Peter Morici: Why central bankers are so confused by low prices

Pablo Martinez Monsivais, AP

Federal Reserve Chair Janet Yellen goes over her notes prior to testifying on Capitol Hill in Washington, Thursday, July 13, 2017, before the Senate Banking Committee.

Central bankers are captive to conventional economics — faced by low inflation and low unemployment, they are flummoxed about pulling back on monetary stimulus. Their dilemma lies in an incorrect reading of statistics and taking modern macroeconomic theory too seriously.

Unemployment in the European Union is at its lowest level since 2009, yet inflation across the pond drags along at about 1.3 percent. U.S. unemployment is at a similar trough, while headline and core inflation remain well below the Fed’s 2 percent target.

According to the textbooks, unemployment and inflation are supposed to move in opposite directions, not in tandem as they have. As summarized by the Phillips curve, falling unemployment should coincide with tightening labor markets and rising wages and prices, and the inverse should be true as unemployment rises.

For one thing, headline unemployment rates are proving an increasingly poor measure of what is going on in many labor markets. In the United States and Europe, large numbers of adults are on the dole and opting out of work altogether, and on both continents many university graduates are underutilized in low-paying jobs — serving coffee at Starbucks, chaperoning tours of historic venues and the like.

For another, macroeconomic models deal poorly with the fact that entitlement programs have created large pools of contingent workers — folks who may only again participate in the labor force if wages rise very sharply. More generally, those models paper over other demand- and supply-side structural changes that are holding down prices and subverting the historically expected inverse relationship between unemployment and inflation.

Central bankers point to low oil prices, instigated by the U.S. shale revolution, but those fell last year to about to $44 a barrel in 2016 and generally have been a bit higher in 2017.

Janet Yellen is fond of pointing to falling…

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