Posted Thursday, June 21, 2012, at 10:03 AM
After I wrote about monetary policy yesterday I got a surge of commentary from hard money types, often involving the phrase "inflation doesn't create jobs, [fill in the blank]."
That's true. The problem with the Fed's strict inflation targeting strategy isn't that inflation would create jobs. It's that employment would create inflation.
Think about North Dakota. Amidst the huge nationwide recession, North Dakota has had a localized boom due to the combination of an oil discovery and an extremely low baseline population. This has led to a soaring price level in North Dakota. Lots of people have flooded into the Bakken Shale area, using up all the housing stock and causing absurd appreciation in the quality-adjusted rent. Restaurants and stores are more crowded, which has led to higher prices (to ration access) and to increases in staffing levels (to accommodate more customers at what were previously off-peak times) and the increased demand for low-skilled labor has led to wage increases. This inflation has been the consequence, rather than the cause, of North Dakota's localized boom.
But suppose we had a nationwide employment boom, what would happen then?
Well you'd see similar price spikes to what's occurred in North Dakota. Except the United States as a whole is much much larger than North Dakota, so the price spikes would have a much broader impact. Unlike little North Dakota or even a country like Sweden, the American economy is large enough that a nationwide surge in employment would have a meaningful impact on worldwide commodity prices. With rents and commodities soaring, you'd see both the core and headline CPIs go up and you'd see some localized and occupation-specific wage increases.
Except you wouldn't see any of that, because the Federal Reserve has promised to keep the inflation rate below 2 percent this year and next year.
But the only way to live up to that commitment is to ensure that business conditions are not ripe for a nationwide jobs boom. When the economy is already at full employment, adopting a strict inflation target that's incompatible with a jobs boom is fine. Inflation is annoying and a jobs boom from a full employment baseline wouldn't accomplish anything. But when unemployment is 8.2 percent, only a jobs boom will get us back to where we need to be. And strict adherence to the Fed's 2 percent inflation ceiling makes a jobs boom impossible.
So remember: Inflation doesn't create jobs. But booms create inflation. And we need a boom.