that comfort the already comfortable and afflict the already afflicted. Consider the so-called corporate welfare state, or tax expenditures like the mortgage interest deduction and the deductibility of health costs (only) of the stably employed. These things come to exist for specific historical reasons, they are won by particular lobbies, but they endure because of widespread hospitable ideology. It should be possible to “make it”. “Making it” should be a safe, comfortable place, while those who fail to make it should bear consequences for their deficiencies.

Suppose, as I think many people on the right would argue, this ideology or worldview has contributed to power and prosperity of the United States. Sharp distinctions between winners and losers encourage individuals to work hard rather than slack off. Some succeed, some don’t, but the net effect is to reward effort and enterprise, generating a vibrant, prosperous economy. The punishment of losers is a price that must be paid to create a nation that is collectively a winner. And the burden of that price falls on those who most deserve it, those who lose — in part due to misfortune sure, but largely because they simply failed to work as hard or as well as their competitors.

People on the political left would dispute this account for all kinds of (good) reasons. But let’s put that aside, and consider it on its own terms. This perspective on American life would, I think, be described as “rugged individualism”.

But, in the lingo of economics, consider the “social welfare function” embedded in this story. The claim is emphatically not that this system maximizes some measure of aggregate utility that could be decomposed to a sum of individual welfares. On the contrary, it celebrates as necessary large costs in individual welfare for the sake of impersonal characteristics of the aggregate: “prosperity”, or “strength”. It is an entirely collectivist justification for policies that are deeply harmful at an individual level, if you take seriously at all the idea of diminishing marginal utility. The individualist approach to maximizing welfare would be to redistribute. If we (contentiously but commonly) assume people share comparable utility functions, aggregate utility is maximized by taking from the rich and giving to the poor. At least in a methodological sense, it is socialists who are the individualists, attending to the sum of individual welfares, while unsympathetic capitalists rely upon collectivism to justify their good fortune and the policy apparatus that magnifies and sustains it.

People on the political right who are uncomfortable with the claim that their policy views are only coherent if they put the welfare of a depersonalized collective above the welfare individual humans might respond in two ways. Some libertarians would slough off the whole conversation, and argue that they are not concerned with either the well-being of any collective, or of individual human beings in the abstract, but require only that just procedures should be followed and concrete liberties respected, regardless of outcome. That’s a self-consistent view, but one that will never be very useful or interesting, other than to its disproportionately comfortable adherents. The more interesting rejoinder is a claim that there is no tension between individualism and collective goals like American strength and prosperity. Even accounting for the utilitarian harms provoked by celebrating and therefore engineering sharp divergences in outcome, the success of the collective improves characteristics of the population of outcomes so much that welfare gains due to increased prosperity outweigh welfare losses due to tolerance of internal divergences.

That’s an interesting claim, contestable but not incoherent. It would in principle depend upon the scale of the increase in prosperity and the degree to which it “raises all boats”. I think it’s a hard view to support, what with sinking rowboats and rising yachts and successful counterexamples like the Nordic countries. But perhaps Acemoglu, Robinson, and Verdier are right and the Nordics only succeed by free-riding off of America’s collective achievement.

Regardless, it’s a very communitarian view, one in which welfare dynamics cannot be adequately understood by building from individual microfoundations. It is a theory that both acknowledges divergences in individual welfare and posits an important role for social or “meso”-level abstractions in explaining (and justifying) the American status quo. The religious right and “national greatness” conservatives will be perfectly at home with all this. But it’d be nice if the economists on whom they rely to craft (and justify) policy would catch up.

Inspired by @zerg_rush01 and @MattBruenig.

About a week ago, I argued that the Great Inflation of the 1970s was largely a demographic phenomenon. That claim has provoked a lot of debate and rebuttal, in the comment sections of several posts here, and elsewhere in the blogosphere. See Kevin Erdman, Edward Lambert [1, 2, 3], Marcus Nunes [1, 2], Steve Roth [1,2], Mike Sax, Karl Smith [1, 2, 3], Evan Soltas, and Scott Sumner [1, 2], as well as a related post by Tyler Cowen. I love the first post by Karl Smith. My title would have been, “Arthur Burns, Genius.”

These will be my last words on the subject for a while, though of course they needn’t be yours. To summarize my view, I dispute the idea that the United States’ Great Inflation in the 1970s resulted from errors of monetary policy, errors that wise central bankers could have avoided at modest cost. During the 1970s, the simultaneous entry of baby boomers and women into the workforce meant the economy had to absorb workers at more than double the typical rate to avoid high levels of unemployment. This influx was effectively exogenous — it was not like a voluntary migration, provoked by the existence of opportunities. Absorption of these workers required a fall in real wages and some covert redistribution to new workers, which the Great Inflation enabled.

