Mises Wire

Shedlock on Wages and Inflation

Shedlock on Wages and Inflation

Mike Shedlock gives a rather Austrian-flavored explanation of inflation, noting that it is “best described as a net expansion of money supply and credit” through fractional reserve banking; that it cannot accurately be measured; that it can not accurately be measured with a fixed index; and that it generates a boom and bust cycle.

Then why does he, in this post, approvingly cite Billmon referring to the Neo-Keynesian theory of “cost-push inflation” and a “wage-price spiral”? Suppose that wages in some industry rise. Then can this lead to a rise in the general price level? Suppose that the industry is one that has relatively inelastic demand for its output, so it can pass along its cost increases in the form of higher prices. Then, in order to pay these higher prices, the purchasers of the output must, somewhere along the line, spend less on something else. There will be no general rise in prices. There can only be a general rise in prices if there is an increase in the quantity of money and credit money in the economy.

Shedlock goes on to state:

It [inflation] all comes down to wages and housing and jobs. Without meaningful rises in employment and wages, the former above the birth rate plus the rate of immigration (both illegal and illegal), and the latter above the TRUE cost of living, inflation really does not have a chance. Yes at 1% we had sustainable inflation. An incredible housing boom was the result. The better question (looking ahead) is “What Now?”

...

It is really simple: “wage increases, job growth, and housing that does not bust”. I see little reason to change course now. In fact, treasuries are probably a screaming buy.

None of: wage increases, job growth, economic growth, a strong housing market are necessary in order to have have inflation. All that is necessary is an expansion of money and credit in the banking system. The Fed offers credit to banks at a fixed rate. If the Fed keeps the short-term rate of interest below the level at which borrowing and saving would be in balance, the Fed and/or the banking system will create enough credit to balance out the difference.

Real wage growth is not a pre-condition of inflation. Nor are negative real wage growth and inflation mutually exclusive. Wages, in real terms tend to fall periods of high inflation because wages typically do not adjust as rapidly as prices. If enough money and credit is pumped into the system, nominal wages will eventually increase but real wages may or may not. Real wages tend to grow during economic expansions and shrink during recessions. It was thought, prior to the 70s, that inflation could only occur if the economy became “overheated” due to an unsustainably high growth rate. But the stagflation of the 70s destroyed this. The country went through a period of simultaneous inflation and recession, during which real wage growth was negative.

Inflation is a monetary phenomenon. Print enough money and it will find a home, somewhere.

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