June 07, 2004

Why Oh Why Can't We Have a Better Press Corps? (Mickey Kaus Refutes Milton Friedman Edition)

A correspondent writes:

At the end of Mickey Kaus' love note (http://slate.msn.com/id/2101504/) to Reagan is this paragraph:

Reagan's 1981 breaking of the air traffic controllers' strike also seems a crucial part of the late-twentieth century boom. Union power was the mainspring of the 1970s wage-price spiral, as unions leapfrogged each other trying to stay a step ahead of the rising prices their hefty wage hikes then helped ensure. The air controllers provided the cautionary example of a labor organization that went on an ill-advised strike, was defeated, and ceased to exist. With the public's support! Big Labor hasn't been the same since--and, not coincidentally, neither has inflation.

As a fan of your site, I thought I'd bring it to your attention. Do with it what you will.

Thus <sarcasm> crack economist</sarcasm> Mickey Kaus draws on his <sarcasm>deep expertise in monetary economics</sarcasm> to refute Milton Friedman, who argues that inflation is a monetary phenomenon: the result of the central bank's allowing the money stock--the economy's stock of liquid assets--to expand too fast.

It is true that in the 1950s, 1960s, and 1970s you heard some on the right saying that inflation was the fault of Big Labor pushing up wages, and some on the left saying that inflation was the fault of Big Business pushing up prices, but these arguments were never very coherent. A monopolistic industry wants the relative prices of the goods it sells to be relatively high, but not too high--too high and the marginal loss of sales outweighs the extra margin on each sale. A monopolistic provider of labor wants the relative wage paid its workers to be relatively high, but not too high--too high and the marginal loss of jobs outweighs the extra earnings of those of its members who still have jobs. But there is a difference between seeking relatively high prices (or wages) and seeking prices (or wages) that rise at an accelerating rate: the second does not go with the first. The union movement was much, much stronger in the 1950s than in the 1970s. The relative wages of auto workers, steel workers, and coal miners were higher in the 1950s than in the 1970s. But inflation was much, much lower. Why? Because Milton Friedman was right: in the long run (in the medium run too) inflation is primarily a monetary phenomenon.

The "Big Business" and "Big Labor" inflation stories were never primarily economic and always primarily political. They were spin: ways of shifting the blame for bad macroeconomic performance off of the government and onto somebody else in the interest of boosting the reputation of those currently in power.

Now there is a more sophisticated argument--due to current Treasury Undersecretary John Taylor--in which I have about 75% confidence: that in the short run inflation in a country with an intermediate union strength will be more "inertial" than in a country with either low or high union strength. In an intermediate-union-strength country, inflation will be slower to rise when the money stock starts growing faster (because unions sign long-term contracts and pay attention to one another's relative wages as well as to labor market supply and demand) and inflation will be slower to fall when money stock growth slows down (for the same reason). But that's not what Kaus is saying.

And there is another more sophisticated argument that in the short run Big Labor can be an effective device for controlling inflation even when the economy is overheated: the government can strike deals in which Big Labor reduces wage increase demands in return for expanded social insurance benefits, and those reduced wage demands can play a role in keeping inflation low. But that also is not what Kaus is saying.

What is Kaus is saying when he calls Big Labor "the mainspring of the 1970s wage-price spiral, as unions leapfrogged each other trying to stay a step ahead of the rising prices their hefty wage hikes then helped ensure" and says that Reagan won the fight against inflation by destroying PATCO and thus crippling Big Labor, which "hasn't been the same since--and, not coincidentally, neither has inflation"? He is saying that Milton Friedman was wrong. And he is saying that Paul Volcker was guilty of criminal stupidity: If Kaus were to be right, Volcker didn't need to cut back liquidity growth, watch interest rates rise sky-high, make unemployment rise to 10% (much higher than he had hoped it would rise), and create 15 million extra person-years of unemployment in the early 1980s in order to push inflation down from 10% to 4%. Kaus seems to think that Volcker could have just sat on his hands, and the reduction in union power achieved by Reagan would have done (most of) the trick.

The dominant opinion among macroeconomists is (and for two and a half decades has been: see Sargent and Wallace, "Some Unpleasant Monetarist Arithmetic") that Reagan made Volcker's task of reducing inflation not easier but harder and more costly: the Reagan budget deficits made people worry that the U.S. government might decide to inflate away America's rapidly growing debt, and made it more difficult and expensive for the Federal Reserve to earn the necessary confidence that its low-inflation policies were for real and would be sustained.

Posted by DeLong at June 7, 2004 07:07 AM | TrackBack | | Other weblogs commenting on this post
Comments

Good thing that Kaus is a liberal! Imagine if he were actually a right-winger - he'd probably be taking an AK-47 to his local union hall, and shooting it up.

Hey - since Kaus is a liberal, could us liberals put him on trial for political heresy? He shouldn't have any objections, him being such a liberal and all.

Posted by: Barry on June 7, 2004 11:39 AM

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Brad,

You did an excellent job explaining why firms' desire to have high profit was not the cause of inflation in the 1970s. I wish you had explained to Greenspan (and Bernarke) last summer that "lack of pricing power" would not cause deflation either. The economy might have avioded the lindmines of $1 trillion under 5.5 percent mortgage debt if you had.

