One could argue that growth is the cause of inflation ...

... but there would be better things to do with your time, unless you were trying to show just how really bad a certain sort of evidence can be.

I think many bits of parody and wit get lost online.

- Michael Leddy

Like Newton inventing gravity, let us invent the notion that there is a cost associated with growth. Imagine that we can state this cost as a number and that we can work with it as others might work with, say, "Unit Labor Cost" data. We can call our number "Unit Growth Cost".

We can even model our new data series after the Unit Labor Cost series. Their source data is "total labor cost" data. Our source data should be something associated with economic growth. I think the most legitimate, well-respected data we could use is the GDP data itself.

Since we are most concerned with the cost of growth, we want to choose the variant of GDP that best expresses the cost involved. That variant would be actual (or "nominal") GDP, which measures the actual cost to purchase output.

So we have our numerator. As for the denominator, we would want to use the same valuable divisor that is used for the Unit Labor Cost calculation: inflation-adjusted (or "real") GDP.

Before we proceed, let's stop and review some of the other causes of inflation besides growth, and the evidence that has been put forth for those causes. There is of course the problem of labor, and the Unit Labor Cost evidence:

Graph #1: The GDP Deflator (red) as a Measure of Prices, and Unit Labor Cost (blue)

It is easy to see the similarity between the two lines. The red line is prices. The blue line is the labor cost measure. They are strikingly similar, unbelievably similar. So labor cost must be the source of inflation.

Unbelievably similar, and unbelievably significant. Matthew Yglesias says "my favorite indicator of inflation is 'unit labor costs'" (via SRW). Cullen Roche says "there is a very high correlation between inflation and labor costs in the USA... Higher labor costs coincide with higher wages." The Revision Guru says "Changes in unit labour costs (ulc's) are important in determining the underlying rate of inflation..."

But there is another cause of inflation, better known even than unit labor cost. It is Milton Friedman's "money relative to output" which we can show in a FRED graph:

Graph #2: The GDP Deflator (red) as a Measure of Prices, and the Quantity of Money Relative to Output

Again it is easy to see the similarity between the two lines. Friedman even points out that "there is nothing in the arithmetic that requires the two lines to be the same"

But the lines certainly are similar!

Now, to our superlative measure, the one that shows that growth is the true cause of inflation. Our measure is the blue line on Graph #3. Our calculation is actual GDP as a percent of output. The red line is prices:

Graph #3: The GDP Deflator (red) as a Measure of Prices, and GDP per unit of Output

Oh my God! This is an exact match! Friedman's graph was good, and the Unit Labor Cost graph was good, but this graph is spectacular! See how closely our blue line tracks the red "prices" line! This is unbelievable!

Perhaps we have discovered something here today.


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