INFLATION, like demand itself, is always and everywhere a monetary phenomenon. Milton Friedman was right about that. But while that's a useful thing to know it's not always the answer to the question we're really asking about macroeconomic troubles. If you ask what America's main macroeconomic problem is at the moment, one correct answer is that it's suffering from a demand shortfall associated with inadequately expansionary monetary policy. But that doesn't really tell you what you need to know, which is why monetary policy is insufficiently expansionary. Is it an intellectual failure? An institutional or technical problem?

In the same way, saying the Great Inflation of the 1970s was a monetary phenomonenon is true and important but also unsatisfying to some extent. The really interesting question is why monetary policy permitted the inflation. There is surely some truth to the standard explanations. Some reckon the trouble was due to a Keynesians wandering into an intellectual cul-de-sac, in which there was always and everywhere a trade-off between inflation and unemployment. The Great Inflation was therefore a result of efforts to pump up demand and bring down unemployment even as the economy approached its resource limits. Once the inflation was in place Keynesians argued it was down to "cost push" factors like rising labour costs, such that monetary policy couldn't rein inflation in and needn't try. Others point to political dynamics, in particular a Federal Reserve chairman, in Arthur Burns, who was insufficiently independent from political pressure.

But an entertaining blog discussion has broken out that highlights the importance of other factors. Tyler Cowen posts this chart:

And he asks why high-growth countries seem to have high rates of inflation. Looking at the chart we see that low-inflation economies are developed, for the most part, while high-inflation economies fall into the emerging-market category. That dovetails nicely with what we'd expect based on the Balassa-Samuelson theory. It points out that rich countries have higher price levels than poor ones. Productivity in the tradable sector sets wage rates across the economy; wages rise with productivity, and since producers of traded goods hire workers from the national labour pool producers of non-traded goods and services must raise their wages to compete for workers. Non-traded goods and services are therefore very expensive in rich countries and cheap in poor ones. That implies that an economy experiencing rapid productivity growth in its tradable sector—because it is catching up to the rich world, say—will have a high rate of inflation relative to rich economies. Put simply, convergence of its price level with the price level in more developed countries necessitates a higher rate of inflation. That's not much help explaining what happened in America and other rich economies in the 1970s. On the contrary, the 1970s marked a significant slowdown in productivity growth across the rich world; the rate of American productivity growth from 1973-1990 was roughly half that from 1948-1973 and from 1995-2000. Indeed, one way of looking at the inflation is as a result of attempting to maintain a rate of growth in real output per person that was no longer manageable. But again the question arises: why? Karl Smith quotes Arthur Burns, who was chairman of the Fed through most of the 1970s:

Viewed in the abstract the Federal Reserve System had the power to abort the inflation in its incipient stage fifteen years ago or at any later point, and it has the power to end it today. At any time during that period, it could have restricted the money supply and created sufficient strains in financial and industrial markets to terminate inflation with little delay. It did no do so because the Federal Reserve was itself caught up in the philosophic and political currents that were transforming American life and culture.

Mr Smith reads in this a story of inflation as a manifestation of optimism:

Disinflation is an act of betrayal, because you deny the future a chance to show you how productive it could have been. When you argue that there is too much money chasing too little production and the former must be reduced, you by implication dismiss the possibility that we could produce more. If we are a high growth country today, then let us be higher growth country tomorrow. Let real production mop up excess money; and let ingenuity and grit make good on the massive extensions of credit. To borrow is to dream of a tomorrow that is better, faster and higher. To lend is to believe in that dream. Few Central Bankers can look a successful can-do economy in the face and reply: No, you cannot.

Contrast that with a view from Steve Randy Waldman:

The root cause of the high-misery-index 1970s was demographics, plain and simple. The deep capital stock of the economy — including fixed capital, organizational capital, and what Arnold Kling describes as “patterns of sustainable specialization and trade” — was simply unprepared for the firehose of new workers. The nation faced a simple choice: employ them, and accept a lower rate of production per worker, or insist on continued productivity growth and tolerate high unemployment. Wisely, I think, we prioritized employment. But there was a bottleneck on the supply-side of the economy. Employed people expect to enjoy increased consumption for their labors, and so put pressure on demand in real terms. The result was high inflation, and would have been under any scenario that absorbed the men, and the women, of the baby boom in so short a period of time. Ultimately, the 1970s were a success story, albeit an uncomfortable success story. Going Volcker in 1973 would not have worked, except with intolerable rates of unemployment and undesirable discouragement of labor force entry. By the early 1980s, the goat was mostly through the snake, so a quick reset of expectations was effective.

