There are many news items that create a strong reaction for me. One, that almost drives me nuts, is the permanent and incessant claim by economists and government financial people that we need inflation.
My name is Michael Phillips. I hope the irony of my name is recognizable by many of my readers. The reason for the incessant desire by economists for inflation is the Phillips’ Curve. Made popular by William Phillips in the late 1950’s from his professorship at the London School of Economics.
Phillips demonstrated from a large database that there was a close curvilinear relationship between inflation and unemployment. When unemployment is low inflation is high and rising. The conclusion from this correlation was that a modest inflation rate 3% (in the U.S.) corresponded with a modest unemployment rate, 4%. The force connecting these two was presumed to be a growing economy that demanded workers and drove up inflation.
The U.S. now has a low unemployment rate, in the 4% range, but virtually no inflation. This seems to economists and others to be atypical, wrong and harmful for economic growth. These people, including all the central bankers on the planet, want some inflation, which they associate with growth.
The evidence against the Phillips’ Curve is that Japan has had stable employment for 25 years while having deflation. The Japanese economy as measured by GDP doesn’t appear to be growing.
The reason for this whole confusion and the inability of economists and their peers to recognize what is really happening relates to how GDP is measured.
GDP is always deflated by a currency measurement call the GDP deflator which is the rate of inflation. This makes sense. If GDP appears to be growing by 5% but the inflation rate is 2% then the 5% is really made up of a distorted currency increase. So GDP loses 2% and is publicly treated as 3%.
When the GDP growth is 0% as in Japan or 2% in the U.S. and deflation is operating on the currency, nobody thinks about adding the deflation to the GDP growth. It’s habit, it’s tradition but mostly it’s hysteria. Everybody believes the same thing because everyone else does.
There is nothing wrong with deflation. It moves money to the middle class because the price of everything they buy is going down. But the economic hysteria, over 50 years, is in love with modest inflation. God help us.