Here is a brief summary of the 2017 economy: In a tug-of-war between political surreality and global reality, reality won.
While President Donald Trump has been an instrument of chaos—goading nuclear powers, blasting the FBI, and mocking his enemies—the global economy scarcely seems to have noticed. In Europe, manufacturing confidence hit a 10-year high, according to JP Morgan. In Japan, business confidence has hit a 30-year high. The U.S. labor market has added jobs for 75 consecutive months—a record. In the likely event that the economy is still expanding in May, this will be the second-longest period of economic growth since the end of World War II. (GDP would have to keep growing for another 18 months to catch the all-time record, the 1991–2001 expansion.) On Wednesday, the Dow Jones Industrial Average surpassed 25,000 for the first time ever, after another round of strong jobs data.
It’s impossible to say for certain how long any of this will continue in 2018. The 2017 economy benefited from several trends, like the nice bump in oil and metal prices, that could be temporary boons. But if 2018 is indeed a redux of 2017, we may finally glimpse an emerald-rare phenomenon in the post-1970s economy: inflation higher than 2 percent.
There are two important questions regarding inflation: Can higher inflation, which can sometimes spin out of control, be good; and why aren’t we getting more of it?
The first question is easier to answer. Inflation in the economy is like yeast in bread; both too much and too little ruins the loaf, but a little bit makes the dough rise. The right amount of inflation—say, between 2 and 3 percent—can push up wages and stimulate economic expansion. Since the Great Recession ended, the most common measure of inflation, the “core” consumer price index (which discounts volatile food and energy costs), has been under the Federal Reserve’s target of 2 percent. That’s one reason why so much of the economic recovery has felt so feeble.
The second question—why is higher inflation so elusive—is one of the larger mysteries of the last few years. Since March 2009, the world’s central banks have pumped more than $11 trillion in stimulus into the global economy. Stock prices have tripled. But U.S. inflation hasn’t surpassed the Federal Reserve’s target of 2 percent for more than a few months total. Price and wage growth are dormant across developed economies like the U.S., Europe, and Japan.
There are several possible reasons. First, lower inflation is a natural feature of a moribund recovery following a financial crisis, like the Great Recession, when families spend less after they lose jobs and their housing values plummet. Second, aging populations in advanced economies might be restraining economic growth, since pensioners, by definition, don’t work much. Third, internet companies and communications technology might be keeping prices low; for example, Uber has made urban transit cheaper, and Amazon and Walmart have held down retail prices. Finally, it’s possible that larger companies—not necessarily monopolies, but monopoly-ish—have fewer competitors, so they can afford to restrain wage growth. (The average market cap of a public U.S. company is 10 times higher than it was four decades ago, according to JP Morgan.)
The specter of inflation haunts goldbugs and bond investors looking for risk-free returns. But 2018 might finally be the year where the apparition enters the realm of reality. This materialization would be great for workers, since median wage growth is still far below its late-1990s levels.
The first reason why inflation might finally be right around the corner is that the U.S. seems awfully close to full employment. The official unemployment rate is 4.1 percent, which is lower than any time between 1971 and 1999. But that’s not all: The share of part-time workers is lower than any time in a decade, and a survey of small businesses’ intention to hire recently returned an all-time high (the survey began in 1974).
Wage inflation and overall inflation are somewhat interlinked, since having to pay workers more can force companies to raise prices. One of the key signs of impending wage inflation is that industries struggle to fill low-wage jobs, since workers are constantly threatening to leave for a higher-paying position. Indeed, restaurants like Cheesecake Factory are finding it harder to keep workers around without raising wages and prices. Another low-wage job, delivery drivers who drop off packages for UPS or FedEx, is in such high demand that the occupation was the third–most popular job listing on Monster.com in 2017. More competition for low-wage workers should push up wages, and prices will likely follow.
Second, the Republican tax cut might provide an interesting experiment for 2018, because it does something rather unprecedented in U.S. budget policy. It purposefully increases deficits deep into a recovery with unemployment under 5 percent. And while the overall tax cut skews toward the rich, the 2018 distribution is more progressive because it includes the largest tax benefits for middle-class families, which later expire.
The last time that unemployment was this low, President Bill Clinton was presiding over budget surpluses. But the Joint Committee on Taxation estimates that the tax cut signed by Trump will add $135 billion to the deficit in the first nine months of 2018 (the remainder of the fiscal year) and another $280 billion to the deficit in the following 12 months. This is a bold experiment in expansionary fiscal policy. No modern American government has ever passed a tax cut this large with such low unemployment. It would be awfully surprising if cutting taxes by more than $100 billion a year in a growing economy with near full employment didn’t produce at least a little bump in inflation (even if the overall bill is largely a sop to the ultra-rich).
In the 1970s, inflation teamed up with high unemployment to deliver a miserable few years for working Americans. But a little bit of inflation isn’t a disaster. It would raise wages and stimulate economic growth after years of steady but sluggish expansion. The Federal Reserve has the power to quickly raise rates to cool the economy. But perhaps it should allow just a bit of overheating. We know what a decade of sluggishness looks like. Let’s see what a little bit of inflation can do.