Category Archives: PSST and Macro

How is 2021 inflation like 1946 inflation?

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Economic advisers Cecilia Rouse, Jeffery Zhang, and Ernie Tedeschi write,

The period right after World War II potentially provides the most relevant case study, as the rapid post-war inflationary episode was caused by the elimination of price controls, supply shortages, and pent-up demand.

But in 1946 government spending was headed down. In the 1950s, the government was running large primary surpluses (tax revenues were higher than non-interest government spending). Today, it is completely different.

[UPDATE: I listened to Niall Ferguson, and near the end of the interview he says that the best historical analogy is with the 1960s, when inflation started out low and ended up at 6 percent. Then came the 1970s.]

The industrial revolution: how did workers eat?

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Davis Kedrofsky writes,

There was an Industrial Revolution, and it was slow.

The debate’s been over for two decades. The gradualists, armed with new growth accounting techniques, have won, exorcising forever the Ashtonian vision of an eighteenth-century leap into exponential growth. Where historians once thought the spinning jenny, steam engine, and factory system the immediate preconditions of England’s dramatic transformation, they now accept that these advances emerged in a trickle in a few tiny sectors.

Pointer from Tyler Cowen.

I believe that that the gradualists may have it wrong. Here is a clue, from later in Kedrofsky’s essay.

And a growing share of the population moved out of agriculture and into that increasingly-recognizable branch of manufacturing—from 33.9 percent in 1759 to 45.6 percent in 1851.

How did these manufacturing workers eat? There had to be a significant increase in agricultural productivity. But I am guessing that a lot of the increase did not take place on farms. Here is Wikipedia.

The British Agricultural Revolution, or Second Agricultural Revolution, was an unprecedented increase in agricultural production in Britain arising from increases in labour and land productivity between the mid-17th and late 19th centuries. Agricultural output grew faster than the population over the century to 1770, and thereafter productivity remained among the highest in the world. This increase in the food supply contributed to the rapid growth of population in England and Wales, from 5.5 million in 1700 to over 9 million by 1801, though domestic production gave way increasingly to food imports in the nineteenth century as the population more than tripled to over 35 million

I want to focus on the last point, about food imports. Borrowing a trope from David Friedman, I would say that British manufacturing workers were very productive at growing foodstuffs. They produced manufactured goods, put them on ships, and the ships came back with foodstuffs.

Suppose that productivity did not change in either agriculture or manufacturing between 1800 and 1850. A worker could produce a bushel of grain per day either year, and a worker could produce a bolt of cloth per day either year. But if you can trade a bolt of cloth for two bushels of grain, and you move some workers out of agriculture and into manufacturing, that worker now produces twice as much grain.

Adam Smith and David Ricardo knew more about how living standards improve than do modern productivity historians. And my guess is that the transformation that people who were alive around 1800 were seeing with their own eyes was real, today’s gradualists notwithstanding.

UPDATE: A commenter points to Anton Howes.

The push thesis implies agricultural productivity was an original cause of England’s structural transformation; the pull thesis that it was a result. The evidence, I think, is in favour of a pull — specifically one caused by the dramatic growth of London’s trade.

On the larger question, Howes is a gradualist.

The virus, public health, and science

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In an interview, epidemiology professor Vinay Prasad says,

Another great failure is that we didn’t learn a lot. We did so many different interventions, but we didn’t actually study many of them. For example, there are still questions about how much to wear masks, and under what circumstances. We don’t know much more about that than when the pandemic began.

If I had been in charge, this would have been different. You will recall that I clamored for rigorous testing very early on. He also says,

Zoom allowed a lot of upper-middle-class white-collar people the ability to work and make money and not lose their jobs, and to exclude themselves from society. That fundamentally changed the pandemic. If you went back 15 years ago, and you didn’t have Zoom, you would be facing unprecedented layoffs of wealthy, upper-middle-class people. I think a lot of businesses would have had staggered schedules and improved ventilation. Schools would have pushed to reopen. Amazon Prime and Zoom and all these things in our lives allowed a certain class of people to be spared the pains of COVID-19, taking them out of the game, and making them silent on many of the issues that affected other communities.

Speaking for Grumpy

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A commenter has several questions for John Cochrane. I will try to answer them myself.

1. I can’t take a t-bill and use it to pay for coffee at Starbucks. For that I need money. That’s true for all consumption, and consumption is the biggest part of the economy. So the money supply has to be important–there is a difference between t-bills and money.

