The 70s Are Over

A lot of monetary policy discussions, including Ben Bernanke’s press conference today, spend a frighteningly large quantity of time dwelling on oil price increases.

There are a lot of cuts at what’s misguided about this, but one particular way of seeing the problem is to fire up the wayback machine and think about the economics of the 1970s. At that point in time labor unions were an important force in the American economy, representing a large share of workers. And it was common for unionized workplaces to have contracts that stipulated workers would get automatic cost-of-living increases in their wages. That was nice for the workers, but it had some perverse effects in the face of oil price spikes. In particular, it left the economy vulnerable to the following sequence of events. First, something totally non-monetary causes oil prices to shoot up. This causes the “cost of living” to go up which causes wages to go up, which, in turn, causes the price of everything to shoot up. That right there is inflation. What’s more, since the demand for gasoline isn’t very elastic and America is a net oil importer the rising price of oil is also a negative shock to aggregate demand that causes unemployment to go up. Then when the Fed tries to fight the unemployment the inflation situation gets really out of control. Bad news.

And of course this was bad news.

But part of what the monetary hawks of today seem to have forgotten is that circa 1980 there was a great Reagan Revolution and America spent the bulk of the next 25 years grinding labor unions into the dust. One can celebrate that or deplore it as one likes, but blocking this feedback loop from commodity prices into wages and thus into generalized inflation was one of the primary stated reasons for the anti-labor crusade. And for better or for worse, the union-busters won and there is now absolutely no chance that a rise in commodity prices will lead to generalized inflation in the face of a slack labor market. There’s no mechanism through which this could happen.

That the right seems unwilling to acknowledge this is, I might add, something of a synecdoche for the entire state of the neoliberal project circa 2011. Having largely won the war for flexible labor markets, floating exchange rates, integrated financial markets, lower marginal tax rates, free trade, etc. all in the name of boosting growth rates elite policymakers are now refusing to deliver the growth we were promised. Instead, they’re seeing the ghosts of the 1970s behind every corner. But if the center-right establishment is going to act super-pessimistic about America’s potential output, then what did we do all this for?