Your Friend, The Sucking Chest Wound

The Sucking Chest Wound of Economics is stagflation. This is the condition where you have high unemployment at the same time you have high inflation. Under classical economic theory, this is supposed to be impossible. When people are out of work, demand falls, creating oversupply, driving prices lower not higher. Alas, were it so.

Those of us old enough to be alive [and young enough to have been mostly sober] through the 1970's in America have memories of varying clarity of a time when we had lots of unemployment, and prices were shooting through the roof. Classical economists were standing around with this sour look on their faces. "This isn't supposed to be happening!" Monetarist economics partly arose to prominence in the 1980's because, whatever their other failings, they had an at least half-assed explanation for WTF was going on.

There are now lots of competing theories for how and why stagflation happens. The monetarists only have one of several. The Keynesians, naturally, descended into the basement, sucked on a battery for a few years, and came back with a theory that explains it. According to them, there are two kinds of inflation: demand-pull and cost-push.

• Demand-pull inflation is when demand rises and supply can't keep up, usually because of market failure and the general failure of capitalists to treat planners like human beings. It tends to come with low unemployment, rising wages, i.e. all the things that capitalists hate hate hate. The Federal Reserve usually gets excellent results in stomping on this kind of inflation by jacking interest rates up.


• Cost-push inflation is when supply falls while demand continues to grow, which tends to happen when some public resource or environmental condition everybody is taking for granted suddenly comes up in short supply, c.f. the Oil Crisis of 1973. This is the kind of inflation that usually comes with high unemployment. It doesn't respond as well to interest rate hikes, because that just puts more people out of work and spreads the economic pain deeper and wider among the peasants. In fact, the traditional remedy for stagflation is to lower rates, eat the inflation, and treat or avert recessionary pressures on the economy first— then jack up rates again to kill the inflation you caused. The treatment is to shove something otherwise foreign into the sucking hole in the chest of your patient and hope you can deal with the inevitable infection later.

I bring this to your attention now as background to the news today that the Federal Reserve has cut both the federal funds target rate and the discount rate by 50 basis points. The guidance language in the statement from the Federal Open Market Committee says, and I quote, "Today’s action is intended to help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and to promote moderate growth over time."

Bullshit, I say. They're not worried about "disruptions in financial markets" causing a recession. How does that even work, anyway? They're worried about the possibility of stagflation caused by Peak Oil and the unwinding of the Asian currency dollar carry trade. That's what I say.

Did you notice where crude oil futures closed today?