NCPA - National Center for Policy Analysis

Does Economic Growth Lead To Inflation?

June 6, 1997

Current economic performance is leading some analysts to rethink the relationship between economic growth and inflation. For years, the common wisdom has been that higher growth rates invite inflation, but conditions today undermine that theory.
  • Long-term growth in the labor force is thought to be about 1.25 percent annually and the long-term rise in productivity is thought to be about the same, perhaps even a little lower -- yielding a "speed limit" when added together of 2 percent to 2.5 percent.
  • But the economy has grown at an average annual rate of 3.7 percent since the start of 1996 -- without a significant increase in inflation.

Some economists believe the theory may be faulty, others blame the official statistics which, they claim, are in error.

  • Last year, the work force grew by 2 percent -- well above the 1.1 percent growth in the working age population -- as the booming economy lured more and more people back to work.
  • The government recently estimated that there are at least 4.9 million people not counted in official labor force statistics who want a job -- meaning that the economy may be able to expand much faster.
  • Many economists now believe that the estimated 1 percent growth in productivity over the past few decades is significantly understated.
  • At the same time, government data routinely overstate the level of inflation by 0.3 percent to 1.5 percent, meaning that real output per worker is underestimated.

Source: Perspective, "The Speed Limit," Investor's Business Daily, June 6, 1997.

 

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