Perhaps I am naive, but I remain puzzled that economists, policymakers, and journalists all seem to agree that the only effective response to inflation is to reduce demand by increasing unemployment and thus intentionally impoverishing millions. While raising interest rates may be effective, shouldn't we be more concerned than we seem to be with the morality of such a policy?
If inflation increases when demand exceeds supply, then it seems to me that we have three broad alternatives: 1) we could reduce demand, using monetary policy, 2) we could increase supply, using fiscal or regulatory policy, or 3) we could do both. Given three alternatives, why do we always rely on the Fed to use monetary policy to implement Option #1 and never call on Congress to use fiscal or regulatory power to address Option #2?
I recognize that monetary policy is often faster acting than fiscal policy. But, while speed of response may be a good thing, the devastating impact of its use should be more considered. It should also be recognized that while the short-term impact of higher interest rates may be reduced demand due to increased unemployment, the long-term impact is reduced investment and thus weaker supply in the future. Thus, fighting inflation with monetary policy today seems to increase tomorrow's risk of insufficient supply, and thus new inflation.
I realize that many will argue that while fiscal and regulatory policy might be used more, we currently have a Congress which is incapable of passing the necessary legislation. We rely on the Fed because Congress is broken... While this may be true, I don't understand why it is accepted so silently. Why doesn't every news story that says that the "Fed must raise interest rates to combat inflation" also say: "Because Congress has failed to do its job."?
"There was reason in the tracks of the bond-market inflation-breakeven in early 2022 to fear that confidence in the Federal Reserve’s commitment to return inflation to 2% per year was slipping away—but the Fed than acted ... and market expectations moved back to their “the Fed has got this!” configuration."
Sorry, I forgot to say: this is a good point, and I had forgotten it. Touché and mea culpa.
Lost in all this is the point that there is no good case for a 2 per cent inflation target, rather than 4. As far as I can tell, the strongest case is a meta-argument about expectations about the Fed. "Sure, a 4 per cent target would make sense, but if we changed now, the Fed would lose credibility". That rules out raising the target when inflation is already at or above 4 per cent. And no central bank is going to set a new target above the current rate (the idea of less than 2 per cent inflation was inconceivable when NZ set this target, precisely as the lowest rate that might be sustained.
So, we are stuck with 2 per cent and the prospect of periodic returns to the ZLB until something goes catastrophically wrong.
Here's another thing that I don't grasp. People sort-of-kind-of knew that the Phillips curve wasn't steep. They were then surprised by how much inflation surged without dislodging inflation expectations. If they had truly believed that the Phillips curve wasn't so steep, shouldn't they have looked for alternative explanations? They doubled down instead on policy recommendations based on the Phillips curve's flatfish slope: a large increase in unemployment to lower inflation. In contrast, your initial observation during this episode (correct me if I'm wrong, please) -- that prices had to rise for a market economy to reallocate resources and supply to the sectors that needed them most -- was the correct one. And that reallocation required streamlining the supply of goods as well as labor. That supply-based reallocation would then help moderate goods as well as wage inflation. That's what we saw in the goods market and continue to see in the labor market, helped by productivity recently. I do not see any acknowledgement of such a supply-side response by the people on the other side of this debate. That is really sad, for it betrays a sense that they do not want to learn from what happened.
"And was it Napoleon who said he would rather have a general who was lucky than one who is skilled?"
I think it is one of those aphorisms that is variously attributed to whichever famous person suits one's fancy? Anyway, Frederick II Hohenzollern was among those to whom it is credited. The Frederick story runs like this:
One day, Frederick rewards one of his generals for a victory by giving him a medal. His best general, von Zieten, exclaims "what a pity Your Majesty is not omniscient!"
Frederick: What do you mean?
Zieten: So-and-so completely lost his head in that battle. He was only rescued by the courage and enterprise of his subordinates.
Frederick: What I need is generals who are lucky.
But according to the story, Frederick subsequently rewarded the two deserving individuals "for services previously rendered."
Larry believed that unemployment below 6 percent would lead to inflation at Xmas 1994. When I said to him that it could go to 5 or even 4 percent without causing inflation, which it did, he said “bull shit.” I can’t think of one important issue that people of his persuasion have been right about for the last 30 years.
I should have added finance with the end of regulation Q and Michael Milkins junk bonds. All these things broke the unions and the other price fixers so again the economy today there is a little resemblance to the economy of the postwar, that is the 1970s. Larry Summers does not understand this.
Sectors that Carter opened up to competition: natural gas, transportation principally trucking, but also railroads and airlines, retailing with the end of Wright, Patman, telecommunications, and manufacturing because of changes that allow Japanese cars into the market. The macro numbers don’t capture these structural changes.
