A real cost-reduction agenda for the New Year

Take on fights you wouldn't normally bother with

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There’s very real reason for economic optimism in the coming year, with leading forecasts now calling for stable inflation and falling interest rates. If that holds up, we should see the stock market setting record highs, which ought to improve the “vibes” in the country. And there’s every reason to believe wages will rise faster than prices.

That said, from a policy point of view, it’s always good to try to do better. And even though inflation has fallen quite a lot from its high point, the inflationary episode has clearly left scars on the body politic, which would like to hear from politicians about their plans to address the cost of living. I think it’s widely understood, in economic circles at least, that if officials did what it takes to engineer a period of general deflation, the cure would be worse than the disease. But it does matter at the margin exactly how high the overall rate of increase is.

More broadly, even though the mass public understanding of inflation isn’t very sophisticated, the large-scale interest in the subject tracks a real change in the economy, a change that has not been undone by inflation coming down and which politicians haven’t caught up to yet.

Over the course of my pre-pandemic adult life, the American economy had various ups and downs, but it was all in the context of what was essentially a prolonged labor market slump. At no point during the entire 2001-2020 period did spiking inflation or interest rates seem like a proximate problem, but high unemployment (or a low labor force to population ratio) was quite frequently a problem. Under these circumstances, plans for “job creation” were frequently debated in politics, as were worries that a particular policy proposal would “kill jobs.”

The American Rescue Plan shifted us out of that paradigm and into a new one that we are still living with.

In this new paradigm, it’s not that inflation will be a problem forever, or that interest rates will always be high, but these will almost certainly be sources of concern for the foreseeable future. Inflation might go up, which would force interest rates up to contain it and hurt the investment side of the economy. Conversely, rather than worrying about creating jobs, we should be worrying about creating efficiencies. If productivity rises and we can “do more with less,” that will release new workers into the labor market who can fill vacancies and allow interest rates to fall, boosting the investment side of the economy.

Or to put it another way, in a world where we’re not going to boost growth by mobilizing unemployed workers (we don’t have that many of them), we need to boost growth by boosting productivity. And that requires a different kind of policy agenda.