Inflation is near a forty-year high, and unemployment is near a fifty-year low. For months, experts have debated why inflation is high and what to do about it. These questions are the topic of my opinion piece for The Economist. In a nutshell, the causes of high inflation are complex. While the fiscal policy is only one of many contributing factors, I discuss how tying relief to economic conditions, not political motives, would help us do better in the next crisis.
The Sahm rule would be great except we have a whole political party devoted to eliminating the "undeserving poor" rather than providing for their basic protection and human needs. There are also lots of new data that basic cash income is more effective than agency programs in promoting quality of life for poor families. Have you considered that in the back room the ARP was designed mainly to prevent food riots on the streets of America?
It's funny how you frame the Covid sentences without pointing out the accountability. It is specific policies in response to Covid that caused the downturn. You are stating it like all policies were automatic consequences of Covid as if there were no choices and better thought out alternatives. This avoids dealing with the policy maker's accountability.
It was clear when Delta came that the available vaccines wouldn't be able to stop the spread. This changed what is possible to achieve, and trying to do what is impossible always has a cost.
Not being able to scrutinize such mistakes of the past sets the stage for future misjudgment, without accountability.
No. Fiscal policy did not cause ANY of the inflation. The Fed knows perfectly well what federal deficits are in the pipeline when it sets the levels of it monetary policy instruments. If COVID/recession relief was "too much" (I'm not sure it was) it was becasue it was not financed with taxes.
I've been thinking about the monetary model of inflation for a bit, the two easy accounts are:
1. Demand driven by 'printing too much money'. This is Friedman's classice too much money chasing too few goods.
2. Negative supply shocks - The economy is unable to produce as much as it used too. If incomes fall, it will adjust but if the central bank tries to counter it via #1, you get inflation.
But something that has not been considered until now is a massive demand shock. What happens if people have money but just don't spend it for a while?
Consider this simple case:
Time 0: Units produced 100 = units demanded inflation 0.
Time 1: Units produced 75, units demanded 25 due to massive shutdown inflation 0 because the central bank pumps in a lot of money.
Time 2: Units produced 50, units demanded 50. Inflation 0, people are still 'shutdown' but both consumers and producers are learning to deal with this 'new normal'.
Now for the really interesting stuff. Let's say the pandemic is seen to be abating. In the long run, people expect to return to normal. 100 units produced, 100 units demanded and no inflation. But how will things return to normal? Let's say producers assume every month demand will increase 5 units, and they plan to increase production to match that:
Time 3: Units produced 55, units demanded 60. Uh oh, demand is coming back faster. In theory the economy can go up to 100 units but in the very short term you just don't flip a switch. Shelves go empty because of price stickiness.
Time 4: Units produced 65 units demanded 70. Producers, seeing they had underestimated demand increase have tried to increase their return to full production. It's hard, though, there's a lack of workers, it is hard to get parts unloaded from clogged shipping ports etc. Prices increase and now we scream about inflation.
I think what we are seeing here is that inflation is erractic in the context of a large demand shock. Returning to 'normal' is beset by difficulties on several fronts:
1. Starts and stops. We've sporadic surges in some markets (like lumber) that come and then retreat. Things like sudden port shutdowns or China closing manufacturing causes choas.
2. Demand has changed. As this has gone on for two years now, what people do has altered. We are on a 'different timeline'. For example, restaurants maybe used to have 5 waiters to serve 50 meals a night. But now the restaurant does 25 meals in house and 25 meals for delievery. But this requires 3 waiters and 4 drivers (the drivers may not work directly for the restaurant but an app but no matter). Cost of 'eating out' is now going to be higher no matter what. On the flip side demand for large office building rentals may be lower because working from home now is bigger than ever. What to do?
I suspect the 'alarming' inflation we saw that the start of the year is actually quite soft and can swing much faster than what happened in the late 70's when inflationary expectations were more hard coded into people's mindsets. On top of that inflation is necessary at this point because you need the price increases to signal to producers what they need to focus on.
