Inflation and Jobs: The Big Picture

Guest Author: Karl Smith is Assistant Professor of Public Economics and Government at the School of Government at The University of North Carolina at Chapel Hill. He works primarily in the areas of Public Finance and Public Revenue and Expenditure forecasting. Prior to joining the School he was a graduate fellow at the Institute for Emerging Issues, where his work was focused on state and local tax reform. Smith holds a BA and a PhD in economics from North Carolina State University.  He writes at the blog Modeled Behavior and at Seeking Alpha.  Vita.

I want to continue my assault on the idea that we need to look under every rock for the causes of our current economic tragedy. Lots of things are going on for sure. There are trade imbalance, skill mismatches, Wall Street shenanigans, and uncertainty about the future of taxes and regulation.

However, good science seeks to abstract from the messy details of reality and get right to the core story. A the end of the day what is the biggest economic driver?

This is not to say that economic particulars are not important; no more than the ideal gas law implies that hydrogen and water vapor behave the same. However, if you want to understand why your boiler exploded you are probably going to look to a modified gas law as a start.

I want to abstract from everything else and just look at whether or not employment can be jerked around by monetary policy. Can printing money at an ever faster rate lead to the creation of jobs as many economists suspect?

We know that printing money at a faster rate will eventually lead to increasing inflation. So, lets take a look at increases in the rate of inflation versus increases in the number of jobs.

The correlation is not perfect, but there seems to be a fairly strong relationship. Especially if we allow, as Milton Friedman suggests we do, for “long and variable lags” we see a strong pattern.


Here I have chosen a lag of 12 months. Remember that I am not charting inflation but the change in the rate of inflation, year-over-year. So there is a built in lag in addition to the one I am performing manually.

Also, note that it looks like the lag time between real effects and inflation might have been longer in the 60s and shorter just recently, though its seems like 12 months is right on for the 70s and 80s.

Now, here is the thing. A lot of other stuff is going on here. There is the entry of the baby boomers into the workforce, the productivity slowdown, the entry of women into the workforce, the secular decline of manufacturing, several wars, etc, etc.

None of that is being controlled for. What this chart implies is that even given all of those “big things” much of the change in the employment growth can be explained by changes in the rate of inflation. And this is without any attempt to model the “expectations” that virtually all economists, myself included, think are important.

If we restrict our attention to construction and manufacturing, I think the relationship becomes tighter though the timing more varied.


Next I want to put a moving average on price acceleration instead of a lag. If you notice price acceleration bounces around a lot more than employment growth. A moving average will give a smoother – though less responsive – picture of what’s happening.


Again, no labor unions, no tax policy, no rise of China. None of that is in here. Its inflation and jobs in the construction and housing sectors.

Now, let me show you the chart including what I consider the very likely and very dangerous “Japanese Scenario”

Here I show what would happen to price acceleration if year-over-year inflation continued to fall. I model year-over-year inflation bottoming .2% in the spring of next year then slowly rising a holding steady at .5% Note, that there is no actual deflation in this story. Its just near zero and then very low inflation.


I haven’t developed an actual forecasting model, so I can’t show you what construction and manufacturing employment growth would do over that same period. However, you can infer that such a path for inflation would imply that employment growth in manufacturing and construction will soon peak (at around zero) and then start to fall again.

This gives you a sense of what’s on the line when we think about inflation expectations. Currently they are very low and declining. Chart courtesy of David Beckworth.


This suggests a bleak future for employment regardless of what happens with stimulus, taxes, health care, unions, China, Europe, or any other non-monetary factor you can imagine.

Even if the Fed moved immediately to a target of 4% it would take many months and probably years to hit that target. In the mean time employment in construction and manufacturing will suffer. At this point that’s likely unavoidable.

The question is what actions can we take now to pull off a robust recover over a two to five year horizon. If we fail to do that, the Japanese Scenario will be upon us.

8 replies on “Inflation and Jobs: The Big Picture”

  1. Karl,

    Is sectoral breakdown other than construction and manufacturing available?
    It may turn out that the job growth charts might not be uniform across all sectors. This additional drilling down hopefully should give valuable insights into which are job growth sectors if any.

    Two additional factors might need consideration, international competition in almost all sectors and technology deflator factor. Probably the effect of these two trends would be evident on your charts in years to come?

    One trend is clear; creating jobs is definitely not going to be easy for any economy first world or a third world. And pure economic policies initiatives without, corresponding structural changes in both domestic and international trade , exchange rates adjustments, or investments in meaningful industries, are not going to increase employment. Mindless money printing or equally a mindless liquidity drought might do more harm than good.

    As they say the devil is in the details.


  2. Sanjeev,

    Sectoral breakdown is indeed available for other sectors and I can provide it.

    The point of my post, however, is how little details one actually needs to explain the movements in our two most variable sectors: manufacturing and construction.

    I don’t doubt there are other things going on. However, on net the data is telling us that those thing pale in comparison to the relationship with inflation.

    Now, in fact I think the jobs-inflation connection is mediated through monetary policy. It is not that one affects the other directly but that both are affected by interest rates.

    Lowering interest rates will increase jobs in manufacturing and construction and they will raise the rate of inflation. Raising the interest rate will decrease jobs in manufacturing and construction and will lower the rate of inflation.

    Our current problem is essentially that we cannot lower interest rates any further. However, there is a way out and that is for the Fed to produce inflation anyway and induce a reduction in real interest rates.

  3. Karl,

    “The point of my post, however, is how little details one actually needs to explain the movements in our two most variable sectors: manufacturing and construction.”

    Point well taken.

    Wondering though, that in the US context, what would be next growth sectors based on anecdotal inputs and analyzing VC investments? Manufacturing sector seem highly unlikely.

    Your methodology could probably be used to develop indicators in a “longer” term predictive sense and not merely extrapolating from past data. Also wondering if an extension of methodology can be used for developing economies.

    Just an idea!

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