There’s No Growth-Inflation Link, and There Never Has Been

Vinod Khosla sees AI advances automating 80% of 80% of work. Elon Musk sees robots observing work being done by humans, then performing it themselves. Imagine the staggering growth that awaits if AI in its various forms lives up to even a small fraction of its potential.

It was difficult not to think of Khosla and Musk while reading the latest “Outlook” by Wall Street Journal Fed-watcher Nick Timiraos. Timiraos reports about the economists he follows that “Doubts Arise on Growth-Inflation Link.” The problem is that economists don’t know why they should doubt what doesn’t exist (the link between growth and inflation), and since they don’t, they’ll never come to a satisfactory conclusion.

Timiraos writes in straight-faced fashion that the 4.9% GDP growth rate reported last week “is well above officials’ estimates of the long-run potential growth rate of 1.8%” that they (Fed officials) feel can’t be exceeded if inflation is to be avoided. To be clear, Fed economists believe inflation is a consequence of economic growth, and by extension slow growth is inflation’s cure. In reality, inflation is a currency phenomenon, but for the purposes of this write-up let’s imagine inflation as Fed economists do.

Up front, economies aren’t blobs or machines governed by speedometers or tachometers as economists’ “models” imagine, they’re just people. And businesses comprised of people. Timiraos writes that economists believe the economy can’t exceed 1.8% long-run growth without sparking inflation, but think about this through the prism of people. Apple
AAPL
has grown how much quarterly and annually since 2000? Did Apple power inflation? Just looking at the smartphones that are pocket supercomputers that they sell in the $1,000 range, it’s evident that Apple hasn’t brought on higher consumer prices. Quite the opposite. Would we have rising prices or “inflation” if there were lots of Apple-style corporations? No! Businesses in the real economy are rewarded for mass-producing formerly dear goods and services on the way to mass usage. Business growth is about falling prices, which means economic growth is about falling prices.

What about unemployment? Doesn’t feverish hiring bid up wages on the way to inflation? Timiraos writes that “The unemployment rate has been below Fed officials’ estimate of its long-run ‘natural’ rate of 4% for 20 months.” Except that economies are once again not machines. They’re again people, and what people produce stateside is a consequence of global economic activity. In other words, the “output gap” embraced by Fed economists ignores that when U.S. companies produce, they’re not limited to the plant, equipment, and employees to man that equipment in the United States. All production is a global endeavor. Apple’s iPhone is designed in Cupertino, but without the hands and machines of the world sharing in its production, the iPhone would be way too expensive for all but the richest of the rich.

It’s just a reminder that in the closed economy that is the world economy, unemployment rates and output gaps are utterly meaningless. Better yet, the fact that U.S. businesses can and do access man and machine from around the world is a major driver of the productivity that is relentlessly pushing prices down.

Taking this further, consider yet again the robotic and other AI advances that will automate so much human activity on the job. It’s a crucial market signal that the surest fix for capacity and labor shortages (real and perceived) is the very economic growth that Fed officials worry will cause what they call “the economy” to “overheat.” Contra the economists in the Fed’s employ, growth is what produces the resources necessary to create the robotic advances that will increasingly free humans from work they have to do in favor of new forms of work that they want to do.

Speaking of “overheating,” for fun let’s stop and imagine what Timiraos would be wise to imagine: what will meetings of Fed economists resemble if AI and robots achieve just a little bit of their suggested potential? Imagine the productivity of humans if robots who work sans break can replace humans altogether in some instances, all the while handling 80% of the work load in others. It’s just a signal that worthless as the GDP number is in the first place, 4.9% rates of GDP growth will soon enough read as wildly pedestrian. Put another way, have Fed officials stopped to imagine what the “long-run potential” is if billions and trillions or robots are added?

Will Fed officials fearing inflation say we have to put robots out of work in the way they seek to put humans out of work in order to “beat” inflation, or will they finally get serious? If serious, they’ll acknowledge what’s obvious to the mildly sentient: there’s no link between growth and inflation, and there never was.