Economists believe that money is the root of all evil -- just kidding -- money is the root of spending. Since money has no real interest associated with it -- its main purpose is for spending. Unless prices are falling it does not make a good saving device. In the long-run this money will eventually raise spending. A large injection of money will eventually increase spending at a much faster pace than supply can respond and the difference is inflation. Now this is getting to be as much fun as a colonoscopy. Right?
So it is appropriate to worry that today's government deficits could lead to higher long-term inflation. But many just shrug their shoulders. Why should we care so much about high and rising inflation? There are a lot of answers to this question but the one I want to focus on today is the bout between inflation (Black Trunks) and unemployment (White Trunks). Let's face it -- very few leaders are going to say openly and repeatedly that they want to focus on inflation stability when so many people are unemployed in the USA. Most of these leaders base this PREFERENCE on a so-called TRADE-OFF BETWEEN INFLATION AND UNEMPLOYMENT. Any policy that would reduce inflation today, according to this trade-off, will reduce the growth of spending, reduce the rate of inflation and raise the number of people unemployed. So -- if you are worried about inflation and you activate a policy to reduce it, then you must "pay for it" with fewer jobs and employment. This is not the stuff of reelection.
Did this piece of trade-off economics come down from on high? Not really. In fact, while the trade-off might exist at times, there are also plenty of times in recent USA history when policy was able to reduce both the inflation and the unemployment rate. There have also been some times when both inflation and unemployment rose. Hmmmm -- so much for a reliable and predictable tradeoff.
What causes the inflation/unemployment tradeoff to vanish at times? Answer -- an active supply-side. The trade-off is totally spending or demand based. But surely the expectations and behaviors of firms matter as they decide how much to produce and at what price to sell. Of course expected demand for computers is important to Dell -- but also of importance to Dell and its competitors is the expected wage, the price of commodity inputs, the level of productivity, tax on healthcare, and many other supply-side factors. Notice that any factor -- policy induced or otherwise -- that will have the impact of increasing business productivity and confidence relative to their business costs will have the interesting effect of reducing the cost per unit produced -- allowing them to produce more without raising prices markedly. Viola. Supply can make the trade-off disappear.
Did you ever believe that an economist would say "you can have your cake and eat it too?" But that is the magic of supply-side economics and supply-side policy. Right now we are faced with policy choices with huge implications. Monetizing the government deficits will have a predictable trade-off that could lead to high and rising inflation. But we have other choices. We know that firms are the ones who create the jobs. It seems very sensible to me that part of our policy arsenal should be devoted to finding ways for them to be permanently more competitive, especially if this frees us from undesirable trade-offs and lets us have our cake and eat it too.
One more point about supply. Letting inflation rise in the next couple of years as we use demand remedies to increase demand and employment is a very risky policy. If the increases in ACTUAL inflation causes a rise in EXPECTED future inflation, then the result will be an adverse supply shift as business costs rise faster than productivity. That will lead to higher unemployment and inflation. The trade-off is a very tricky theory to use. There is a lot more to say on this topic but I think I will leave it right here for the time and see if you post any comments.