Daily Archive: June 5, 2009

The stagflation myth – Paul Krugman Blog – NYTimes.com.

The whole thing about stagflation is kind of weird.  The term refers to the economic situation of the 1970’s, where one had high unemployment and inflation.  Usually you don’t have both.

First, there is a misconception about inflation.  It’s not that we print all this money and it’s now worth less.  It’s more that prices go up and a loaf of bread that cost $1.50 yesterday now costs $2.  So the money is worth less but because of prices, not the actual number of bills out there.  In fact, in terms of real money supply, over time the rise in prices brings everything back to a steady state.  

So, usually, as unemployment goes down…i.e. people get jobs and have salaries and start buying things, they tolerate higher prices more and more, and we have inflation.  So you don’t usually have both at the same time.

Economists fall into two general categories when it comes to macroeconomic policies – those that control and influence the overall, national economy.  The first comes from “neoclassical” or “conservative” angles, where government involvement should be small or is useless, and that it’s all about the central bank (The Fed) moving interest rates around to keep everything stable.  In theory, that should work.

The other group follows roughly those ideas put forth by John Maynard Keynes in 19…36, I think.  He basically said that we can affect demand through government spending.  Moving demand moves prices, output, etc, and we can pull ourselves out of recessions and other problems.  Of course, the ideal scenario is a combination of fiscal (gov’t) and monetary (Fed) policies that work together.  

Many conservatives point to stagflation as proof that the Keynesian economists had it all wrong.  However, it’s not that they were wrong, it’s more that since their theories targeted demand and stagflation couldn’t be solved by moving demand around, then Keynesian policies were wrong.  But that’s like saying…just because I can’t make a car go faster with higher octane gas, then high octane gas is useless or “wrong” or something.