It’s No Mystery Why the Fed Sees Low Inflation as a Mystery – The Daily Capitalist

The Wall Street Journal reports that Fed head “Yellen Defends Fed Rate-Rise Plan Despite ‘Mystery’ of Low Inflation.” For Yellen, it’s a “mystery” that the U.S. today enjoys, simultaneously, a low rate of inflation (1.9%) and unemployment (4.4%). It’s a fact, yet “theoretically” impossible, per Yellen, so she’ll keep raising the Fed’s policy interest rate, hoping to prevent further declines in the jobless rate. Get it?

Here’s why Yellen’s silly mystery is no mystery at all, at least to those who know something about the good and bad of economic theory and know some economic history too. For decades, Keynesian economists and their dominant textbooks have pushed the erroneous claim, to millions of students (including many now working at the Fed), that there’s an inevitable, unavoidable “trade-off” between a nation’s inflation rate and jobless rate. This bogus “cost-push” theory of inflation asserts that a low jobless rate somehow boosts labor’s “bargaining power” versus Scrooge-like employers, who eventually buckle under and concede to pay higher wage rates but, intent on preserving profit margins, also raise prices (thus inflation). The alleged tradeoff is captured by the so-called “Phillips Curve.” It’s in Yellen’s head.

In fact, inflation is a purely monetary phenomenon; technically, it’s a decline in the purchasing power of money caused by the interplay between the supply of and demand for money. Its effect is a general rise in prices. The main determiners of money supply are its monopoly issuers: today’s central banks (including the Fed).  Contrary to what the Phillips Curve myth implies, inflation is not caused by real factors – i.e., by a greater proportion of folks working to produce things or by faster rates of growth in economic output. In fact, stability in the value (or purchasing power) of money, much like stability in the rule of law and policy, fosters better growth and employment. Such stability is also beneficial for profits and equities.

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