Outgrowing Inflation II
Posted August 27, 2007on:
Rod Oram has had another crack at explaining why he thinks higher output will lead to lower inflation. His argument is, that higher output can help us reduce housing, labour, and business capacity constraints which are dogging the economy.
The first point seems to be his main one, that there are too few houses and so building more houses will reduce house prices . He has a point here, but not a strict point about inflation. House prices rising doesn’t mean inflation, it means that there has been an increase in the price of houses relative to other goods. However, house prices increases can drive inflation by making people feel wealthy, and thereby increasing their rate of general consumption. As a result, all that matters is the rate of growth (return) in house prices, which is driven by short-run demand factors (as supply takes time to adjust).
Now, growth won’t help increase house construction enough to drive house prices down, the constraints holding up house prices are structural. Councils refusing infill, the difficulty of getting consents to build property, these are the reasons that house construction activity has been sub-par. As a result, its not a matter of keeping interest rates low, it is more a matter of regulatory constraints.
His second point is that we need to increase labour skill training and capital to increase output. Yes that would increase output, however it is not current growth that drives investment, it is the expectation of future growth. As a result, the current goal of monetary policy of stabilising prices is the best way of driving efficient long-run investment (by reducing uncertainty).
The third point is that businesses need to innovate. Again this is a business decision, government policy is not trying to stifle innovation and so this doesn’t do anything to defend the idea that keeping interest rates down will reduce inflation.
Ultimately, I think in this second article he switched tack slightly, and discussed situations where we could grow, rather than attacking monetary policy as he did in the first article, which we wrote about. However, I don’t believe that he has shown that all things constant higher growth leads to lower unemployment, all he has done is changed some of the parameters (making people more productive etc).