An Article Touching On Imports

Folks,
the following article touches on imports and a possible effect on the economy,
but puts it in the context of political discussions. Now that the politicians
will, sadly, be getting back to work we can expect them to start "doing
something". Here is one issue on the horizon:
Myths die hard, and in the case of the "Phillips Curve," it has taken 20

years of obvious contrary evidence to convince many economists that

there is no fixed inverse relationship between unemployment and price

inflation. (Jeffrey Herbener of Grove City College has argued the

relationship never existed, not even at the purely empirical level.) The

article below quotes some Mises Institute scholars, and generally

provides an interesting treatment of the subject:





Who's Afraid Of A Red-Hot Economy?



Investor's Business Daily

February 9, 1999

by Charles Oliver



For more than 20 years, the Federal Reserve has seen its No. 1 job as

balancing growth and inflation, a duty enshrined in the 1978 Full Employment

and Balanced Budget Act.



The theory behind this mission is that too much growth brings inflation, but

slashing inflation too much would jack up unemployment. So the Fed's job was

to bring the Goldilocks economy: not too hot, not too cold, just right.



But in his latest testimony before the Senate, Fed Chairman Alan Greenspan

shot down that idea, noting that very low rates of inflation have coexisted

with very low rates of unemployment for some time now.



That made many economists and business leaders breathe a sigh of relief,

since it means the Fed is less likely to tighten monetary policy because of

tight labor markets.



Greenspan may have just admitted what economists have known for some time.



''Alan was a late believer in the idea that inflation isn't sparked by too

much growth, but the last few years have convinced him you can have growth

and low unemployment and still maintain low inflation,'' said Wayne Angell,

chief economist at Bear, Stearns & Co. and a former Fed governor.



It may have taken a mountain of evidence to convince Greenspan, but the link

between inflation and unemployment has been the subject of fierce debate by

economists for almost 40 years.



It started in 1958, when economist A.W. Phillips published an article

claiming to see a link between unemployment and inflation in Great Britain.

When unemployment fell, inflation tended to rise and vice versa.



Soon, other economists started to find that same relationship in the

economies of other nations. The link came to be called the Phillips curve.



For many, all those studies seemed to confirm that there was a link between

growth and inflation. Soon, economists started to say that the job of a

central bank was to maintain the lowest level of unemployment that doesn't

spark inflation: the so-called non-accelerating inflation rate of

unemployment, or NAIRU.



But some economists weren't convinced. At the University of Chicago, Milton

Friedman argued the Phillips curve was just an illusion.



''He argued that price inflation fooled businesses into thinking the demand

for their product was going up. So they hired more people. That's why there

seemed to be a link,'' said Richard Vedder, an economist at Ohio University.



Friedman's theory explained a key fact about the inflation-unemployment

relation: Inflation tends to precede drops in unemployment, not follow.



''But Friedman said the Phillips curve couldn't be sustained. At some point,

business leaders would wise up, figure out that the reason the prices they

can charge are getting higher is because of inflation, not an increase in

real demand. When that happened the link between inflation and unemployment

would break,'' Vedder said.



Friedman was largely dismissed in the economics profession until the 1970s.

That's when stagflation, the presence of both high inflation and high

unemployment, confirmed his ideas. Friedman won the Nobel prize in economics

in 1976 for his work.



''There's no question now that inflation is a monetary phenomenon. It

happens when the central bank lets the money supply grow too fast, and there

are too many dollars chasing too few goods,'' Angell said.



''Economic growth doesn't cause inflation. If anything it helps reduce it.

When there's more goods out there competing for those dollars, it offsets

growth in the money supply,'' he added.



But some who agree with Angell's point are worried about the current low

unemployment.



''Even Friedman agreed there is what he called a natural rate of

unemployment. Even in a healthy economy there are some people who will be

unemployed for some reason,'' said Roger Garrison, an economist at Auburn

University.



''The only way to push unemployment below its natural level is to pump money

into the credit markets, heating up the economy in a way that can't be

sustained without bringing price inflation,'' Garrison said.



Economists since the late 1980s have typically pegged the natural rate of

unemployment at between 5% and 6%.



The U.S. unemployment rate has been below 5% for 18 months. And since the

money supply has been growing for more than two years at above the 3% to 4%

recommended by Friedman, some economists think the Fed has pushed

unemployment below its natural rate. They keep waiting for price inflation

to pick up.



But there's little sign of inflation.



So what gives?



''Since the global economic crisis began, the U.S. has been getting a lot of

cheap imports, especially commodities. That has helped keep prices down,''

said Ram Bhagavatula, chief economist at NatWest Global Financial Markets.

''But once the rest of the world starts recovering, and import prices pick

up, then U.S. inflation could start to grow, and the Fed will have to

tighten.''



A less-troubling theory is that economists are just wrong about where the

natural rate of unemployment is.



''It could be lower now than economists have believed. If so, unemployment

could fall to 4% or 3% or even 2% without any inflation,'' said Andrew

Hodge, chief U.S. macroeconomist at the Wefa Group, a consulting firm in

Eddystone, Pa.



Welfare reform, rising real wages or other changes may have made joblessness

less attractive and pushed down the natural rate of unemployment. But no one

knows for sure.



''All economists can say right now is that the link between unemployment and

inflation seems to have broken down. But whether this is a temporary

situation or permanent we can't yet say,'' said Stephen Slifer, chief U.S.

economist at Lehman Bros.



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(C) Copyright 1999 Investors Business Daily, Inc.

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