I don’t dispute that monetary contraction could have prevented the inflation of the 1970s. But under the demographic circumstances, the cost of monetary contraction in terms of unemployment and social stability would have been unacceptably high. As a practical matter, monetary policy was impotent, and would have been even if Paul Volcker had sat in Arthur Burns’ chair a decade earlier. I am perfectly fine with Evan Soltas’ diplomatic rephrasing of my position, that perhaps inflation remained a monetary phenomenon, but that the 1970s generated a “worse trade-off [for policymakers that] was not a monetary phenomenon”. I don’t claim that monetary policy was “optimal” during the period. Policy is never optimal, and in an infinite space of counterfactuals, I don’t doubt that there were better paths. But I do think it is foolish to believe that the policy decisions of the early 1980s would have had the same success if attempted during the 1970s. Monetary contraction was tried, twice, and abandoned, twice, in the late 60s and early 70s. There was and is little reason to believe that just holding firm would have successfully disinflated at tolerable cost in terms of employment and social peace. I don’t claim that demographics was the only factor that rendered disinflation difficult. With Arthur Burns (ht Mark Sadowski) and Karl Smith, I think union power may have played a role. It also mattered, again with Smith, that “unemployment was poisonous to the social fabric and the social fabric was already strained, most notably by race relations”. Monetary contraction succeeded — third time’s the charm! — when the demographic onslaught was subsiding, when Reagan cowed the unions, when the country was at relative peace. It might not have been practical otherwise.

I’ve had a wonderful nemesis and helper the last few days in commenter Mark Sadowski, who challenged me to provide evidence for a demographic effect on inflation in international data. Mostly I made a fool of myself (twice actually, and not unusually). Looking at the graphs — after Sadowski helped me get them right! — I see support for a relationship between labor force demographics and inflation in the United States, Japan, Canada, and Finland. Italy is a strong counterexample — it disinflated in the middle of its labor boom. The rest you can squint and tell stories about. (I now have 14 graphs now.) Italy notwithstanding, the claim “it’s hard to disinflate when labor force growth is strong” looks more general than “inflation correlates with labor force growth”. Decide for yourself.

Sadowski is not much impressed by my demographic view of the Great Inflation. But he paid me the huge compliment of devoting time and his considerable expertise to testing my speculations. He writes

I took your set of eight nations plus the four from my original set of counterexamples that you excluded (West Germany, Ireland, Luxembourg and the Netherlands), combined civilian labor force data from the OECD with CPI from AMECO, and computed 5-year compounded average civilian labor force growth rates and CPI inflation rates. The time periods ran from 1960-65 through 2007-12.

Then I regressed the average CPI inflation rates upon the average labor force growth rates. Five of the twelve were statistically significant, and all at the 1% level. The average civilian labor force growth rate and average CPI inflation rate were positively correlated in the U.S. and Japan, and negatively correlated in Spain, the Netherlands and Luxembourg.

Next I conducted Granger causality tests using the Toda and Yamamato method on the level data over 1960-2012 for the U.S., Japan, Spain, the Netherlands and Luxembourg.

The U.S. data is cointegrated, so although the majority of lag length criteria suggested using only one lag, since Granger causality in both directions was rejected at a length of one, I went to two lags based on the other criteria. The results are that CPI Granger causes civilian labor force at the 10% significance level but civilian labor force does not Granger cause CPI.

In Japan’s case civilian labor force Granger causes CPI at the 1% significance level but CPI does not Granger cause civilian labor force.

Granger causality was rejected in both directions for the other three countries.

In short, out of the 12 countries I looked at, only five have a significant correlation between average civilian labor force growth and average CPI inflation, and only two of five have a positive correlation. Of the five, only the two with positive correlation demonstrate Granger causality. But in the US case the direction of causality is in the opposite direction to that which you predict. Only Japan seems to support the kind of story you are trying to tell.

and follows up

I added your set of seven new nations (Canada, Finland, Greece, Italy, New Zealand, Switzerland and Turkey) plus seven additional nations (Belgium, Denmark, Iceland, Korea, Norway, Poland and Portugal) to the set of 12 that I commented on last time. I did the same analysis as I did last time for this new set of 14, that is I combined civilian labor force data from the OECD with CPI from AMECO, and computed 5-year compounded average civilian labor force growth rates and CPI inflation rates. The time periods ran from 1960-65 through 2007-12 with the exception of Korea which started with 1967-72. I regressed the average CPI inflation rates upon the average labor force growth rates. Ten of the fourteen were statistically significant, and all at the 1% level with the exception of Poland which was at the 10% significance level. The average civilian labor force growth rate and average CPI inflation rate were positively correlated in Canada, Denmark, Finland, Greece, Iceland, Italy, Korea, New Zealand and Norway and negatively correlated in Poland.

