One of the first things that confused me when I started to pay serious attention to the financial press was the unseemly way the stock market often responded to reports of falling unemployment by tanking. It always felt like a gut punch from capitalism: The better the news for workers, the worse Wall Street felt. A lower unemployment rate seemed to get investors nervous. Huh? Isn't an economy that's providing jobs for workers a good thing?
Not necessarily, especially from the perspective of people who have lots of money in the bank and are terrified that inflation will eat away at their savings. As I eventually came to understand it, the theory went like this. A tight labor market -- by which is meant, an economy with low unemployment -- gives workers more leverage. They can demand raises or quit their jobs and look for better ones or join in a union action and bring corporate overlords to their knees.
But then employers, in order to cover increasing labor costs, raise prices. And then here comes inflation!
Economists have a name for the relationship between employment and inflation: They call it the Phillips Curve. Today, courtesy of a link from Bred Setser's blog to a conversation between Paul McCulley, a managing director at the money management firm PIMCO, and his pet rabbit (yes, you read that correctly), I learned an interesting thing about the Phillips Curve: Because of globalization, the curve is getting flatter.
Flatter is another way of saying weaker, which is another way of saying that the inverse connection between employment and inflation is not as strong as it once was. The reason: Competition from all those Chinese and Indian and Eastern European workers means that even when unemployment drops in the U.S., worker leverage does not increase: "U.S. labor's pricing power is diminished by competition from an augmented global labor supply."
At first glance, this looks like just more bad news for the American worker. It's an easy-to-understand explanation for why the relatively low unemployment figures of the last few years have not led to the wage gains that workers would normally expect. But there is a slender silver lining.
Since the 1970s, the Federal Reserve has considered its No. 1 job to be the prevention of inflation. Its main tool for doing this is to raise interest rates when the economy starts getting too hot. This usually results in a lot of workers' losing their jobs. Well, what if an "overheating" economy doesn't automatically lead to runaway inflation? What if the Phillips Curve is broken? Doesn't that mean that the Fed should stop plunging the economy into a recession or "soft landing" every time it looks like inflation might be stirring?
The implications for government policy go beyond just the setting of interest rates. Consider the debate about the minimum wage. Business lobbyists say: Don't raise the minimum wage because then employers will raise the prices of their goods and that will spark inflation. Well, maybe not. Maybe instead, raising the minimum wage would go some small way toward giving American workers a larger piece of the pie, without setting off that dreaded inflation chain reaction. The larger point is simple: Inflation may no longer be enemy No. 1. As a new candidate for that position, why don't we try, just for fun, the failure of American workers to share in the benefits of global trade? OK, that's a little unwieldy. How about this one: Enemy No. 1 = rising inequality.
True enough, inflation has been growing in recent months, giving birth to much consternation. But the obvious explanation for that is rising energy prices. Encouraging conservation, energy efficiency, and the development of alternative sources of energy seems, in this corner, to be a more sensible (not to mention moral) approach to dealing with that problem than maintaining the old standby of engineering a recession.