From Transitory Inflation to Prolonged Inflation?

The Wall Street Journal just published one of the best pieces of economic journalism I have read in a long time. It is a story covering a thesis that Charles Goodhart has been proposing for the last few years among economic policy elites. The thesis is that we are about to enter a prolonged period of elevated wage and price inflation. The theory could be called "the labor theory of the price level". It posits that workers' bargaining power determines the extent of inflation. In an era of rapid technological progress and globalization, workers lost bargaining power, so it was easier to keep their wage growth contained. In an era of rapid population aging and de-globalization, workers will regain some of their long lost bargaining power, leading to higher wages. These higher wages will in turn lead to higher prices (in the familiar wage-price spiral that we discussed in class).

You will notice how much this story contrasts with the view, prevalent in 2021 among US and European central bankers, that the current rise in the inflation rate would prove transitory. Indeed, Goodhart's story implies the opposite.

What do I think of this new story? The diagnosis of an aging population and de-globalization giving workers more bargaining power is well-taken. I am less certain that such enhanced bargaining power will lead to persistent inflation. This depends in part on monetary policy actions: it could be averted with sufficient tightening of the money supply. On a theoretical level, the story also requires more work. The manner in which workers gain more bargaining power, in this story, is because they become more scarce, and face less competition from cheap foreign labor. Yet the purchasing power of the older segments of society do not automatically rise, unless their retirement resources are indexed. So the greater wages that the story implies accrue to a smaller share of the population. We would need a formal model to assess whether this force alone is enough to lead to generalized increases in wages and prices. In sum, I buy the premise of Goodhart's story, but I don't think the conclusion of persistent inflation necessarily flows from this premise. 

If you want to learn more about Charles Goodhart and his life, you can read this. Fun fact: His daughter Lucy was my classmate in graduate school. Lucy now teaches economics at Brandeis University.

UPDATE: Over at Bloomberg, Jonathan Levin adds more data along similar lines.

Comments

[Aadithya Umashankar]

Hi Professor,

While I am with you on the thought that this inflation is not permanent, I feel Covid was one of the major forces behind the increased workers' bargaining power, given that the shortages. With low unemployment rates, companies are struggling to find workers for low wages.

[erik maroney]

https://www.cnbc.com/2022/03/10/theres-more-inflation-coming-as-the-federal-reserve-starts-raising-interest-rate.html

Seems as if the fed is raising interest rates while keeping an eye on the markets. It'll be interesting how the transparency Powell is showing will affect exchanges and the predictability will keep the markets going even as rates increase.

[Abram Arredondo]

How high would interest rates need to go to tame inflation? I've read that the current hikes are insufficient to deal with it. I came across this article about about stagflation being possible: https://www.forbes.com/sites/sergeiklebnikov/2022/03/15/most-wall-street-experts-now-predict-stagflation-heres-what-that-means-for-investors-and-the-us-economy/?sh=58d48ebc1400

I've read about the US in the 70s and its experience with stagflation. Is this a serious risk?