What people like Larry do not seem to understand is the enormous structural changes in the economy from the 1970s into the 1990s. Carter opened up all sorts of large sectors to competition so that the experience of the oligopolistic economy of the end of the 1970smeans almost nothing. Almost nothing.
I'm still surprised how little higher interest rates have harmed the finances of weaker employers, as evidenced in fairly good earnings, credit spreads, and bankruptcies relative to pre-Covid. I think this intermediate step warrants more investigation.
Summers understands far more about economics than I ever will, but prominent economists who give pithy, sensational quotes tend to be used as political footballs.
The Phillips curve and its strange obsession with unemployment of labor (taken as a homogeneous lump) makes sense (is a parameter of a reduced form model of the economy) in a one good one factor economy subject to positive demand shocks. Summers was assuming that the Trump/Biden relief packages were larger than justified by an NPV>0 spending rule and hence were that positive demand shock. From there DeLong's reasoning about Summers' model seem to be on target.
It's not clear what Krugman's model is. He talks about inflation movements without a syllable about Fed policy instruments.
"sticking with a theory that is wrong is in some way preferable to retreating to a not-really-a-theory that might not be wrong" -- my poor little head -- the bulb flickers a bit. To old and set in my ways to sit in class, I am glad to be subsriber because of notes like today's <just sayin> ...not to mention the comments from the rest of you
Brad: "There are two ways to reconcile how the economy has followed my production-path forecast with much higher interest rates:
1. Interest-rate increases no longer have significant effects on production.
2. I was greatly underestimating how strong the American economy’s demand-side was, and thus underestimating how fast production was likely to grow had the Federal Reserve been much more moderate raising interest rates."
Point 1 is hardly believable unless there are longer-term investments occurring despite higher interest rates for reasons orthogonal to the level of the interest rates.
Doesn't Point 2 imply that wages would've grown faster than they did? If so, then it wasn't the Fed but labor supply that helped moderate wage growth? The assumption being that the Fed may be unable sway labor supply decisions.
Further, the counterfactual that inflation expectations might have reached 4% is impossible know. That 4% didn't happen. Resting the debate on that counterfactual makes the debate useless. We're talking past each other over a situation that nobody will ever know. However, isn't it equivalent to saying: I was right because what I had feared or projected (i.e. the 4%) did not occur? Most people will hear that and say, "yeah, right."
Perhaps I am naive, but I remain puzzled that economists, policymakers, and journalists all seem to agree that the only effective response to inflation is to reduce demand by increasing unemployment and thus intentionally impoverishing millions. While raising interest rates may be effective, shouldn't we be more concerned than we seem to be with the morality of such a policy?
If inflation increases when demand exceeds supply, then it seems to me that we have three broad alternatives: 1) we could reduce demand, using monetary policy, 2) we could increase supply, using fiscal or regulatory policy, or 3) we could do both. Given three alternatives, why do we always rely on the Fed to use monetary policy to implement Option #1 and never call on Congress to use fiscal or regulatory power to address Option #2?
I recognize that monetary policy is often faster acting than fiscal policy. But, while speed of response may be a good thing, the devastating impact of its use should be more considered. It should also be recognized that while the short-term impact of higher interest rates may be reduced demand due to increased unemployment, the long-term impact is reduced investment and thus weaker supply in the future. Thus, fighting inflation with monetary policy today seems to increase tomorrow's risk of insufficient supply, and thus new inflation.
I realize that many will argue that while fiscal and regulatory policy might be used more, we currently have a Congress which is incapable of passing the necessary legislation. We rely on the Fed because Congress is broken... While this may be true, I don't understand why it is accepted so silently. Why doesn't every news story that says that the "Fed must raise interest rates to combat inflation" also say: "Because Congress has failed to do its job."?
"There was reason in the tracks of the bond-market inflation-breakeven in early 2022 to fear that confidence in the Federal Reserve’s commitment to return inflation to 2% per year was slipping away—but the Fed than acted ... and market expectations moved back to their “the Fed has got this!” configuration."
Sorry, I forgot to say: this is a good point, and I had forgotten it. Touché and mea culpa.
Lost in all this is the point that there is no good case for a 2 per cent inflation target, rather than 4. As far as I can tell, the strongest case is a meta-argument about expectations about the Fed. "Sure, a 4 per cent target would make sense, but if we changed now, the Fed would lose credibility". That rules out raising the target when inflation is already at or above 4 per cent. And no central bank is going to set a new target above the current rate (the idea of less than 2 per cent inflation was inconceivable when NZ set this target, precisely as the lowest rate that might be sustained.
So, we are stuck with 2 per cent and the prospect of periodic returns to the ZLB until something goes catastrophically wrong.
