BIG IDEA | ‘Once again, massive fiscal spending in the United States has invited warnings of inflation and triggered dark memories of the 1970s. But these fears are based on a model that has since been obliterated by economic realities – not least the rise of China, which has fundamentally reshaped the US and global economies.’

I once asked my friend and classmate, now a Fed president, why inflation, against the economic theory I had learned in school, hadn’t gone up in the past few decades.

• Among the reasons he cited: low-cost goods from China, big-box retailers beating up suppliers on price (suppliers either trim margins to keep price low or are replaced), and consumers’ ability to easily shop for the lowest prices online (whether you buy online or take the info to the cheapest brick & mortar store).

I don’t recall if he cited the additional reasons given in James Galbraith’s essay ‘China Is Missing from the Great Inflation Debate.' He probably did, but it was more than I could take in all at once.

• Either way, China is prominent in both their analyses.

‘Once again, massive fiscal spending in the United States has invited warnings of inflation and triggered dark memories of the 1970s.’

• ‘But these fears are based on a model that has since been obliterated by economic realities – not least the rise of China, which has fundamentally reshaped the US and global economies.’

‘Paul Samuelson, who with fellow future-Nobel laureate Robert Solow launched the Phillips curve in 1960.’

• ‘The Phillips curve postulated an inverse relationship between inflation and unemployment: as one fell, the other would rise.’

‘Reality obliterated the Phillips curve.’

• ‘From the early 1980s – and unmistakably from the mid-1990s onward – no inflation could be found, and lower unemployment did not tend to bring it on.’
• ‘The relationship is not vertical or downward-sloping, but flat, which is to say it doesn’t exist – if it ever did.’

‘What happened?’

• ‘The answer can almost, if not quite, be summed up in a single word: China.’

‘From the early 1980s, the US dollar began to rise, crushing America’s Midwest industrial base and trade unions.’

• ‘The ensuing collapse of world commodity prices – and the Soviet Union with them – set the stage for China to emerge as the world’s leading purveyor of manufactured consumer goods’.
• ‘Meanwhile, the forces that drove up US consumer prices after 1970 – including dollar devaluations, oil-price spikes, and cost-of-living adjustments for manufacturing workers (which were passed along in the form of higher prices) – all disappeared.’

‘Since full employment had never been the culprit, the full employment of the late 1990s and in the run-up to the COVID-19 pandemic did not bring back inflation.’

• ‘Moreover, there is no longer a tendency for oil-price fluctuations to feed through to wages and other prices, because American jobs now are mainly in services, where the price of labor is the price you pay.’

Bottom line: ‘The mainstream neo-Keynesian macroeconomics of the 1960s is not a useful guide for understanding a US economy that has become fully enmeshed with the rest of the world and fundamentally reshaped by China’s rise.