Next I conducted Granger causality tests using the Toda and Yamamato method on the level data over 1960-2012 (except for Korea which was over 1967-2012) for the ten countries which had statistically significant correlations.

In Finland, Poland and Korea civilian labor force Granger causes CPI at the 5% significance level but CPI does not Granger cause civilian labor force. In Greece CPI Granger causes civilian labor force at the 1% significance level but civilian labor force does not Granger cause CPI. In Iceland CPI Granger causes civilian labor force at the 10% significance level but civilian labor force does not Granger cause CPI.

So out of the 26 countries I have looked at, fifteen have a significant correlation between average civilian labor force growth and average CPI inflation with eleven of the fifteen having a positive correlation. Of the eleven with positive correlation six demonstrate Granger causality with three showing one way causality from civilian labor force to CPI and three showing one way causality from CPI to civilian labor force. Of the four with negative correlation one demonstrates Granger causality from civilian labor force to CPI.

Only three countries (Japan, Korea and Finland) out of the 26 support the kind of story you are trying to tell.

Mostly I am very grateful to Sadowski for his work.

Alas, I am not at all dissuaded from my view. At the margin I’m even a bit encouraged. The direction of Granger causality is not very meaningful here. (Granger causality, in the econometric cliché, is not causality at all but a statement about the arrangement of correlations in time. Expectations matter and near-future labor force growth is easy to predict, so there’s no problem if CPI changes can precede labor force changes.) I see some support for my thesis in the significant and usually positive correlations Sadowski observes in many countries. However, much as I am grateful, I don’t take this work as strong evidence either way. Sadowski overflatters my graphical analysis technique by translating it directly to an empirical model. Collapsing growth into overlapping 5-year trailing windows smooths out graphs that would otherwise just look like choppy tall-grass noise. But it creates a lot of autocorrelation unless the data is chunked into nonoverlapping periods. (Sadowski may well have done that! It’s not clear from the write-ups.) More substantively, to generate a good empirical model we’d have to think hard about other influences and controls that should be included. One wouldn’t model inflation as always and everywhere a univariate function of domestic labor force growth.

Maybe my view has been definitively refuted and I’m just full of derp! You’ll have to judge for yourself. In any case, I thank Sadowski for the work and food for thought, and for help and correction as I made a fool of myself.

I want to address some smart critiques by Evan Soltas:

Consider a standard Cobb-Douglas production function: Y = zK^αL^β. Consider a large and sustained shock to L, as Waldman shows. Consider, also, that the level of K has some rigidities, such that the level of K is not always optimal given the level of L, but that in a single shock to L, K will eventually approach the optimal level of K over some lag period. With this background, the marginal productivity of labor should drop and remain low over that lag period.

Now assume that real wages tend towards the marginal productivity of labor with a lag. What we should expect to see is that real wages should drop in the 1970s. Why? Surplus labor reduces the bargaining power of workers relative to that of employers. We don’t see that; real wages begin to fall after monetary policy tightens in the 1980s. My Cobb-Douglas model is also a bit limiting, but if anything, we might expect to see downward pressures on the labor share of income β. We don’t see that either — as compared to later periods, the 1970s appears to be a time of slightly stronger labor-share performance.

Under Soltas’ nice description of what I’ll call the “first order” effects of a demographic firehose, we should indeed expect real wages to fall relative to an ordinary population growth counterfactual. Did they? Yes, I think so. Let’s graph a few series.

The blue line is one of the series that Soltas graphed, CPI-adjusted hourly wages of nonsupervisory employees. They fell during the course of the 1970s in absolute terms. The black line is the broadest measure of hourly compensation I could compute, CPI-adjusted employee compensation divided by hours worked. It is essentially flat over the course of the decade, breaking a strong prior uptrend. The red line is CPI-adjusted compensation per employee. It fell in absolute terms over the decade.

Soltas suggests that compensation did not fall based on a graph of CPI-adjusted average manufacturing sector hourly wage, which rose over the 1970s. But manufacturing was simply an unrepresentative sector. (Those unions again?)

Overall, I think it’s fair to say that real wages did fall. They certainly fell relative to the prior trend, and probably in absolute terms. Still, looking at that black line, you might say they fell a bit less or more slowly than you might expect. More on that below.

Soltas also points to a strong labor share during the 1970s as disconfirmative, but that’s hard to interpret. Under the “first-order” demographic firehose story, we expect real wages per unit of labor to fall, but the number of units paid to increase. Which effect would dominate would depend on details of the production function. (It’s not clear that labor share was strong in the 1970s. Labor share seems to have declined over the decade from unusually high levels in the late 1960s.)

