Throughout the late 1970s, an unexpected economic phenomenon occurred: both inflation and unemployment surged simultaneously. This left the top economists of the era perplexed.
The Phillips curve suggests an inverse correlation between inflation and unemployment; when one increases, the other decreases. So, how could both metrics rise together? This unlikely scenario required considerable government intervention to materialize.
As unemployment began to climb in the 1970s, the U.S. Treasury, supported by the Federal Reserve, acted on Keynesian principles. They injected funds into the economy to spur job creation, believing they could responsibly manage rising unemployment without igniting inflation.
Unfortunately, the outcome was contrary to expectations. Instead of creating jobs, inflation took off. Even after multiple attempts to stimulate job growth, the response remained the same: more inflation with no jobs in sight.
Almost Predictable
This episode highlights the unpredictability of the economy. While one decade might see individuals borrowing and spending, the next might foster a culture of saving and debt reduction. No chart can accurately predict these shifts in behavior.
It’s apparent that rising unemployment signals economic downturn; however, one would expect improvements in the economy as unemployment decreases. But, recent years of declining unemployment have not ushered in an economic boom, but rather a period characterized by lethargy. This stagnation may be linked to the simultaneous decline in both the unemployment rate and labor participation rate.
While this theory appears valid, it quickly loses standing when the economy improves—even amidst a declining labor participation rate. The real fascination lies not in whether the economy is predictable or not, but in its almost predictability.
Complicating matters further are the numerous academic individuals who lecture on the economy as if they were teaching basic geometry. Some even earn Nobel Prizes for their bewildering theories. With their graphs and charts, they attempt to demystify the complex economic machinery while suggesting methods to enhance it.
Lost in Extrapolation
One frequent voice in popular economic discourse is former Treasury Secretary Larry Summers. He possesses an aura of superiority and ensures that everyone knows his intellectual prowess. There is likely not a question he cannot answer, nor an answer to which he doesn’t already know the question.
You may recall that Summers was once in contention for the top position at the Federal Reserve, which Janet Yellen ultimately secured. Perhaps this has influenced his frequent public advice to Yellen on how to manage her role.
Recently, he publicly suggested to Yellen what her approach to Fed interest rate policy should be. On a recent occasion, he advised:
“You should raise interest rates, as has been the case historically when dealing with inflation,” he told CNBC, while asserting that inflation wouldn’t exceed 1 percent in the next decade. “In the face of a ‘low-flation problem,’ there’s no reason to raise rates.”
It seems Summers has it all figured out, even predicting the inflation rate a decade ahead, thanks to his reliance on past data to project future trends. Naturally, he shares his prescribed solutions.
“The key is to generate demand if you want companies to invest; otherwise, they’ll invest in unnecessary capacity,” he remarked.
However, Summers appears to overlook the consequences of artificially stimulating demand through borrowing fueled by years of low-interest rates. This reckless accumulation of debt renders it impossible to further stimulate demand through additional cheap credit. Consequently, after seven years of a Zero Interest Rate Policy (ZIRP), the economy lies dormant and unresponsive.
Summers’ advice has yet to breathe life back into the economy, and perhaps he could benefit from a revised approach.
Sincerely,
MN Gordon
for Economic Prism
