The likely Path of Adjustment: workers beware

John Plender of FT wrote an article in today’s FT which is worth a read.

This rather innocuously titled piece Insight: Central bankers face a perplexing paradox concludes in the following manner:

The Fed is clearly in rate cutting mode for the forseeable future. This is a boon for the banks, who can play the yield curve, deploying low cost funds in higher yielding longer term assets. But too little of the benefit of rate cuts finds its way to end borrowers. The chances are that even when the present recession is over, the US economy will be condemned to a long period of below potential growth. It will thus be difficult for the Fed to address the inflationary side of the stagflation equation.

In countries like the US and the UK which have borrowed very heavily, this problem will be exacerbated by currency devaluations. A weak currency is part of the mechanism for correcting imbalances in their economies. Yet plunging currencies can have inflationary consequences. This will most obviously be the case with food and energy. But the wider question is how far companies will be able to pass on rising input prices, which in the UK have recently been soaring at a phenomenal annual rate of more than 19 per cent. Equally interesting is whether the fear of unemployment will be enough to prevent workers everywhere demanding higher wages to cope with rising living costs.

The risk in this nightmarish time for economic policymaking is that central bankers will leave policy too loose for too long. The bond markets offer no anti-inflationary backstop. Excess savings in Asia and the petro economies have caused the euthanasia of the bond vigilantes of yesteryear. Disinflation is dead. We may soon need a new Paul Volcker.

The first concluding paragraph represents what could be called the the consensus among conservative pessimists.

The second considers the likely path of adjustment and wonders out loud if inflation can be solved on the backs of workers.

The third councils that in the case workers don’t respond appropriately to increasing rates of unemployment that it will once again be time to bring the hammer down on workers by engineering relatively high and sustained rates of unemployment. And thus disinflation of wages.
If such becomes the case I am not sure how it can be sold ideologically. I think politics are going to get more interesting not less.


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