Let’s continue see the rest of Soltas’ critique:

Let’s simplify. Waldman’s thesis, stated uncharitably, is that a large increase in the labor supply acted as an inflationary pressure on the economy of the 1970s. I don’t see how that works. Show me the model. Less uncharitably, it forced a worse trade-off on the Fed, specifically forcing higher unemployment or higher inflation. I don’t see how that works, either. Unemployment might have been higher, but that would have put a deflationary pressure on the central bank, all else equal, given the exogenous surge in the labor supply.

Think about it this way: Whatever the Fed of the 1970s did in monetary policy, it faced an unstoppable surge in the labor supply. That should be a tremendous headwind against wage increases and broader inflation. You can argue that the capital stock wasn’t ready for the higher labor supply, and I would grant that point, but that should translate into a downward pressure on wages, not an upward pressure on inflation. It’s not an adverse supply shock.

Now we come to the “second order” story.

The piece of the model that Soltas isn’t seeing is rigidity. First, there is that most conventional rigidity, nominal wage stickiness. If real wages must decline for the labor market to clear, but nominal wages are sticky downward, then the only way to avoid unemployment is to tolerate inflation.

But in addition to nominal rigidities, there are real rigidities. All those kids in the 1970s graduating high school or college and entering the labor force had expectations about the kinds of lives they should be able to live when they got a job. They would not have been satisfied with increasing dollar wages, if those dollars could not support starting lives and families of their own, independent of Mom and Dad. Middle class labor force entrants then expected to be able to support a home, a car, even start a family on a single income.

Rigidities aren’t forever. Those expectations have evaporated over the past 40 years. That is the famous Two Income Trap, under which the necessities of “ordinary life” as most Americans define it now require two, rather than just one, median earner. But Rome wasn’t destroyed in a day. Baby boomers entered the labor force with real expectations. They were not mere price takers. But the declining marginal productivity in Soltas’ Cobb-Douglas production function meant boomers could not earn sufficient real wages to meet those expectations in a hypothetical perfect market. They faced precisely a supply shock [1], arising from each boomer’s own diminished capacity to supply relative to prior cohorts, for reasons entirely beyond their control. They would not be very happy about it. A tacit promise would have been broken.

To avoid social turmoil, the political system had to find ways of not disappointing the budding boomers’ expectations too abruptly. That implied some redistribution, from older workers and capital holders to new workers. Among other things, inflation can be a means of engineering covert redistributions. This is the part, I think, that puzzles Scott Sumner. High inflation reduces the real purchasing power of people living off of interest, and of people already employed who are slow or lack bargaining power to negotiate raises. That foregone purchasing power liberates supply, which becomes available to subsidize the real wages of the newly employed. Real GDP did not collapse during the 1970s, but the inflation created losers. The share of production that losers lost went to someone. I think that, among other mischief, it helped subsidize the employment of new workers at real wages below but not too far below what the generation prior had enjoyed.

We’ve seen that Arthur Burns was a genius, but I don’t think that any of this was conscious strategy. Like most real-world policymakers, Burns felt his way towards the least painful solution, then used his considerable intellect to justify what he found himself doing. When Burns tightened money, unemployment rose sharply and Greg Brady got mad that the jobs he was refusing wouldn’t pay enough to cover wheels and a pad across town from his annoying sisters. He started to smoke dope, get into politics, frighten his parents and neighbors. (We won’t even talk about J.J and the Panthers.) When money was loose and inflation roared, times were bad for everyone, which helped ease the sting. Greg’s job offers still paid less in real terms than he’d have hoped, but the money illusion made the numbers sound OK, and he could stretch the salary to move away, albeit into a smaller place than he had hoped. Carol and Mike breathed a sigh of relief, as did their congressman, Richard Nixon, and Arthur Burns.

If you’ve read all of this, there is something terribly wrong with you. I thank you nonetheless. As I said at the start, this will be my last episode of “That ’70s Show”, at least for a while. (Thanks @PlanMaestro!) I want to move on to other things. Do feel free to have the last word, in the comments or elsewhere.

[1] More abstractly, fix the median new worker’s market clearing real wage as our numeraire. Prior to a population boom, the median new worker supplies her labor for a particular bundle of goods and services. But in the population boom, because of the diminishing marginal productivity of labor (holding K constant), the median new worker cannot produce enough in real terms to purchase the same bundle. The worker’s demand curve has not changed at all: she remains willing to trade one unit of salary for one unit of consumption bundle, just as her predecessor did. But that trade is no longer available to her, because she herself is unable to supply real production in sufficient quantity to purchase those goods, despite expending her fullest effort. This is a supply shock, from the worker’s perspective, not a demand shock. The population boom is a shock to her ability to supply, which would be reflected by inflation of the cost of goods relative to the numeraire of her labor.