2. Mr. Cochrane claimed (as I understand it) that inflation will happen when the public loses faith in the gov’t’s ability to pay its debts. But isn’t that likely to be deflationary?

3. Mr. Cochrane’s wonderful equation is inflation = inflation expectations + pressure. He never comments on the pressure term, but I assume that refers to things like demographics, new technology, changes in consumer sentiment, etc.,

My guess is that if you go to Starbucks, you will see most of the transactions taking place without money. Customers use credit cards. Or ApplePay. Or who knows what?

In today’s economy, it is hard to imagine that the amount of money in circulation determines spending. Instead, I think that wealth, broadly defined, determines spending. I think of private-sector wealth as anchored in reality. Stocks have to pay real dividends. The connection may be loose, but it is there. But government-printed wealth is artificial.

Government artificially creates household wealth when it spends more without raising taxes. It pays for its spending either with t-bills or money, and the private sector can count these as wealth. (You can argue that the private sector should not count these as wealth. Almost fifty years ago, when the “rational expectations” fad was sweeping the economics profession, Robert Barro wrote a famous paper arguing that people do not count government bonds as wealth.) The way I look at it, t-bills and money are both treated as wealth, so I don’t think that the difference between the two is as important as the fact that deficit spending raises perceived wealth, and higher perceived wealth raises spending and inflation.

Regarding (2), if my creditors lose confidence in my ability to repay my debts, they cut me off and my spending goes down. That is deflationary. But if the government’s creditors lose confidence in its ability to repay its debts, the government has an option that I don’t have: print more money. That will be inflationary. If instead the government adopts a “sudden stop,” meaning that it sharply cuts spending and/or raises taxes substantially, then that will indeed be deflationary.

Regarding (3), an important source of pressure is the additional private-sector wealth created by deficit spending. Too much wealth chasing too few goods, as it were.

I think that John would tell the story somewhat differently. Rather than focus on wealth perception, he would say that unsustainable deficit spending raises concern that the government will have to print money. As this concern gets built into expectations, people will take steps to protect themselves from a government default and/or a lot of inflation. Many of those precautions in fact hasten default and trigger inflation.

I don’t have a problem with John’s story. He has government deficits affecting expectations, and I have deficits affecting pressure. It could be both.

Unreal wealth

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The WSJ reports,

U.S. households added $13.5 trillion in wealth last year, according to the Federal Reserve, the biggest increase in records going back three decades.

Real wealth is the stock of tangible and intangible capital. If anything, real wealth probably went down last year, because of the pandemic. When people permanently lose jobs, they tend to lose some human capital. When firms go out of business, some of their tangible capital goes down the drain.

So if nominal wealth went up and real wealth went down, to me that means that most of the increase in wealth was artificial. It came from liabilities created by the U.S Treasury and the Fed, which show up as assets on the private sector’s balance sheet. In other words, it came from the helicopter drop. Note that the Fed’s data cover only 2020, before the Biden Administration took off in the helicopter.

I see this increase in paper wealth as very likely to cause high inflation. Suppose that you believe the Fed can and will do something to keep inflation from soaring. I am not sure what that “something” will be, but in order to work it must have the effect of making some of the paper wealth disappear.

In your comments, don’t just tell me that “we didn’t have inflation after 2008” or “the markets don’t expect inflation.” Explain to me the process by which a dramatic increase in paper wealth gets absorbed into the economy with little effect on inflation.

Noah Smith on various topics

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Talking with Eric Torenberg, Noah Smith says “The Fed will not stick to any rules that it officially adopts.” (minute 32) “The Fed will always exercise discretion.”

If I had more time, I would annotate this podcast. Instead, I will make a few other comments.

1. He claims that we don’t restrict supply in health care, and instead the problem is that prices are too high. If the government took over health insurance and drove down prices, all would be well. This is wrong, for reasons I won’t get into here. The analysis I offered in Crisis of Abundance still holds.

2. He claims that the government is not responsible for supply restrictions in higher ed. If Harvard wanted to expand one hundred-fold, it could. But that would dilute its brand. That seems right. But I would say that policy acts as if getting everyone a low-end college degree is like getting everyone into Harvard.

