Thomas Nugent coins a new term – Graham-Schumer-push inflation only after he tells us that the labor market is wonderful:
Heretofore, the gloom-and-doom crowd fixated on the slow creation of jobs during this economic cycle and on the idea that outsourcing and illegal immigration were combining to steal American jobs. But at the current unemployment rate of 4.7 percent, any argument that the economy is not creating enough jobs can only be met with laughter.
I’m sorry Thomas – but we can only meet your ignorance of the fact that the labor force participation rate and the employment-population ratio are both lower today than before Bush took office with laughter, but let’s move on:
One reason why inflation has remained low is the proliferation of low-cost imports from China. By building a dynamic manufacturing base complemented by low-cost labor, China has become a major U.S. trading partner. Since China’s growth rate is one of the fastest among industrialized economies, the Chinese government’s monetary policy has been one of price stability. To achieve this stability, the Chinese have benchmarked their currency relative to the dollar and, as such, have enjoyed strong economic growth and low inflation. This policy has also tended to keep interest rates low in the U.S., as the Chinese have invested close to $1 trillion of dollar reserves in U.S. government securities.
You see – inflation in China is low because its rate of monetary growth is so high. I’m sorry to laugh as we really need to get to your thesis:
Imagine what would happen if Graham-Schumer, or any of our elected federal officials, are successful in “retaliating” against China. If this is the case, U.S. consumers will have to absorb the price increases that would come with the importation of Chinese goods. Given our heavy imports from China, a rise in the prices of domestic goods and services would undoubtedly push the traditional measures of inflation a lot higher. Since the Fed doesn’t ask questions, and only reacts to rising prices, a pop in the inflation numbers would mean tighter money and higher interest rates. Meanwhile, if the Chinese retaliate against our retaliation, either through tariffs or quotas, then more than a few American laborers will be put out of work. Such a downward spiral in standards of living in the name of fighting inflation would not be welcome by most Americans. Key Chinese politicians are visiting the U.S. over the next few weeks in an attempt to mollify politicians and keep the yuan from a free float. Chinese resistance to these pressures may be weakening and a change in their policy may be in the offing. If not, and if a 27.5 percent tariff on Chinese imports makes it into law, economists will have the opportunity to stick a new catch phrase on inflation. Demand-push? Cost-push? Try Graham-Schumer-push.
My head is spinning. Prices of Chinese imports will rise because of the tariff. OK – that might be right. But as we consumers buy American goods instead of Chinese goods, U.S. employment will decline. HUH? And the higher unemployment will lead to more inflation? Was Nugent drunk when he wrote this?
If Mr. Nugent is hoping that the Chinese government decides to let the yuan float so as to accomplish an expenditure-switching shift in demand away from Chinese goods and towards U.S. goods, let me echo this hope. Of course, such a devaluation of the dollar would increase the price of goods purchased from China – just as a tariff would do.
OK, I’m not in favor Graham-Schumer on the microeconomic grounds that it is an inefficient way of achieving a macroeconomic end with currency realignment being a preferred means of achieving the macroeconomic end. If there are any macroeconomic differences between these two means to this end, Mr. Nugent does not present them.
IMF staff estimate that on average globalisation has reduced inflation through the channel of non-oil import prices by around ¼ percentage point a year in the advanced economies, with a larger effect of ½ percentage point a year in the US. But, as noted, these import effects are neither regular nor persistent, and so cannot be relied upon to prevent higher inflation in the period ahead. Globalisation is “no guarantee of low inflation over the next year or two”, as “robust global growth and diminishing economic slack have reduced the restraining impact of declining import prices on inflation.”
Limiting free trade does impact relative prices and may have very modest albeit temporary effects on inflation – that’s true. As is the premise that lower unemployment (not higher as Mr. Nugent suggested) would tend to offset any deflationary effects from declining import prices.