Update: Sometimes using a “data source of convenience” leads one badly astray.

Mark Sadowski points out that that the price level in the Penn World Tables represent an attempt at a global price level, rather than a country-specific domestic index, based upon the price of US GDP. Thus changes in the real exchange rate between a country and the US show up as changes in the price level, but don’t always represent “inflation” or “deflation” within the local economy. Combining these flawed price levels with what we already knew to be a flawed proxy for labor force, I think the graphs below are too noisy to be meaningful. This renders much of my discussion, which was based on the flawed graphs, essentially bullshit.

At Sadowski’s suggestion, I’ve regenerated graphs where I could based entirely on data from the OECD’s Main Economic Indicators database, as hosted by FRED. (Sadowski suggests AMECO data for CPI, but I’ve not had a chance to look at that yet. I’ve used the OECD CPI series.) The OECD database (at least as hosted by FRED) is not complete. There were surprising omissions. In particular, the lack of UK and Austrian Civilian Labor Force series prevented me from reproducing those graphs from the original post.

I’ve generated graphs for a larger set of countries that I did originally. (I basically generated graphs for all countries for which both OECD data series were reasonably complete.) In an Appendix to this post, I’ll first place the six graphs from the original piece I could reproduce, and then all the rest. I’ll defer any discussion to a later post. I’m going to strike through the original text, and add cautionary watermarks to the flawed graphs, in order to emphasize the essentially bullshitty nature of the original discussion.

The two previous posts on demographics and the Great Inflation remain very much not bullshit. They are…

See also a whole lot of excellent discussion of this topic by others, links are here.

Skip to the corrected graphs in the Appendix.

Mark Sadowski (in comments here and here) and Scott Sumner challenge me to support my thesis that inflation is related to demographics with international data. Doing that right would be hard — inflation correlates across borders, as did World War II and its effect on postwar fertility. Even if international data appeared to support my hypothesis perfectly, one could argue that the whole thing is just a correlated coincidence. I’m not going to make a project of teasing out causality econometrically. But the least I can do is show you some graphs.

Graphs in economics are always Rorschach Tests. They are invitations to confirmation bias. But I’m going to go out on a limb and say there’s some evidence for my thesis in these pictures. You, of course, will decide for yourself.

You will be looking at data from Penn World Tables version 8.0, which I am supposed to cite as

Feenstra, Robert C., Robert Inklaar and Marcel P. Timmer (2013), “The Next Generation of the Penn World Table” available for download at www.ggdc.net/pwt

This was a data source of convenience. It’s designed for international comparisons, and includes population and price-level data beginning in 1950. I have graphed 5-year trailing growth rates of the price level (i.e. 5-year compounded average inflation rates) against 20-year lagged population growth rates, also trailing 5-year averages. Lagged population growth is an imperfect proxy for what I really want, which is contemporaneous labor force growth. It misses entirely the effect women’s entry in the workforce, which I think is an important part of the story, and ignores variations in the rate of labor-force exit. Nevertheless, it is the best I could (easily) do.

There’s nothing special about the 5-year lookback window or the 20-year lag. I haven’t data-mined them. In my initial post I chose a 10-year window, and it seemed to work. This time I tried a 5-year window for the hell of it. It’s still fine. Note that growth rates are reported in gross terms, that is “1.1” refers to a 10% growth rate, not a 110%.

Without further ado, here is my base case, the United States:

Unsurprisingly, as this is the economy from which I drew the thesis, it matches up pretty well.

Let’s try Australia next:

Again, to me, the smoothed inflation rate and population growth level follow one another during the disinflation rather strikingly. The inflation changes seem to lead the population growth rate changes a bit, which is somewhat surprising. But the population growth is 20-year lagged. Inflation in 1970 isn’t likely to be causing changes in the 1950s birthrate. Here, as in many of the graphs, I’m going to write off this lead of price changes off as due to some combination of an ill-chosen lag, missing effects of workforce composition changes, and forward-looking policymakers anticipating near-future entrants to the labor force. Reasonable or confirmation bias? You be the judge!

Next let’s look at Sweden.

Sweden is one of four countries I looked at that Sadowski cited as a counterexample. But once you look at time series rather than individual data points, I think it’s okay. Again, the price level leads a bit, but otherwise the two series track one another fairly well.

