The Inequality Connection

In early December, I’m supposed to talk at a Columbia University conference on inequality and its consequences. One issue I’ll have to address is the ongoing question of whether rising inequality makes countries more vulnerable to financial crises, makes it harder to recover from such crises, or in some other way degrades performance.

I’ve been wary of this line of argument, in part because it appeals so much to my general leanings: Inequality worries me a lot, and it would be great if it was bad on the macroeconomics side, too. So I bend over backward not to buy into that proposition too easily.

And I continue to be skeptical, in part because there have been some pretty bad crises with lousy recoveries in countries that don’t have a lot of inequality. Consider, in particular, the post-1990 slump in Sweden, which was brought on by runaway deregulated banks and a real estate bubble (sound familiar?), and which took place in a society with very low inequality. How did that compare with the experience in the United States after 2007?

Actually, they were very close.

By comparing gross domestic product per capita in the years after the crises, and including the Luxembourg Income Study’s estimates of inequality as measured by the Gini coefficient for the relevant period, Sweden in the early 1990s had very low inequality, but nonetheless basically ran a dress rehearsal for the Great Recession and aftermath.

Just one piece of evidence. But I’m still having trouble with this one.

The Wisdom of Peter Schiff

No, seriously. Well, sort of. Mr. Schiff made a big splash in 2008-2009 by predicting runaway inflation, if not hyperinflation, in the United States; he was a favorite of Glenn Beck’s.

And in a new article on Mr. Schiff lays out the analytical issue very clearly:

“Mainstream economists (who hold sway in government, the corporate world, and academia) argued that as long as the labor market remained slack, inflation would not catch fire. My fellow Austrian economists and I loudly voiced the minority viewpoint that money printing is always inflationary – in fact, that it is the very definition of inflation.”

He continues:

“The truth is that high levels of unemployment are historically correlated with higher inflation and low levels of unemployment with lower inflation. That is because an economy that more fully utilizes labor resources is more productive. More production brings down prices. In contrast, an economy that does not fully employ its citizens is less productive, and its government is more prone to pursue misguided inflationary policies to stimulate the economy.”

O.K., leave aside the business about defining money-printing as inflation; guys, nobody cares. But what Mr. Schiff writes very clearly is that according to his worldview, rolling the printing presses should cause inflation (by the normal definition) even in a depressed economy, and that high unemployment should, in fact, make inflation higher, not lower.

He has that exactly right: The central dispute is between those who see depressions as the result of inadequate demand, implying that inflation will fall and that printing money does nothing unless it boosts employment, and those who see depressions as the result of maladaptation of resources or something – anyway, something on the supply side. The latter predict that running the printing presses will lead to runaway inflation.

How could you test those rival views?

Why, how about having a huge slump, to which central banks respond with aggressive monetary expansion?

And that is, of course, the test we’ve just run. And everywhere you look, inflation is low, verging on deflation.

So we’ve just run the Schiff test – and his brand of economics, by his own criteria, loses with flying colors. And that goes for just about all anti-Keynesian doctrines: We ran as close to a clean experiment as you’re ever going to get, and the answer is no.

Now, just about everyone on that side insists that it’s not true, that sinister bureaucrats are smuggling away the inflation evidence and burying it in Area 51.

That tells you a lot about who we’re dealing with. But at least Mr. Schiff states the issue clearly before refusing to admit error.