- There's a common belief that economic growth, in any form, causes inflation.
- So it's not surprising many conclude an economic slowdown will fend off inflationary pressures.
- Both theories, while seemingly logical on the surface, are wrong—if not downright backwards.
If a theory makes sense on the surface, folks are likely to accept it without digging deeper to confirm said theory. This behavior, of course, much delights policymakers, advertisers and media outlets. One form of such behavior manifests itself in the ongoing and pervasive belief that a growing economy causes inflation and a slowing economy suppresses inflation. If this was true, and if you don't like inflation, you should hope for slower economies—but who wants that? Yet, this belief continues to be widely insinuated in media reports, if not plainly stated as fact.
Productivity Report Eases Fears About Inflation
By Staff, The Boston Globe
TIPS Show Bonds See Bubble Burst for Commodity Prices
By Sandra Hernandez, Bloomberg
Price Data Suggests Slowdown Is Cooling Inflation
By Peter S. Goodman, The New York Times
Case in point, review a quote from the above article: "Consumer prices edged up slightly in April, but far more slowly than many economists had expected, the government reported Wednesday, lending credence to the view that a slowing economy is applying the brakes to inflation."
The above statement is absolutely bass-ackwards. Economies don't create or control inflation—they simply react to it. Truly high inflation over time tends to stifle economic growth, whereas benign inflation tends to create a better environment. Keep in mind, as wise old Uncle Milton said, always and everywhere inflation is a monetary phenomenon—simply the reduction in purchasing power of a unit of currency. However, for brevity's sake, we won't belabor our detailed thoughts on inflation, as you can review our 1/17/2008 cover story, "Inflation—It's Prices, Not Price."
A quick history lesson can squash this backwards thinking. Remember the 1970s? Recall the bellbottom jeans, the feathered hair—and the outrageous inflation with sky-high interest rates?! Guess what? The 1970s also had some of the slowest economic growth rates since the Great Depression. And yet, inflation was out of control—what gives? The miserably slow economic growth of the 1970s in no way tamed runaway inflation, because inflation back then was caused largely by poor global monetary policy.
Since the early 1980s, inflation has steadily declined, nearly the entire time, to its current and historically benign levels. According to the going thesis, low inflation should mean slow growth too, right? Wrong! The US has experienced unprecedented economic growth since the end of the disco era. Yes, there have been a few recessions (1982, 1991, and 2001), but the first was on the heels of the 1970s economy, and the latter two were relatively mild and short-lived. One recession per decade isn't too bad.
Don't expect slow growth to be an inflation-killer or for strong growth to stoke inflation—there's no connection. And certainly, hoping for slower growth because of its alleged inflation-killing powers is the proverbial cutting off of one's nose.