The UK is the first country that contains a really interesting anomaly:

Note the downspike in inflation in the mid-1980s, entirely unmatched by any fall in population growth. I think this anomaly is very easy to explain, and very informative. Concomitant with the Volcker disinflation in the US, the Bank of England allowed interest rates to climb very high. Sure enough, tight money, killed inflation! But inflation seems to be very zombie-like when the labor force is rapidly growing! You can kill it, but unless you painfully hold it down, it comes right back. That was the US experience in the late 1960s and 1970’s: each attempt to tighten money (reflected in high interest rates) provoked a sharp bout of unemployment, until the Fed cried uncle. Was the problem insufficient grit and determination on the part of the Arthur Burns Fed? Or did Volcker get lucky, in that his tightening cycle happened to coincide with the peak growth rate of the US labor force? Maybe a bit of both? (I know we love to fight, but most hypotheses are not mutually exclusive!)

Anyway, the UK experience was very clear. There was a lot of grit and determination in the early 1980s, it was temporarily effective, but it didn’t take. The inflation zombie rose again. It was slain for good when, perhaps coincidentally, the lagged population growth rate collapsed.

How about Japan:

I don’t know what to say about Japan. In a general sense, the two series track. Population growth collapsed and the economy went into deflation. But the two series certainly don’t wiggle together in any obvious way. Totally a Rorschach Test.

Next let’s look at Austria.

Again, you can call this one either way. On the one hand, Austria’s disinflation corresponded very well to a collapse of putative workforce growth. But the initial inflation did not. I could wave my hands about commodity prices and the Great Inflation being a global phenomenon, so that explains the early start. But you know, confirmation bias. You decide, I’ll call it a draw.

France graphs like the surprisingly sexy love child of the UK and Austria:

Like Austria, France suffered from embarrassing premature inflation. It did the job, though! Babies were conceived and born in the 20-year-lagged time machine, and eventually there was a nice boom of workforce entrants, timed to match the Volcker disinflation in the 1980s. As in the UK, there was a satisfying downspike then a zombie-like return of price level growth. Inflation then fell roughly — very roughly! — coincident with the decline in population growth. Like Austria, the nadir of the two series match very well but any comeandering of the rest is less clear. There is something interesting in the tail of the France graph. Post-2000, inflation rose sharply, in a manner that doesn’t seem at all proportionate to population growth. We’ll see there was a similar spike in Spain. (Also in Austria, but that did track population growth.) One explanation for these spikes would be post-Euro capital flows: Price level growth is often attributed to foreign lending, and both France and Spain were current account deficit nations. (Do foreign capital flows fall under the definition of a “monetary phenomenon”? You tell me!)

So, Spain. Let’s do Spain:

Of the countries I examined, Spain was the one that least fit my story. Spain disinflated before population growth collapsed, and reinflated just when it did. So Spain is a legitimate counterexample. I have my stories: There may have been unusual political will towards disinflation in the high population growth 1990s Spain, so the country could qualify for Euro entry. Once the Spain entered the Euro, it was a prime destination for speculative lending. The timing of these events was completely decoupled from Spain’s population dynamics.

But, confirmation bias is a real danger. I have to concede that, on face, Spain’s inflation dynamics looks nothing like I would expect from my demographic hypothesis.

Overall, I think my claim that labor force expansion imparts an inflationary bias is supported by these graphs. The Great Inflation and its unwind, I score four clear “wins”, three iffy cases, and one clear loss. These were the only countries I examined. (I’m not cherry picking from a larger group.)

Throughout the graphs, there are some recurring themes. Inflation downspikes in the 1980s are nearly universal, but they “take” as persistent disinflation only when ratified by falling labor force growth. The relationship between disinflation and slowing labor force growth seems more precise than the relationship between labor force growth and the initial inflation. Current account deficit countries (including the UK and Australia and Eurozone countries, but not the US) tended to experience inflation unrelated to population growth in the period following Y2K.

I think demographics has had a very great deal to do with inflation dynamics. My cards are on the table. Obviously this is imperfect evidence. So what do you think?

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p.s. The messy spreadsheet from which these graphs were generated is here. R&R my ass — I screw this kind of thing up all the time.

Appendix: Please see the update at the top of this post. The spreadsheet from which these new graphs were generated is here. These are graphs of 5-yr trailing growth rates, annualized. They are presented as gross rates, so that 1.2 means a 20% growth rate in more conventional terms.

Graphs from the original post, redone (corrected!):

Other countries:

Scott Sumner replies to my claim that the Great Inflation of the 1970s wasn’t a monetary phenomenon by saying, yes, in fact it was.

But reading his post, I don’t see any substantive inconsistency between his views and mine at all. He argues that the Fed overstimulated, because if it was trying to prevent unemployment, it would simply have stabilized nominal wage growth. Instead it tolerated — or caused, depending how you tell the story — wage inflation in excess of its long-term growth rate. My view is that stable nominal wages and full employment (under the Fed’s more robust 1970s definition of full employment) were simply inconsistent, so stabilizing nominal wages would not have been an effective strategy. Decent employment of a labor force growing faster than productive employment was only possible via a combination of falling real wages and a cross-subsidy from creditors, that is by high inflation.

