Growing Joblessness and Inflation erode U.S. Sense of Prosperity
From Sunday Times 1 May 2005
By Paul Krugman, New York Times
In the 1970s. soaring prices of oil and other commodities led to
stagflation – a combination of high inflation and high unemployment,
which left no good policy options. If the US Federal Reserve cut
interest rates to create jobs, it risked causing an inflationary
spiral; if it raised rates to bring inflation down, it would further
increase unemployment. Can it happen again?
Fears of a return to stagflation this week sent stock prices to a
five-month low. What few seem to have noticed, however, is that a
mild form of stagflation has already arrived.
True, measured unemployment isn’t bad by historical standards, and
inflation is in the low single digits. But inflation is creeping up,
and it’s doing so despite a labour market that is in worse shape
than the official unemployment rate suggests.
Let’s start with the jobs picture. The official unemployment rate is
5.2% - roughly equal to the average for the Clinton years. But
unemployment statistics only count those who are actively looking
for jobs. Every other indicator shows a situation much less
favourable to workers that that of the 1990s. A lower fraction of
the adult population is employed, and the average duration of
unemployment is much higher than it was in the 1990s.
Above all, the weak job market leaves workers with no bargaining
power, so they aren’t getting ahead: wage increases have been
minimal, and haven’t kept up with inflation.
Underlying these disappointing numbers is sluggish job creation.
Private-sector employment is still lower than it was before the 2001
recession.
Things could be, and have been, worse. But those whose standard of
living depends on wages, not capital gains – in other words, the
vast majority of Americans – aren’t feeling particularly prosperous.
Most people polled say the economy is “only fair” or “poor”.
Why, then, has the Fed been raising interest rates? Because it is
worried about inflation, which has risen to the top end of the 2% to
3% range the Fed prefers.
What’s driving inflation? Not wages: labour costs have been falling
because wages are growing less than productivity. Oil prices are a
big part of the story, but not all of it. Other commodity prices are
also rising; healthcare costs are once again on the march. A
combination of capacity shortages, rising Asian demand and a
weakening dollar has given industries like cement and steel new
“pricing power”.
It all adds up to a mild case of stagflation. Inflation is leading
the Fed to tap on the brakes, even though this doesn’t look or feel
like a full-employment economy.
We’re not back to the economic misery of the 1970s, but the fact
that we’re already experiencing mild stagflation means that there
will be no good options if something else goes wrong. Suppose, for
example, that the consumer pullback visible in recent data turns out
to be bigger than we now think, and growth stalls. Can the Fed stop
raising interest rates and go back to rate cuts without causing the
dollar to plunge and inflation to soar?
Or, suppose that there’s some kind of oil supply disruption – or
that warnings about declining production from Saudi oil fields turn
out to be right?
Suppose that Asian central banks decide that they already have too
many dollars. Suppose that the housing bubble bursts. Any of these
events could easily turn our mild case of stagflation into something
much more serious.
How do we get out of this bind? As the old joke goes, I wouldn’t
start from here. We should have spent the years of cheap oil
encouraging conservation; we should have spent the years of modest
growth in medical costs reforming our healthcare system. Oh, and
we’d have a wider range of options if the budget weren’t so deeply
in deficit.
So if any of these things does come to pass, we’ll just have to see
how well an administration in which political operatives make all
economic policy decisions, and the treasury secretary is only a
salesman, handles the crisis.