Thursday, March 18, 2010

Krugman on Inflation and Stagflation

Being that Paul Krugman has attempted to rewrite the financial history of the 1970s and 1980s, I am surprised that he even admits that there was stagflation -- a combination of high inflation and unemployment -- during the 1970s. After all, under Keynesian doctrine, rates of inflation and unemployment supposedly have a negative relationship, and Keynesians supposedly believe that stagflation is an oxymoron.

Since the numbers did not lie, Keynesians decided that they had to create a one-time scenario in which oil prices somehow were the culprit. Writes Krugman:
The kind of inflation we had in the 1970s, the famous era of stagflation — high inflation combined with high unemployment — was quite different (than some of the famous hyperinflations). Deficits weren’t the issue — actually, US deficits were much smaller in the inflationary 70s than in the disinflationary 80s. Instead, what you had was a combination of excessively expansionary monetary policies, based on an unrealistic view of how low the unemployment rate could be pushed without causing accelerating inflation (the NAIRU), plus oil shocks that pushed up inflation across the board thanks to widespread cost-of-living clauses in contracts. There was never any risk of hyperinflation; the only question was whether and when we’d be willing to pay the price in high unemployment of bringing inflation back down.
Now, Krugman does not explain why unemployment and the rate of inflation went down together during the 1980s, but that is an issue for another post at another time.

I do find it curious that Keynesians will resort to the "cost-push" inflation line when it suits them, as they are trying to claim that prices go up because, well, prices go up. I have likened the Keynesian (and Krugman) explanation for deflation to that famous scene in "The Blues Brothers" in which Jake Blues (played by the incomparable John Belushi) tries to talk his fiancee out of gunning him down in the sewer:

Indeed, the idea that the changes in price of one commodity -- even a commodity as important as oil -- causing huge fluctuations in the U.S. economy makes Jake Blues' appeal sound true. By the way, inflation in the 1980s did not go down because unemployment went up, no matter what Krugman says. (He cannot have it both ways.) Inflation went down because the Federal Reserve System put down the brakes on money creation and held them down for a long time.

By the way, unlike our current situation, the USA had a real recovery after the recession of 1982. But, then, Paul Krugman was not influencing the government to print, borrow, and spend wildly.

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