I think Sumner says basically what I’m saying, when he describes stories of the Great Inflation he considers reasonable:

There are some theories that help us to understand why the Fed blew it in the 1966-81 period:

1. Assumption of stable Phillips Curve.

2. Mis-estimation of the natural rate of U, which was rising.

3. Confusion between nominal and real interest rates.

Waldman’s theory deserves to be added to that list. It’s not the whole story, but it’s a significant piece of the story.

In the language that Sumner (like many economists) uses, the “natural rate of unemployment” was rising. In that language, my claim is simply an explanation of why this rate was rising: Growth of the workforce was temporarily outstripping the economy’s capacity to employ marginal workers at expected levels of productivity. It sounds like Sumner considers this to be at least a reasonable conjecture.

The Great Moderation consensus was that unemployment should be reduced to this “natural” or “non-accelerating inflation rate of unemployment“, but no lower. But that reflects a value judgment about the relative pain of inflation versus unemployment, a judgment that central bankers of the 1970s simply did not share. To say that policymakers erred or even misestimated, you’d have to claim they did not understand that their employment-focused policies might bring inflation. I think it’s pretty clear that they did understand that. They simply made a choice that became taboo during a later period. They accepted a risk of accelerating inflation in pursuit of full employment.

So was the Great Inflation a “monetary phenomenon”? It really depends on how you assign causality. Suppose that I am right, that largely for demographic reasons, the “natural rate” of unemployment was higher than the socially acceptable rate of unemployment. Central bankers deliberately tolerated a risk — unfortunately realized — that inflation would become a significant problem. Does that mean the inflation was a monetary phenomenon? In a sense, yes, in a sense, no. The inflation could have been avoided with different monetary policy at cost of accepting a painfully high “natural” rate of unemployment. In that sense, it was monetary.

But the deeper cause, the factor that created the conditions under which the central bank was faced with so terrible a choice, was a real mismatch between the growth rate of the work force and the speed with which organizations and machines could be arranged to make all that labor productive.

Let’s try an analogy. Consider the hair loss of a cancer patient. Doctors make a choice, weighing the harms of chemotherapy with the risks of nontreatment. When doctors choose to apply chemotherapy, they “cause” the loss of hair and other toxic side effects of chemotherapy. The choice to treat or not to treat may sometimes be a close call, so doctors and patients never really know whether the putative reduction of cancer risks was worth the certain pain of chemo.

Nevertheless, we don’t often describe all that hair loss and pain as “iatrogenic illness“, even though strictly speaking it is. To do so, we recognize, would be to place blame where it doesn’t belong, on the people making very difficult choices in response to circumstances they did not create. We rage about iatrogenic illness when people are hurt because doctors fail to wash their hands or follow checklists. But during chemo, we acknowledge the cancer as the true cause of the bad situation, and don’t blame the doctors.

Similarly, if the real-economic situation was as I contend in the 1970s, it strikes me as churlish to refer to the inflation as a “monetary phenomenon”. Yes, different monetary choices might have led to less inflation. But they would have risked much higher levels of unemployment. No, we never will know how that counterfactual would have worked out. But I consider the absorption into the labor force of the baby boom, of both sexes of the baby boom, to be a remarkable achievement. Considering the social and political circumstances in the late 1960s and early 1970s, I don’t think it’s at all obvious that we’d have been better off choosing a different balance of risks.

Sumner points to the assumption of stable Phillips Curve as a potential explanation of the Great Inflation. There might have been some economists who believed in a stable Phillips Curve, but I think that is mostly a straw man. It’s hard to find examples of influential people actually making this mistake. The Phillips Curve certainly did shift into the 1970s, but I’d argue it did so precisely due to the demographic / real-economic problem the United States faced during that era rather than due to the Lucas Critique explanation that näive reliance on the relationship undermined it. I think there was no näive reliance at all, just difficult choices made by policymakers fully cognizant of the uncertainties they faced. I perceive a lot more overconfidence and dogmatism in post-1980s reaction to the Great Inflation than there was in the choices that preceded it.

Ultimately, hubris is the issue. I am writing in 2013 about choices made in 1973 because I think a mythology has developed around 1970s experience that is very harmful. Whether he agrees or disagrees with anything I’ve said here, Scott Sumner is much more ally than adversary. He as much as anyone has challenged the new orthodoxy symbolized by “divine coincidence”, a property woven into some New Keynesian models to sanctify the claim that there are no trade-offs in macroeconomic policymaking. Stabilizing inflation is always enough in these models, because stabilization of output necessarily follows. That is a terrible error. Arthur Burns was pushed around by Richard Nixon and knowingly made difficult trade-offs. Jean Claude Trichet was pushed around by no one, and stabilized inflation “impeccably“. In doing so, Trichet made errors that have already been far more costly than the American experience of the 1970s, mistakes whose costs have yet to be fully tallied.