There are some interesting assumptions being made here about just what is causing what. Is it possible, really, that low productivity growth was a consequence of rapid labour-force growth? Once upon a time Paul Romer speculated that it might be:

One interpretation...is that there is a negative exernality associated with labor. this could arise if there is a form of innovation that economizes on labor, if investment in this kind of innovation is sensitive to movements in wages, an dif this innovation has positive external effects because of spillovers of knowledge. in this case, an increase in the rate of growth of the labor force, with the implied decrease in the rate of grwoth of wages, could case a decrease in innovation, and hence a decrease in knowledge spillovers from innovation. The net effect that an increase in labor supply has on output would then be the combination of the positive direct effect of more workers and the negative indirect effect of less innovation. The suggestion that this kind of effective could be present is not new. This kind of interaction between wages and innovation has been invoked repeatedly in the comparative analysis of productivity growth in the United States and Britain during the nineteenth and early twentieth centuries.

More recently, Daron Acemoglu has done extensive work noting that innovation responds to factor scarcity or abundance. If there's rapid growth in labour supply then one should expect lots of innovation in technologies that complement labour and very little in labour-saving innovation. Whether that should net out to a slowdown in overall productivity growth is unclear, but the story isn't something to write off out of hand.

Demographics may influence inflation in other ways, as well. In 2012 St Louis Fed president published research with Carlos Garriga and Christopher Waller, noting that younger countries tend to have higher inflation rates than older ones. The authors conclude:

Young cohorts have few assets and wages are the main source of income. Old generations work less and prefer a high rate of return from their savings. When the government has access to lump-sum taxes and transfers, redistributive policy need not resort to distortionary measures (such as capital taxes or inflation). When lump-sum transfers are not possible but the planner is allowed to use inflation or deflation to achieve as much of the redistribution as possible, there exists a competitive equilibrium with a constrained efficient redistributive policy. The equilibrium requires optimal distortions on relative prices that are necessary to achieve the constrained efficient allocation. When the old have more influence over this redistributive policy, the economy has a lower steady-state level of capital, a higher steady-state real rate of return, and a lower or negative rate of inflation. By contrast, when the young have more influence, the economy has more capital than the efficient level, wages are relatively high, and the market solution requires a low rate of return from money holdings—that is, a relatively high inflation rate.

A new IMF working paper turns up similar evidence: that monetary-policy effectiveness falls as a population ages. The author argues that this may be because net creditors respond less to changes in interest rates. It strikes me as difficult to separate cause and effect here. If net creditors prefer low inflation (and if central banks are responsive to public preferences) then older societies will have lower inflation rates generally. That, in turn, implies less inflation volatility, more nominal rigidities, greater risk of running up against the zero lower bound, and a less effective response at the zero lower bound. Causation runs in both ways, in other words, and the key takeaway is the relationship between ageing and (dis)inflation.

There is a thread running through the blog conversation to the effect that the 1970s inflation was in some sense the optimal response to economic shifts. That's probably true to a degree, though I suspect that stable inflation between 4% and 7% would probably have been just as effective. Some of the inflation, in other words, was pure expectations spiral that almost certainly did net harm to the economy.

I'm a bit taken with the idea of high inflation as the fruit of a young, optimistic economy—and of low inflation or deflation as the choice of economies in the twilight of life, excessively cautious, with an eye on the past rather than the possibilities of the future. Alternatively, inflation is a salve that helps mitigate the pain of mistakes (by making it easier to reduce the real value of debts or wages, for instance). Mistakes are the domain of the young; regrets of the old. But mistakes are a critical part of an economy's dynamism. And imposing the sobriety or asceticism of old age on younger generations has significant costs. One starts to wonder whether a society, or a monetary regime, that always advantages the economic interests of the young isn't preferable to one that simply caters to the modal generation across its life-cycle.