Here's another thing that I don't grasp. People sort-of-kind-of knew that the Phillips curve wasn't steep. They were then surprised by how much inflation surged without dislodging inflation expectations. If they had truly believed that the Phillips curve wasn't so steep, shouldn't they have looked for alternative explanations? They doubled down instead on policy recommendations based on the Phillips curve's flatfish slope: a large increase in unemployment to lower inflation. In contrast, your initial observation during this episode (correct me if I'm wrong, please) -- that prices had to rise for a market economy to reallocate resources and supply to the sectors that needed them most -- was the correct one. And that reallocation required streamlining the supply of goods as well as labor. That supply-based reallocation would then help moderate goods as well as wage inflation. That's what we saw in the goods market and continue to see in the labor market, helped by productivity recently. I do not see any acknowledgement of such a supply-side response by the people on the other side of this debate. That is really sad, for it betrays a sense that they do not want to learn from what happened.
"And was it Napoleon who said he would rather have a general who was lucky than one who is skilled?"
I think it is one of those aphorisms that is variously attributed to whichever famous person suits one's fancy? Anyway, Frederick II Hohenzollern was among those to whom it is credited. The Frederick story runs like this:
One day, Frederick rewards one of his generals for a victory by giving him a medal. His best general, von Zieten, exclaims "what a pity Your Majesty is not omniscient!"
Frederick: What do you mean?
Zieten: So-and-so completely lost his head in that battle. He was only rescued by the courage and enterprise of his subordinates.
Frederick: What I need is generals who are lucky.
But according to the story, Frederick subsequently rewarded the two deserving individuals "for services previously rendered."
Larry believed that unemployment below 6 percent would lead to inflation at Xmas 1994. When I said to him that it could go to 5 or even 4 percent without causing inflation, which it did, he said “bull shit.” I can’t think of one important issue that people of his persuasion have been right about for the last 30 years.
I should have added finance with the end of regulation Q and Michael Milkins junk bonds. All these things broke the unions and the other price fixers so again the economy today there is a little resemblance to the economy of the postwar, that is the 1970s. Larry Summers does not understand this.
Sectors that Carter opened up to competition: natural gas, transportation principally trucking, but also railroads and airlines, retailing with the end of Wright, Patman, telecommunications, and manufacturing because of changes that allow Japanese cars into the market. The macro numbers don’t capture these structural changes.
What people like Larry do not seem to understand is the enormous structural changes in the economy from the 1970s into the 1990s. Carter opened up all sorts of large sectors to competition so that the experience of the oligopolistic economy of the end of the 1970smeans almost nothing. Almost nothing.
I'm still surprised how little higher interest rates have harmed the finances of weaker employers, as evidenced in fairly good earnings, credit spreads, and bankruptcies relative to pre-Covid. I think this intermediate step warrants more investigation.
Summers understands far more about economics than I ever will, but prominent economists who give pithy, sensational quotes tend to be used as political footballs.
The Phillips Curve is not a reasonable tool when considering an economy with shocks that are heterogeneous across sectors. [My take at: https://thomaslhutcheson.substack.com/p/the-rise-and-fall-of-the-phillips]
The Phillips curve and its strange obsession with unemployment of labor (taken as a homogeneous lump) makes sense (is a parameter of a reduced form model of the economy) in a one good one factor economy subject to positive demand shocks. Summers was assuming that the Trump/Biden relief packages were larger than justified by an NPV>0 spending rule and hence were that positive demand shock. From there DeLong's reasoning about Summers' model seem to be on target.
It's not clear what Krugman's model is. He talks about inflation movements without a syllable about Fed policy instruments.
"sticking with a theory that is wrong is in some way preferable to retreating to a not-really-a-theory that might not be wrong" -- my poor little head -- the bulb flickers a bit. To old and set in my ways to sit in class, I am glad to be subsriber because of notes like today's <just sayin> ...not to mention the comments from the rest of you
Brad: "There are two ways to reconcile how the economy has followed my production-path forecast with much higher interest rates:
1. Interest-rate increases no longer have significant effects on production.
2. I was greatly underestimating how strong the American economy’s demand-side was, and thus underestimating how fast production was likely to grow had the Federal Reserve been much more moderate raising interest rates."
Point 1 is hardly believable unless there are longer-term investments occurring despite higher interest rates for reasons orthogonal to the level of the interest rates.
Doesn't Point 2 imply that wages would've grown faster than they did? If so, then it wasn't the Fed but labor supply that helped moderate wage growth? The assumption being that the Fed may be unable sway labor supply decisions.
Further, the counterfactual that inflation expectations might have reached 4% is impossible know. That 4% didn't happen. Resting the debate on that counterfactual makes the debate useless. We're talking past each other over a situation that nobody will ever know. However, isn't it equivalent to saying: I was right because what I had feared or projected (i.e. the 4%) did not occur? Most people will hear that and say, "yeah, right."