The Inflation Threat Is a Bogeyman

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Here's the one number that proves that inflation isn't "really" 10 percent. 
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British celebrity historian and Harvard professor Niall Ferguson thinks inflation is "really" much higher than its official number. So does celebrity politician and self-styled Austrian economist Ron Paul. And then there's John Williams of Shadow Stats. He too warns of double-digit inflation -- but curiously takes payments for his newsletter in dollars. Even more curiously, he hasn't increased its price in years.

There's just one problem with the inflation monster. It's not real.

The U.S. economy has added 1.9 million jobs over the past 12 months. That number is the best indicator that inflation isn't 10 percent. Here's why.


A country's nominal GDP (NGDP) refers to the total size of its economy. In other words, it's the dollar size of our economy, including both inflation and real growth. Here's why it's interesting: If we work backwards from NGDP and inflation, we can infer how much real GDP grew in the past year. And we can infer from real GDP how many jobs we would expect the economy to add.

The below chart shows much NGDP has grown year-over-year since the Great Recession hit. (Note: 2008 was the first time NGDP hit negative territory since 1960). 

NGDP.png

In 2011, NGDP grew just a hair under 4 percent. That's not good in normal times, let alone after a deep slump. Trend NGDP growth is around 5 percent, so we would hope to grow substantially faster than that to catch-up to where we should be. It's why the Fed should adopt a more aggressive target now. And it also tells us that inflation is certainly not far higher than its reported figure.

Let's try a thought experiment. If inflation really is 10 percent, that implies that real GDP fell around 6 percent last year. How bad is that? That's roughly where the economy was in the first quarter of 2009. Basically, complete free-fall. And thanks to Okun's Law -- which relates real GDP and unemployment -- we can guesstimate what that would mean for jobs. A back-of-the-envelope estimate says that unemployment should have risen between 3 and 4 percent in that scenario. Instead, we added 1.899 million jobs in the last year.

And no, this wasn't about government hiring distorting things. Government has been the only sector cutting jobs the past year, due to austerity at the state and local level. There's only one logical conclusion. Real GDP was positive, if disappointing, and inflation was in fact low.

The conspiracy theory that inflation is being wildly under-reported doesn't withstand more than 30 seconds of scrutiny. So why the persistent belief that we're reliving the stagflationary nightmare of the 1970s when the deflationary nightmare of the 1930s is much more relevant? It's mostly frequency bias. The things people buy the most often -- gas and groceries -- have gone up the most the past few years. The things people buy the least often -- gadgets and other goods -- have not. It's an understandable mistake. But still a mistake.

Of course, none of this is new. The same fears of increasing prices paralyzed policymakers and the public alike during the 1930s -- despite precipitous falls in prices. British economist Ralph George Hawtrey likened it to "cry[ing] 'Fire! Fire!' in Noah's flood." Ben Bernanke and other central bankers have thankfully managed to prevent outright deflation this time around, but high inflation is still our economic Godot. It's not here, and it's not coming anytime soon.

Update: Ramesh Ponnuru of National Review made very much the same argument in response to Niall Ferguson back in 2011.
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Matthew O'Brien

Matthew O'Brien is a former senior associate editor at The Atlantic.

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