“Cost-push” & “Cost-pull” theories of inflation

In the 1960s and 1970s, “cost-push” was the great explainer of inflation. On the pro side, a group of highly influential economists:

Paul Samuelson – Nobel winner

James Tobin – Nobel winner

Walter Heller – CEA Chair

Gardner Ackley – CEA Chair

Arthur Okun – CEA Chair

Arthur Burns – Fed Chair

On the contra side, advocating monetary causes for inflation, an almost lone voice:

Milton Friedman – Nobel winner

Just one example from the “cost-push” side:

As late as 1979, just as Paul Volcker was getting appointed Fed Chair and about to start a monetary experiment to curb inflation, Walter Heller claimed, in Congressional Testimony, that:

…“three years of slack in the economy from early 1975 to early 1978…failed to dent the underlying rate of inflation”, writing approvingly of “a vigorous policy of wage-price restraint to curb cost-push inflation”.

Friedman was very clear on his rebuttal to the “cost-push” view:

“The price level and inflation are monetary phenomena, not institutionally determined data to be analyzed by psychologists and industrial relations and industrial organization specialists”

To Friedman, the factors typically cited as sources of cost-push inflation could not, in fact, have a sustained effect on inflation unless they were accommodated by monetary policy.

Shortly after Heller´s defense of a “vigorous policy of wage-price restraint”, Volcker, through “vigorous” monetary restraint, broke the back of inflation expectations.

The charts show what transpired through the mid-2000s, reflecting the stabilization of nominal spending (NGDP) growth at an adequate NGDP path.

Bernanke then comes in and is spooked by the inflationary impact of an oil shock. Monetary policy is “squeezed”, a recovery does not take place and the economy is condemned to remain in depression.

Bad ideas, however, never die, so now we witness the revival of “cost-push”, only this time in the guise of “cost-pull”. While the factors pushing costs up were things such as oil producers, oligopolies and unions, the factors now “pulling costs down” are things such as globalization, technological advances and demography.

While previously it was thought that inflation control required the implementation of incomes (wage, price restraint) policy, now, with monetary policy ineffective to combat “too low” inflation, suggestions comprise a change in the monetary framework, with Bernanke suggesting a temporary Price Level Target (PLT) when the economy hits the ZLB or, as suggested by Olivier Blanchard and Larry Summers, greater reliance on fiscal policy.

In the late 1990s and early 2000s, there were several conferences and papers on “Monetary Policy in a Low Inflation Environment. All emphasized the danger of hitting the ZLB..

The panel below shows very clearly that the “danger” is not “low inflation”, but “too tight” monetary policy, in particular one that allows NGDP growth to tank and even “submerge”. That´s the factor that leads directly to the ZLB

Japan did it first, in the 1990s. The others did it together in 2008. There´s no deflation like in Japan because the US, the UK and the Eurozone all have a positive (around 2%) inflation target. (Japan´s implicit inflation target was zero %!).

In the US, UK and EZ, NGDP growth, after tanking, remains positive, but low and stable. In Japan, it was either zero or negative.

The “solution” is starring you in the eyes. One, establish a level target for NGDP and once the target level is reached, decide on a stable growth rate, depending on the country, a 3% to 5% growth rate.

Just as when NGDP growth was positive and stable the ZLB was just a “theoretical curiosity”, it will once again become one.

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