Thank you Claudia. You are the most lucid economist I read. We need more of this even-handed thinking. Too many people are too quick to dismiss the impact of the ongoing supply constraints and focus on the demand story. They should get you on Bloomberg instead of their usual rotation of people all drinking the same Kool Aid.
The Sahm rule would be great except we have a whole political party devoted to eliminating the "undeserving poor" rather than providing for their basic protection and human needs. There are also lots of new data that basic cash income is more effective than agency programs in promoting quality of life for poor families. Have you considered that in the back room the ARP was designed mainly to prevent food riots on the streets of America?
It's funny how you frame the Covid sentences without pointing out the accountability. It is specific policies in response to Covid that caused the downturn. You are stating it like all policies were automatic consequences of Covid as if there were no choices and better thought out alternatives. This avoids dealing with the policy maker's accountability.
It was clear when Delta came that the available vaccines wouldn't be able to stop the spread. This changed what is possible to achieve, and trying to do what is impossible always has a cost.
Not being able to scrutinize such mistakes of the past sets the stage for future misjudgment, without accountability.
No. Fiscal policy did not cause ANY of the inflation. The Fed knows perfectly well what federal deficits are in the pipeline when it sets the levels of it monetary policy instruments. If COVID/recession relief was "too much" (I'm not sure it was) it was becasue it was not financed with taxes.
We need the Sahm rule to be law.
I've been thinking about the monetary model of inflation for a bit, the two easy accounts are:
1. Demand driven by 'printing too much money'. This is Friedman's classice too much money chasing too few goods.
2. Negative supply shocks - The economy is unable to produce as much as it used too. If incomes fall, it will adjust but if the central bank tries to counter it via #1, you get inflation.
But something that has not been considered until now is a massive demand shock. What happens if people have money but just don't spend it for a while?
Consider this simple case:
Time 0: Units produced 100 = units demanded inflation 0.
Time 1: Units produced 75, units demanded 25 due to massive shutdown inflation 0 because the central bank pumps in a lot of money.
Time 2: Units produced 50, units demanded 50. Inflation 0, people are still 'shutdown' but both consumers and producers are learning to deal with this 'new normal'.
Now for the really interesting stuff. Let's say the pandemic is seen to be abating. In the long run, people expect to return to normal. 100 units produced, 100 units demanded and no inflation. But how will things return to normal? Let's say producers assume every month demand will increase 5 units, and they plan to increase production to match that:
Time 3: Units produced 55, units demanded 60. Uh oh, demand is coming back faster. In theory the economy can go up to 100 units but in the very short term you just don't flip a switch. Shelves go empty because of price stickiness.
Time 4: Units produced 65 units demanded 70. Producers, seeing they had underestimated demand increase have tried to increase their return to full production. It's hard, though, there's a lack of workers, it is hard to get parts unloaded from clogged shipping ports etc. Prices increase and now we scream about inflation.
I think what we are seeing here is that inflation is erractic in the context of a large demand shock. Returning to 'normal' is beset by difficulties on several fronts:
1. Starts and stops. We've sporadic surges in some markets (like lumber) that come and then retreat. Things like sudden port shutdowns or China closing manufacturing causes choas.
2. Demand has changed. As this has gone on for two years now, what people do has altered. We are on a 'different timeline'. For example, restaurants maybe used to have 5 waiters to serve 50 meals a night. But now the restaurant does 25 meals in house and 25 meals for delievery. But this requires 3 waiters and 4 drivers (the drivers may not work directly for the restaurant but an app but no matter). Cost of 'eating out' is now going to be higher no matter what. On the flip side demand for large office building rentals may be lower because working from home now is bigger than ever. What to do?
I suspect the 'alarming' inflation we saw that the start of the year is actually quite soft and can swing much faster than what happened in the late 70's when inflationary expectations were more hard coded into people's mindsets. On top of that inflation is necessary at this point because you need the price increases to signal to producers what they need to focus on.
Thank you Claudia. You are the most lucid economist I read. We need more of this even-handed thinking. Too many people are too quick to dismiss the impact of the ongoing supply constraints and focus on the demand story. They should get you on Bloomberg instead of their usual rotation of people all drinking the same Kool Aid.