November 16, 2016
Sebastian Mallaby use his Washington Post column to warn readers that the fiscal stimulus from a Trump administration, in the form of stimulus spending and tax cuts, could lead to too much demand in the economy. The result will be higher interest rates and higher inflation. And then things might get really bad:
“The economy would spiral back toward the stagflationary 1970s. It is too dark a prospect to believe. But the logic that takes us from here to there is chillingly straightforward.”
Woooooooo, “chillingly straightforward?”
Okay, some of us are old enough to remember the seventies and they were not exactly the horror story that Mallaby paints. Employment grew by more than 27 percent over the course of the decade. This translates into an annual growth rate of almost 2.5 percent, which would come to more than 3.2 million new jobs a year. Are you scared yet?
GDP grew at an annual rate of almost 3.2 percent. That looks pretty good compared to the 2.0 percent rate we have been seeing the last six years.
Of course, the seventies were not all great. There was a sharp slowdown in productivity growth that began in 1973. This led to stagnating wages for the rest of the decade. It is worth noting that, in contrast to later decades, the wage stagnation of the 1970s was due to weak productivity growth, not upward redistribution.
It is also worth pointing out that there were unique events that pushed inflation higher in the 1970s, most importantly the quadrupling of world oil prices in 1973–74 and then again in 1978–1979 following the Iranian revolution. Also, there was a measurement error in the consumer price index that had the effect of amplifying rises in the inflation rate at a time when wage and other contracts were widely indexed.
Anyhow, the key point here is that the horror story of the seventies, which is often told by Mallaby and others, is their own invention, not something that existed in the real world. This is important in the context of Trump’s economic proposals, since they actually could provide a considerable boost to demand and employment.
It is certainly possible that his tax cuts go too far in creating large deficits, which could mean higher interest rates and higher inflation, as Mallaby suggests. But it is absurd to claim that economic disaster, in the form of runaway inflation, is just around the corner.
There are many very good reasons to fear a Donald Trump administration, but the risk that he might over-stimulate the economy is not one of them.
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