By John H. Cochrane
STANFORD, Calif. ( Project Syndicate )—Surging inflation, skyrocketing energy prices, production bottlenecks, shortages, plumbers who won’t return your calls—economic orthodoxy has just run smack into a wall of reality called “supply.”
Demand matters too, of course. If people wanted to buy half as much as they do, today’s bottlenecks and shortages would not be happening. But the Federal Reserve and Treasury have printed trillions of new dollars and sent checks to just about every American. Inflation should not have been terribly hard to foresee; and yet it has caught the Fed completely by surprise.
The Fed’s excuse is that the supply shocks are transient symptoms of pent-up demand. But the Fed’s job is—or at least should be—to calibrate how much supply the economy can offer, and then adjust demand to that level and no more. Being surprised by a supply issue is like the Army being surprised by an invasion.
Economic beliefs must change
The current crunch should change ideas. Renewed respect may come to the real-business-cycle school, which focuses precisely on supply constraints and warns against death by a thousand cuts from supply inefficiencies. Arthur Laffer, whose eponymous curve announced that lower marginal tax rates stimulate growth, ought to be chuckling at the record-breaking revenues that corporate taxes are bringing in this year.
Equally, one hopes that we will hear no more from Modern Monetary Theory, whose proponents advocate that the government print money and send it to people. They proclaimed that inflation would not follow, because, as Stephanie Kelton puts it in , “there is always slack” in our economy. It is hard to ask for a clearer test.
But the U.S. shouldn’t be in a supply crunch. Real (inflation-adjusted) per capita gross domestic product just barely passed its pre-pandemic level this last quarter, and overall employment is still 5 million below its previous peak. Why is the supply capacity of the economy so low? Evidently, there is a lot of sand in the gears. Consequently, the economic-policy task has been upended—or, rather, reoriented to where it should have been all along: focused on reducing supply-side inefficiencies.
One underlying problem today is the intersection of labor shortages and Americans who are not even looking for jobs. Although there are more than 10 million listed job openings—3 million more than the pre-pandemic peak—only 6 million people are looking for work. All told, the number of people working or looking for work has fallen by 3 million, from a steady 63% of the working-age population to just 61.6%.
We know two things about human behavior: First, if people have more money, they work less. Lottery winners tend to quit their jobs. Second, if the rewards of working are greater, people work more.
Our current policies offer a double whammy: more money, but much of it will be taken away if one works. Last summer, it became clear to everyone that people receiving more benefits while unemployed than they would earn from working would not return to the labor market. That problem remains with us and is getting worse.
Remember when commentators warned a few years ago that we would need to send basic-income checks to truck drivers whose jobs would soon be eliminated by artificial intelligence? Well, we started sending people checks, and now we are surprised to find that there is a truck-driver shortage.
Practically every policy on the current agenda compounds this disincentive, adding to the supply constraints. Consider child care as one tiny example among thousands. Child-care costs have been proclaimed the latest “ crisis ,” and the “ Build Back Better ” bill proposes a new open-ended entitlement. Yes, entitlement: “every family who applies for assistance…shall be offered child care assistance” no matter the cost.
The bill explodes costs and disincentives. It stipulates that child care workers must be paid at least as much as elementary school teachers ($63,930), rather than the current average ($25,510). Providers must be licensed. Families pay a fixed and rising fraction of family income. If families earn more money, benefits are reduced. If a couple marries, they pay a higher rate, based on combined income. With payments proclaimed as a fraction of income and the government picking up the rest, either prices will explode or price controls must swiftly follow.