Today I wish to address what is one of the major economic swizzles of our time. That is the drip drip feed by the establishment and a largely supine media that inflation is good for us, and in particular an inflation rate of 2% per annum is a type of nirvana. This ignores the fact that that particular number was chosen by the Reserve Bank of New Zealand because it “seemed right” back in the day. There was no analysis of the benefits and costs.
On the other side of the coin there has been a major campaign against low or no inflation claiming it is the road to deflation which is presented as a bogey(wo)man. There are several major problems with this. The first is that many periods of human economic advancement are exhibited this such as the Industrial Revolution in the UK. Or more recently the enormous advances in technology, computing and the link in more modern times. On the other side of the coin we see inflation involved in economies suffering deflation. For example Greece saw consumer inflation rising at an annual rate of over 5% in the early stages of its economic depression. That was partly due to the rise in consumer taxes or VAT but the ordinary Greek will simply feel it as paying more. Right now we see extraordinary economic dislocation in Argentina where a monthly inflation rate of 4% in August comes with this from Reuters.
The country’s economy shrank 2.5% last year and 5.8% in the first quarter of 2019. The government expects a 2.6% contraction this year.
Argentina’s unemployment rate also rose to 10.6% in the second quarter from 9.6% in the same period last year, the official INDEC statistics agency said on Thursday.
The Euro Area
The situation here is highlighted by this release from the German statistics office this morning.
Harmonised index of consumer prices, September 2019
+0.9% on the same month a year earlier (provisional result confirmed)
-0.1% on the previous month (provisional result confirmed)
This is around half of the European Central Bank or ECB inflation target so let us switch to its view on the subject.
Today’s decisions were taken in response to the continued shortfall of inflation with respect to our aim. In fact, incoming information since the last Governing Council meeting indicates a more protracted weakness of the euro area economy, the persistence of prominent downside risks and muted inflationary pressures. This is reflected in the new staff projections, which show a further downgrade of the inflation outlook.
That is from the introductory statement to the September press conference. As you can see it is a type of central banking standard. But later Mario Draghi went further and to the more intelligent listener gave the game away.
The reference to levels sufficiently close to but below 2% signals that we want to see projected inflation to significantly increase from the current realised and projected inflation figures which are well below the levels that we consider to be in line with our aim.
My contention is that this objective makes the ordinary worker and consumer worse off.
The behaviour of real wages has changed a lot in the credit crunch era. If we look at my home country the UK we see that nominal wage growth has only recently pushed above an annual rate of 4%. But if we look at the Ivory Tower style projections of the OBR it should have pushed above 5% years ago based on Phillips Curve style analysis like this from their report on the 2010 Budget.
Wages and salaries growth rises gradually throughout the forecast, reaching 5½ percent in 2014…………Thereafter, the more rapid increase in employment is sufficient to lower unemployment, so that the ILO unemployment rate falls to
6 per cent in 2015.
As you can see wages growth was supposed to be far higher than now when unemployment was far higher. If they knew the number below was associated with a UK unemployment rate of below 4% their computers would have had a moment like HAL-9000 in the film 2001 A Space Odyssey.
The equivalent figures for total pay in real terms are £502 per week in July 2019 and £525 in February 2008, a 4.3% difference.
Real pay still has some distance to go to reach the previous peak even using a measure of inflation ( CPIH) that is systematically too low via its use of Imputed Rents to measure owner-occupied housing inflation.
It is the change here which means that old fashioned theories about inflation rates are now broken but the Ivory Tower establishment has turned a Nelsonian style blind eye to it. Let me illustrate by returning to the ECB press conference.
While labour cost pressures strengthened and broadened amid high levels of capacity utilisation and tightening labour markets, their pass-through to inflation is taking longer than previously anticipated. Over the medium term underlying inflation is expected to increase, supported by our monetary policy measures, the ongoing economic expansion and robust wage growth.
This is the old assumption that higher inflation means higher wage growth and comes with an implicit assumption that there will be real wage growth. But we have learnt in the credit crunch era that not only are things more complex than that at times things move in the opposite direction. There is no former rejection of Phillips Curve style thinking than the credit crunch history of my country the UK. Indeed this from the Czech National Bank last year is pretty damning of the whole concept.
Wage dynamics in the euro area remain subdued even ten years after the financial crisis. Nominal wage growth1 has seldom exceeded 2% since 2013 (see Chart 1). Wages have not accelerated significantly even since 2014, when the euro area began to enjoy rising economic growth and falling unemployment. Following tentative signs of increasing wage growth in the first half of 2017, wages slowed in the second half of the year.
It is the breakdown of the relationship between wages and inflation that mean that the 2% inflation target is now bad for us. The central bankers pursue it because one part of the theory works in that gentle consumer inflation helps with the burden of debt. The catch is that as we switch to the ordinary worker and consumer they are not seeing the wage increases that would come with that in the Ivory Tower theory. In the UK it used to be assumed that real wage growth would be towards 2% per annum whereas in net terms the credit crunch era has shown a contraction.
If we look at the United States then last week’s unemployment report gave us another signal as we saw these two factors combine.
The unemployment rate declined to 3.5 percent in September, and total nonfarm
payroll employment rose by 136,000, the U.S. Bureau of Labor Statistics reported
today………In September, average hourly earnings for all employees on private nonfarm payrolls,
at $28.09, were little changed (-1 cent), after rising by 11 cents in August. Over the
past 12 months, average hourly earnings have increased by 2.9 percent.
It is only one example but an extraordinary unemployment performance saw wage growth fall. There have been hundreds of these butt any individual example the other way is presented as a triumph for the Phillips Curve. Yet the US performance has been better than elsewhere.
Oh did I say the US has done better, Here is the Pew Research Center from last year.
After adjusting for inflation, however, today’s average hourly wage has just about the same purchasing power it did in 1978, following a long slide in the 1980s and early 1990s and bumpy, inconsistent growth since then. In fact, in real terms average hourly earnings peaked more than 45 years ago: The $4.03-an-hour rate recorded in January 1973 had the same purchasing power that $23.68 would today.
All of this is added to by the way that rises in the cost of housing are kept out of the consumer inflation numbers so they can be presented as beneficial wealth effects instead.