Remember when trendy thinkers insisted that old-fashioned notions of supply, demand, prices, and deficits had been swept away? They told us that the economy could largely be shaped the way politicians wanted it to be, promising a new world of prosperity directed from above. Then came the pandemic, which provided a test case for high spending, expansion of the money supply, and statist intervention. Ouch. After all, old-fashioned economic concepts turned out to be quite relevant.
“Some years force us to question established theory and see new and unusual possibilities for the future,” writes George Mason University economics professor Tyler Cowen. “Not 2022. This is the year orthodoxy got its revenge.
Cowen is undergoing a thorough review of the year, but there were signs from the start that someone was paying attention. In February 2022 The New York Times profiled proponent of modern monetary theory, Stephanie Kelton. As reporter Jeanna Smialek noted, MMT “presupposes that if a government controls its own currency and needs money . . . it can simply print it if its economy has the capacity to churn out the necessary goods and services.” The piece was apparently planned as a celebration of Kelton. But after trillions of dollars in “stimulus” spending under two presidents, the development has drawn some notes of skepticism.
“Inflation skyrocketed to 7 percent. Government debt exploded to $30 trillion, from about $10 trillion at the start of the downturn in 2008 and $5 trillion in the mid-1990s,” Smialek noted. “Some economists blame heavy spending in the pandemic for today’s rapid price growth.”
Inflation went higher from there, and not just in the United States. Countries that have flooded the world with money have found, as often predicted, that money is buying less.
“About $16.9 trillion in fiscal measures have been announced globally to combat the pandemic, with relatively more support in advanced economies,” Ruchir Agarwal and Miles Kimball of the International Monetary Fund commented on the high inflation analysis. “The warning that large fiscal stimulus combined with loose monetary conditions will lead to high and persistent inflation came from a group known as ‘Team Persistent’… the evidence has shifted in favor of Team Persistent in several countries.”
“It wasn’t that long ago that economists insisted that demand shortfalls were permanent and that stimulus was almost never excessive,” adds Cowen. “This extreme version of the Keynesian view has been shelved, while Milton Friedman’s version of monetarism is on the rise again.”
Agarwal and Kimball also pointed to several other factors contributing to rising prices, including Russia’s invasion of Ukraine, shifts in demand among customers sent home by lockdowns and social distancing, and work disruptions. They noted that “lockdowns and mobility restrictions have led to severe disruptions in various supply chains, causing short-term supply shortages”.
After months of backed up traffic, closed factories and empty shelves, it was not a new sight.
“Market economies tend to be pretty good at getting food on supermarket shelves and fuel at petrol stations if they keep it to themselves,” British economist Philip Pilkington pointed out in 2021. “That last part is key: if they leave it to themselves to myself. Manual meddling in market economies tends to create the same pathologies we see in socialist economies, including scarcity and inflation. That was an unintended consequence of the lockdown.”
Fortunately, adds George Mason’s Cowen, “another lesson is that supply chains unravel themselves. Photos of cargo ships waiting to be unloaded were once a regular feature of my coverage. The availability of foreign goods and services was spotty and their prices could be high. During 2022 most of these queues and bottlenecks dissolved because the market could function. A very traditional approach to economics was reasserted.”
If market disenchantment has largely repaired the damage caused by government officials interfering in supply chains, traditional market responses have also helped offset some of the damage caused by other state intervention. Before the pandemic, left-wing activists pushed for an increase in the minimum wage, raising the price floor for labor. It had predictable results for employers and for entry-level and unskilled workers priced out of the market.
“New York City business owners are cutting jobs, cutting hours and raising prices as a result of the $15 minimum wage increase that was implemented late last year,” ReasonBilly Binion wrote in 2019.
But the social upheavals of the past few years have played with work habits. “Participation in the labor supply remains below pre-pandemic levels in several countries,” according to Agarwal and Kimball of the IMF. This means that labor prices have risen above the threshold set by many minimum wage laws.
“Wages have risen sharply since the pandemic, particularly for low-wage workers, for several reasons, including widespread labor shortages,” Austen Hufford told The The Wall Street Journal. “Through September, the bottom 10 percent of workers by income in every state earned an hourly wage that was, on average, one-third higher than their state’s minimum wage.”
Inflation undoubtedly plays a role as the money with which workers are paid loses value. Some states index minimum wages to inflation, but most do not, so the minimums are less relevant because the dollar amounts in which they are denominated buy less. Unfortunately, as high inflation continues, this means a race between rising wages and falling purchasing power, leaving too many people poorer.
“Consumer prices rose 7.1 percent in November from a year earlier,” adds Hufford. “After adjusting for inflation, average hourly earnings for all private sector workers fell 1.9 percent over the same period.”
The market works very well and as expected if it is allowed to work. However, it cannot immediately correct all the distortions created by large-scale interventions in the economy.
“Central planning for a fundamentally decentralized system is not possible for very long,” notes Tyler Cowen on the economic impact of China’s failed COVID Zero policy.
This is an insight that can easily be applied to all the damage caused by economic interventions in recent years. Free markets that can work can eventually heal the damage caused by government officials trying to “improve” the voluntary interactions of millions of buyers, sellers, employers, and workers. But we would all prefer that politicians spare us economic experiments.
