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Olivier throws it down: the Fed does not decide what is inflation is, we do
Macroeconomics is waking up and not a moment too soon. Olivier Blanchard, a prominent macroeconomist, has started an important conversation about the power dynamics behind inflations and solutions.
Today’s post is my explanation and critical evaluation of a Twitter discussion that Olivier Blanchard began last week. These are my views and are expressed in my style. As he once noted, “We have different styles.” Yup. Any errors here are mine, not his.
The first rule of Macro Fight Club is to talk about Macro Fight Club.
Source: Fight Club, the movie, not NBER Summer Institute.
Here are Olivier’s eight points:
A point often lost in inflation and central bank policy discussions. Inflation is fundamentally the outcome of the distributional conflict between firms, workers, [my addition: consumers, shareholders,] and taxpayers. It stops only when the various players are forced to accept the outcome. [Translation: Power is key, and different groups fight for it. Note: I fixed some grammar in his points.]
The source of the conflict may be too hot an economy: In the labor market, workers may be in a stronger position to bargain for higher wages given prices. But, in the goods market, firms may also be in a stronger position to increase prices given wages. And, on it goes. [An economy firing on all cylinders is often good for workers; shareholders too.]
The source of the conflict may be too high prices of commodities, such as energy. Firms want to increase prices, given wages, to reflect the higher cost of intermediate inputs. Workers want to resist the decrease in the real wage and ask for higher wages. And on it goes. [High food and energy prices unleash some of the hardest battles. This point foreshadows a later one about the limits of the Fed.]
The state can play various roles. Fiscal policy can slow down the economy and eliminate the overheating. It can subsidize energy costs, limiting the real wage decrease and the pressure on nominal wages. [Translation: the White House and Congress have a role in fighting inflation. It is not all on the Fed.]
It can finance the subsidies by increasing taxes on some current taxpayers, say exceptional profit taxes, or through deficits and eventual taxes on future taxpayers (who have little say in the process... [my addition: or stronger anti-trust.] [Translation: Governments—elected officials accountable to taxpayers—have special powers to fight inflation. The commodity shortages due to the war in Ukraine are a textbook example of when exceptional profit taxes are good policy.]
But, in the end, forcing the players to accept the outcome and thus stabilizing inflation is typically left to the central bank. By slowing down the economy, it can force firms to accept lower prices given wages and workers to accept lower wages given prices. [Translation/commentary: Outrageously, we leave fighting inflation to the Fed alone. An unelected, unaccountable group decides who wins and loses. Seriously??]
It is a highly inefficient way to deal with distributional conflicts. One can/should dream of a negotiation between workers, firms, [consumers, shareholders,] and the state, in which the outcome is achieved without triggering inflation and requiring a painful slowdown. [Translation: the Fed is not the best.]
But, unfortunately, this requires more trust than can be hoped for and does not happen. Still, this way of thinking about inflation shows what the problem is and how to think of the least painful solution. [Translation/commentary: Throw in the towel, but know why it stinks.]
When a Granddaddy of Macro throws it down, others in Fight Club join in. Here are some reactions [See more below, as well as quote tweets of and replies to his thread.]:
We do not have a blob of inflation.
I was blown away when I saw the discussion. [I am lurking silently on Twitter with a very small locked account.] I feel heard. Repeatedly in interviews, I have said, “we do not have a blob of inflation.” The price tags reflect billions of decisions of businesses that, in turn, reflect many more billions of context. It’s complex.
Next time you hear the breathless commentary on the latest monthly Consumer Price Index, remember it is one way to take the economy's temperature, but it masks why it went up or down. CPI is a starting, not a stopping point.
We must dig deeper. Good economic policy now, whether from the Federal Reserve, Congress, or the White House, hinges on our ability to discern the current causes. It’s a moving target that we must dedicate ourselves to figuring it out.
Throw away the useless simplistic tools.
The first step to solving a problem is admitting you have one. Olivier was screaming in a chill Olivier way that the current conversation about inflation among macroeconomists is falling woefully short.
He brought nuance and spurred a thoughtful discussion. That’s a huge step forward from the tools thrown around by the men who play thoughtful macroeconomists on TV. One tool that angers me is the Phillips Curve. It buries the sources of inflation. It is simplistic and falsified and paints workers as the enemy now; they are not.
The costs of the Fed going it alone to bring down inflation is not only “inefficient,” as Olivier argues, but pointlessly, downright cruel. Me months ago:
Blue sky thinking.
My most significant disagreement with Olivier is his hopelessness. Cheer up, hon.
The Fed is not the only game in town. The government has stepped up. Gasoline prices are down below the invasion of Ukraine. That’s not the Fed. The White House opened up the Strategic Petroleum Reserve and wrote contracts with oil producers to guarantee a minimum price to refill the reserve. Congress enacted the Inflation Reduction Act, with our first climate change policy, which will help protect us from future energy price spikes in the global fossil fuel markets. Much more’s possible.
Good ideas are out there. Isabella Weber, an economics professor at the University of Massachusetts Amherst and the architect of the current German energy price relief, added importantly to Olivier’s thread:
It’s not hopeless; it’s hard work.
New Keynesian macroeconomists must open their minds and welcome others. That’s starting [slowly]. Other schools of thought, from the Real Business Cycle to Post-Keynesian to Political Economy [strange bedfellows], have argued that inflation is more than aggregate demand and more than the Fed can fix alone.
Now is not the time to fight; it’s the time to work together.
Keep going. Let’s put creative policy ideas on the table. No, it won’t likely be fast enough for this time. For better or worse, the Fed is on it. Even so. supply-driven crises will come again. We must be ready and do what we can to avoid that next time.
Ángel Ubide sums it up well:
This thread shows how excessive inflation is, conceptually, a multidimensional phenomenon, and thus its resolution requires action at all policy levels to achieve the solution that optimally distributes the losses. Mon[etary] policy is rarely enough. Happy 2023!
Olivier started an urgent conversation about the roots of inflation. It won’t be easy, and we will need new tools. In the famous words of Larry Summers:
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