Posted by: pat on June 7, 2004 01:24 PM

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All of Kaus' so-called analysis misses the point entirely. PATCO was a union representing federal employees, for whom it was (and is) illegal to strike. PATCO never had the power to drive up wages through strikes and that was definitively proven by its members' dismissal from service. Reagan did not deflate union power by firing striking government workers- he merely demonstrated that those particular workers never had that power to begin with.

Posted by: solar on June 7, 2004 01:39 PM

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"Union power was the mainspring of the 1970s wage-price spiral, as unions leapfrogged each other trying to stay a step ahead of the rising prices their hefty wage hikes then helped ensure."

In other words, *if* we assume that labor unions systematicly overestimate future inflations rates, and that the unions have the power to translate those predictions into wage rates, then labor unions will tend to be inflationary.

One problem with this analysis is that during the 1970s, labor unions were getting out of the economic forcasting business. Rather than trying to predict future inflation rates and incorportate those predictions into labor contracts, labor unions simply negotiated contracts containing cost of living adjustments.

The bigger problem with the analysis is the one Brad points out: there is (so far as I know) no data suggesting faulty inflation forcasts by labor unions ever had a non-trivial impact on inflation.

Posted by: Kenneth Almquist on June 7, 2004 02:34 PM

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"Union power was the mainspring of the 1970s wage-price spiral, as unions leapfrogged each other trying to stay a step ahead of the rising prices their hefty wage hikes then helped ensure."

In other words, *if* we assume that labor unions systematicly overestimate future inflations rates, and that the unions have the power to incorporate those predictions into wage rates, then labor unions will tend to be inflationary.

One problem with this analysis is that during the 1970s, labor unions were getting out of the economic forcasting business. Rather than trying to predict future inflation rates and incorportate those predictions into labor contracts, labor unions simply negotiated contracts containing cost of living adjustments.

The bigger problem with the analysis is the one Brad points out: there is (so far as I know) no data suggesting faulty inflation forcasts by labor unions ever had a non-trivial impact on inflation.

Posted by: Kenneth Almquist on June 7, 2004 02:35 PM

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Mickey Kaus is one of the worst writers imaginable. He believes in nothing and his main motivation is spite.

Posted by: KevinNYC on June 7, 2004 03:50 PM

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"The relative wages of auto workers, steel workers, and coal miners were higher in the 1950s than in the 1970s." I don't know about the coal miners, but the autoworkers and steelworkers won a very big wage increase in the late 1960's, so big that it significantly affected their relative wages, and undermined the position of those industries relative to imports. The wages of autoworkers and steelworkers were higher, relative to average wages, in the 1970's than at any other time after 1950.

As for the inflationary spiral of the 1970's, while I think Milton is analytically right, there were very significant "fiscal" and institutional factors, which ought to be part of any historical narrative: Nixon's irresponsible fiscal policies, attributable to his desire for re-election coincided with a rare business cycle peak throughout the industrial world, which in turn made possible the OPEC embargo, followed by a muddled policy of monetary expansion to accomodate higher energy prices and of "cost-of-living adjustments", which seemed to institutionalize inflation. These last, which I suppose kaus is referring to, were a big concern of Friedman, among others, in the late 1970's.

It is easy to forget how frustrated policy analysts were in the late 1970's, with "stagflation." I am no fan of Reagan, or his deficits, but an expansionary fiscal policy was a necessary counterpoint to the Fed's restrictive monetary policy. Both stagnation and inflation had to be addressed at once. Reagan's extensive deficits were the anvil against which Volker's hammer beat inflation out of the economy.

An aspect of the problem, which economists tend to neglect, is the stock of financial capital available to the economy, which rising inflation tends to deplete. The deficits put a lot of government bonds into the financial markets, and diverted a significantly greater part of federal revenue to the financial markets; high inflation accelerated the adoption of practices, which reduced the purely transactional demand for money. All of this meant that the total stock of financial capital was increasing even as money supply growth was held in check.

Posted by: Brian Wilder on June 7, 2004 04:50 PM

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Brad,

Kaus seems to have confused Thatcher with Reagan. Unions have never been a dominant force in the US economy. The air controllers dispute was not a watershed. The US economy was never held prisoner by union power.

The Kaus argument might be reasonably made about Thatcher, but again you are right on the inflation score. The British unions played a much more dominant role in the UK economy and controlled one of the two major parties. It was after the unions brought down successive Tory and Labour governments that Thatcher acted to break the unions.

Nobody would argue that breaking the unions tamed inflation, or at least if they did they would be unable to see that inflation came under control long before the fight with the unions was over.

There could however be a second order effect. Keeping public sector pay in check was what allowed Thatcher to keep the deficit in check and that in term helped efforts to control money supply growth.

None of which remotely applies in the US since the salaries of 11,000 workers is not relevant in the overall US budget.

Posted by: Phill on June 7, 2004 05:31 PM

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Debunking Kaus is far too trivial a task for someone of your stature. You should have assigned it to one of your undergraduate students, or perhaps one of your children.

Posted by: Kuas on June 7, 2004 05:32 PM

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Appreciate your analysis, hate that it responds to Kaus - his brain is an asparagus and I fear that with any acknowledgement whatever he may be able to negotiate greater longevity on his present soapbox. Jeez, on the other hand, maybe it could slide him on over to the WSJ, which would be a most satisfactory mutual disundercreditation.

Posted by: Ken on June 8, 2004 08:02 AM

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