Inflation Nowhere and Everywhere

When I took Econ 101, the textbook presented a concept called the Phillips Curve. Named for William Phillips, who might have garnered a Nobel Prize in Economics had he lived past the age of 60, the Phillips curve is still one of the key pillars of economics as it is taught today. The Phillips Curve simply plots on a graph the relationship between unemployment and consumer price inflation. This concept is the “North Star” of the Federal Reserve, the world’s most powerful central bank. In 1977 (six years after Nixon severed the dollar’s official link to gold) Congress tasked the Federal Reserve with two jobs. This “dual mandate” comprises (1) keeping people employed, and (2) keeping prices stable.⁴⁶

These are laudable goals. But keeping prices stable has come to be defined narrowly as keeping prices of goods and services stable. Let’s return to the three classifications of goods from Chapter 2: (1) consumption goods, (2) capital goods, and (3) money. Your Econ 101 textbook will explain how you get “inflation” in the prices of consumption goods. Such inflation in “consumer prices” is popularly measured in the “consumer price index” (CPI), though central bankers have other similar metrics for it, such as “personal consumption expenditures” (PCE).⁴⁷

However it is measured, the inflation is believed to occur via the “wage-price spiral.” The mechanism is simple. The central bank prints money via channels discussed earlier. Consumers take the incremental new money and they feel richer. So they save some of it, but they also spend some of it. This increase in overall spending (also known as an increase in “aggregate demand”) means they buy more consumption goods. This causes the companies that make those goods to raise production since they see an opportunity to increase their revenue and profits. But in order to make more goods, they have to find more labor. At the margin, securing more labor means either (1) paying existing workers to work more hours, or (2) enticing non-workers to join the workforce. Either way, convincing existing or prospective workers to toil more hours per week than they did before requires raising their wages. Raising workers’ wages puts more money in their pockets, which causes them to demand more goods. A self-reinforcing feedback loop results in rising wages and consumer goods prices.

This logic seems sound, but the economy is more complex. There are at least two other major factors at work: (1) trade, and (2) technology. With the exception of the last few years, the last several decades were a period of increasing international trade in which greater volumes of goods and services were traded across national borders. But the growth in international trade really kicked into high gear when China joined the World Trade Organization (WTO) in December of 2001.⁴⁸ China’s effect on world trade is evident in Figure 2.