Stagflation, It’s More Than A ‘High Class Problem’

Inflation is becoming increasingly felt by consumers as prices have been rising at or near historic rates. As a result, the term stagflation is becoming part of the public discourse. Of course, former Obama administration economist, Jason Furman, took some heat for tweeting that current inflationary conditions are a “high class problem.” That has put him the crosshairs and has fueled partisanship. However, those calling him out often fail to address similar policies and understanding fostered within their party. The objective of this post is to take a closer look at stagflation and its source.

One of the issues with economic models at understanding stagflation is the ignorance of any theoretical framework. According to Milton Friedman, the need for an underlying theory is displaced by a statistical relationship. This logic has resulted in economics degrees being full of math and statistical models and no discussion of economic theory. In fact, my degree in economics didn’t require a single class in economic theories and there was never a chance at debate! That’s incredulous when you think of it.

Inflation Theories

Friedman and Edmund Phelps created a model that addressed the Federal Reserve’s impact on the natural rate of employment, economic growth, and inflation. Their model overturned the negatively sloped Phillips Curve that plotted changes in wage inflation as function of unemployment.

The Phillips Curve

In the 1960s, governments used the Phillips curve as a way to engage in expansionary demand policy. The rationale was that there would only be a small trade-off of higher prices. How wrong they were! Phelps and Friedman attempted to demonstrate that actual and expected rates of inflation had to be considered. Also, the impact on policy and holding the unemployment rate below the equilibrium rate would cause inflation to accelerate.

This “progressive” look at inflation and employment concluded that policies could only temporarily impact growth. Let’s take a closer look at their model.

Friedman & Phelps

Using the Fed’s dual mandate of inflation and employment as the source of stimulus, we begin our journey with expansionary monetary policy. The assumption is that this leads to economic growth and an increased wealth effect. The increase in “wealth” yields an increase in the demand for goods and services, which of course spurs on increased production. The increase in demand requires a higher demand for labor that lowers the unemployment rate below the “natural rate.”

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