3. He relates productivity growth to energy technology. And a lot of the productivity boom of the 1930s was due to widespread use of oil instead of coal. To me, this seems like possible support for a PSST interpretation of the Great Depression. A lot of jobs, particularly in the agriculture sector, got destroyed by machine substitution (gasoline-powered tractors, for example). And it took a long time to reconfigure the economy to get to full employment.

4. Along these lines, he thinks that improved battery technology is revolutionary.

5. He thinks that MMTers are “meme warriors” and they are correct that the fiscal budget constraint is inflation. That is, the government can spend as much as it wants until its paper causes inflation. This is reasonable. The question is how much we want government to spend and how much we should worry about inflation. On those issues, I differ quite a bit from MMTers.

The nominal GDP indicator

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Scott Sumner writes,

In general, those who claim inflation is too high have a preference for a tighter monetary policy, and vice versa. But fast NGDP growth is a much better indicator of whether the economy is overheating.

Later in his post, Sumner writes,

We don’t need easy money or tight money; we need stable money. That’s why I didn’t believe the low inflation of 2019 was a problem and it’s also why I don’t think the high inflation of 2021 is a problem. Inflation is not a reliable policy indicator.

I gather that Scott believes we have stable money now. Even though NGDP in the first quarter grew at an 11 percent annual rate. I assume that this qualifies as “fast” by Scott’s standards, but it is just one quarter.

In the past, Scott has said that his preferred indicator is future growth in NGDP. But nobody knows what that is. We have to rely on forecasts. For example, the Congressional Budget Office has a forecast for NGDP growth over the next several years, and it looks pretty benign. But even in the short term, NGDP is notoriously difficult to forecast.

I would be the last (or maybe next-to-last) person to defend using measured inflation as a reliable indicator. But it’s not like there is a reliable indicator sitting out there like the proverbial $20 bill on the sidewalk, waiting to be picked up.

There is No Labor Shortage

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I reprint an essay I first posted almost a quarter century ago.

Although most economists would share my confidence that the market can take care of a labor shortage, there is much that we do not know. We do not know how far away the current wage rate is from the one that is consistent with no excess demand for labor. We do not know if the process of wage adjustment will be inflationary (nominal wages rising) or deflationary (prices falling relative to wages). We do not know how long the process may take.

That was in 1997. In today’s environment, I would bet that the upward adjustment of wages will take place in the context of inflation. As I write this, prices are going up faster than wages, which exacerbates the appearance of a “labor shortage.” Market forces are likely to drive wages higher, and we will see history repeated. Not like 1997. More like 1977.

Inflation is closer to 8 percent

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I show my work.

I am just looking at the CPI as reported by the government statisticians. If you rely on media reports, you are not getting the real story told by these numbers. Reporters are claiming that inflation is only 5 percent, and they add that even this number is overstated. Nothing to see here, move along.

John Cochrane agrees with my dismissal of the “base bias” story.

I am looking at the same numbers but taking a three-month average multiplied by 4, and using the core CPI. Such a calculation informs me that inflation is actually 8 percent.

Why health officials were slow to understand COVID transmission

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Zeynep Tufekci writes (NYT),

If the importance of aerosol transmission had been accepted early, we would have been told from the beginning that it was much safer outdoors, where these small particles disperse more easily, as long as you avoid close, prolonged contact with others. We would have tried to make sure indoor spaces were well ventilated, with air filtered as necessary. Instead of blanket rules on gatherings, we would have targeted conditions that can produce superspreading events: people in poorly ventilated indoor spaces, especially if engaged over time in activities that increase aerosol production, like shouting and singing. We would have started using masks more quickly, and we would have paid more attention to their fit, too. And we would have been less obsessed with cleaning surfaces.

If you were reading me back in the early days of the pandemic, you will see that I noticed, without understanding the science, that outdoors was especially safe. I was also a big skeptic of what I called “doorknob effects,” the idea that you could get the virus by touching a surface that someone else had touched.

The point is not that I know virology better than the virologists. I don’t. But I believe in drawing inference from evidence. My biggest complaint with the public health establishment, which I voiced emphatically and often, is that they would not conduct experiments to test hypotheses in a situation where there was considerable uncertainty.

In the early days of the pandemic, we were not following science. We were following bureaucrats, who put way too much emphasis on “computer models,” which anyone with a strong scientific mind could see were garbage. They refused to use evidence-based reasoning, and they never considered conducting experiments.

The problem was much deeper than just the one issue that Tufekci describes.