The real economy always gets a vote. The political economy always gets a vote. This isn’t some kind of econopartisan divide. There are post-Keynesians who claim that the combination of good fiscal policy and a job guarantee can always deliver price stability and full employment. But no policy rule can guarantee those things. If real output collapses, or if the population grows in ways that cannot be technologically matched to production of the goods and services it wishes to consume, meaningful full employment will imply inflation or else more direct transfers. First-best policy would be to prevent real- and political-economic cul de sacs. Unfortunately, we’ve already failed to prevent some political-economic disasters: the institutional configuration of Europe, rent extraction and socioeconomic segregation in the United States. Because they were not prevented, we face real tradeoffs, between those who might be harmed by inflation and those at greatest risk of unemployment, and along all kinds of other dimensions. Polities will have to make these tradeoffs, or find creative means of rearranging themselves to circumvent the fighting. Absurdly abstract cautionary tales flogged as “science” by representatives of a class of people whose interests are enmeshed in the tradeoffs are much worse than suspect.

The previous post, like nearly all my posts, generated a comment thread with thinking and writing much better than my own. (Read it!) I continue to believe that demographics plus real-economic rigidity created conditions that rendered the 1970s inflation better than many alternatives. I don’t claim that always and everywhere population booms must coincide with productivity collapses — sometimes population booms coincide (usually not coincidentally!) with opportunities for expanded production. I don’t claim that all monetary expansions derive from attempts to employ a burgeoning population. (Sometimes they are about exchange rates, for example!) History is not an ergodic process. If the evidence for my conjecture seems unrigorous, I’d ask you to compare it to the widely accepted view all we needed was Paul Volcker a decade earlier and things would have been just fine. Where is there evidence for that?

Update: Scott Sumner responds.

Nor was it a fiscal phenomenon, my (post-)Keynesian comrades. Let’s not be glib.

I’m talking about the inflation of the 1970s. Sorry, Milton, I know you got a lot of mileage out of the line, but the great inflation was not at root a monetary phenomenon. Let’s take a look at a graph:

The crucial economic fact of the 1970s is an incredible rush into the labor force. The baby boom came of age at the same time as shifting norms about women and work dramatically increased the proportion of the population that expected jobs.

The “malaise” of the 1970s was not a problem with GDP growth. NGDP growth was off the charts (more on that below). But real GDP growth was strong as well, clocking in at 38%, compared to only 35% in the 1980s, 39% in the 1990s, and an abysmal 16% in the 2000s.

What was stagnant in the 1970s was productivity, which puts hours worked beneath GDP in the denominator. Boomers’ headlong rush into the labor force created a strong arithmetic headwind for productivity stats. Here’s a graph of RGDP divided by the number of workers in the labor force. The malaise shows up pretty clearly:

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. Ultimately, the 1970s were a success story, albeit an uncomfortable success story. Going Volcker in 1973 would not have worked, except with intolerable rates of unemployment and undesirable discouragement of labor force entry. By the early 1980s, the goat was mostly through the snake, so a quick reset of expectations was effective.

Fiscal policy could not have solved the problem, unless you posit that new workers would have been more productively employed by government than the private sector was capable of employing them. Contemporary market monetarism could not have solved the problem. Given the huge demographic shift, stabilizing NGDP growth at an arbitrary level would have been a prescription for depression. Market monetarists sometimes hint that NGDP per capita would be a more appropriate growth path target than simple NGDP. Consider: Both supply and demand tend to correlate with work. Workers make stuff, and they also expect to consume more than nonworkers. One might argue, then, that NGDP per member of the labor force would be a good level for a market monetarist to target. Let’s take a look at that:

It seems to me that the Fed did a pretty good job of matching NGDP to workers in the 1970s. If anything, they were a bit too tight, but permitted some catch-up growth in the 1980s to offset that.

Since the 1970s, macroeconomics as a profession has behaved like some Freud-obsessed neurotic, constantly spinning yarns about how the trauma of the 1970s means this and that, “Keynes was wrong”, “NAIRU”, independent (ha!) central banks. A New Keynesian synthesis made of output gaps and inflation and no people at all, just a representative household reveling in its microfoundations. Self-serving tall tales of the Great Moderation, all of them.

It was the people wut done it, by being born and wanting jobs. Even the ones without penises.

Oh, and give poor Arthur Burns a break. You couldn’t have done any better.