The New York Times asks ten economists about the risks of “overheating.” I don’t go along with the mainstream macro paradigm, but several of the responses resonated with me, especially Olivier Blanchard’s.
I shall plead Knightian uncertainty. I have no clue as to what happens to inflation and rates, because it is in a part of the space we have not been in for a very long time. Uncertainty about multipliers, uncertainty about the Phillips curve, uncertainty about the dovishness of the Fed, uncertainty about how much of the $1.9 trillion package will turn out to be permanent, uncertainty about the size and the financing of the infrastructure plan. All I know is that any of these pieces could go wrong.
I would have answered the question this way:
1. During the pandemic, many Americans accumulated a lot of paper wealth, as the government printed paper wealth in the form of bonds and the stock market returned to a state of possibly-irrational exuberance. This wealth now hangs over an economy with some supply bottlenecks and a progressive Administration that is likely to exacerbate those bottlenecks. The only way that we avoid price increases is if the people with the wealth choose to spend it very, very gradually.
2. If spending and inflation do pick up, we are going to find that the Fed’s brake pedal does not work. The Fed can try to raise interest rates by, for example, raising the interest rate that it pays on Fedcoin (digital bank reserves). But higher rates will be politically unpalatable, because the interest bill for the government will be too much to bear.
Suppose that the Fed can get past the political objections. Then we will have an experiment to test my heterodox view that government bonds are as inflationary as money. If rates were allowed to rise, the interest bill would send the government’s deficit up. So the government will have to issue more bonds, which in my view are inflationary fuel themselves. In my view, it is up to Congress to stop inflation by cutting deficits.
It’s not that I don’t understand the conventional (monetarist) view of inflation or that I have missed some argument in its favor. So don’t waste your breath calling out my ignorance. We’ll see what happens if and when we run the experiment.
3. As to the question of “overheating,” I think of inflation in terms of phase changes. Just as water changes properties when it boils, an economy changes properties when it goes from low and steady inflation to high and variable inflation. By the time it has changed phases, it is too late to deal with it using mild measures.
Although economists won’t see overheating until it’s too late, historians of this episode will go back and see that in hindsight signs of overheating were evident by early 2021. The digital currency mania and the rally in GameStop will be seen as emblematic of the distortions caused by excessive creation of paper wealth.
Your “heterodox view that government bonds are as inflationary as money” has already been tested. In recent years the government has issued unprecedented quantities of bonds, and inflation has been very low. Irrational stubbornness?
Arnold, I love your blog and your model of PSST as opposed to the GDP factory metaphor.
Notwithstanding, when you write this:
“Although economists won’t see overheating until it’s too late, historians of this episode will go back and see that in hindsight signs of overheating were evident by early 2021.”
I think it fair to ask you to explain how today is different from 2015, when you wrote this:
“QE finances deficit spending with off-balance-sheet “paper” (bank reserves) which in theory are money but in practice are allowed to mount up in banks without acting as money–yet.”
You could argue that today’s deficits are much bigger than in 2015; but in 2015 you were suggesting those deficits were large enough to make inflation unavoidable.
I think we also need to acknowledge how quickly PSST adapted in the last year, more than I thought possible. Despite massive shocks to airline and travel industries, unemployment is way down and there are pockets of labor shortages. Give credit where credit is due: the Fed’s massive response beginning in March last year seems to have averted a major recession in the face of a large disruption of PSST.
In your defense, you do embrace Knightian uncertainty.
Please don’t hate me…I’m critical because I care, and I learn a lot from you.
Almost all the “inflation” has been in asset hyper-inflation.
Never before seen in history, so economic “science” can’t really discuss it well.
Headline UE is down, but headline UE only says ‘how many people are unemployed right now’. Almost everyone has noted that the labor force participation rate has declined by ~2 percentage points which basically means that the UE rate is 2% higher than the current number suggests. However almost no one is actually discussing the ~700,000 new weekly UE claims we are still getting. Since the beginning of August we have ~25 million new weekly UE claims which means there is a massive churn of jobs in the background of headline rates. The only other time in US history where such a thing has happened is during the Great Depression where estimates are that 75-80% of people lost their job at some point, and people who got new jobs often got temporary ones. That is a very different style of recession and headline numbers miss important aspects of that.
Both are great points, conceded and well-taken.
However, neither addresses my main point that after the post-2008 Quantitative Easing programs, Arnold (and I) warned of inevitable inflation. Which never happened.
Being wrong about post-QE inflation, I looked for other possibilities. Scott Sumner’s model seemed plausible. He was right about no post-QE inflation, right about no recession in 2013, and it appears he was right about the March 2020 aggressive Fed action.
Cool steam, and you can change it back into (liquid) water. What’s the problem? (Some of the cooling will go into effecting the change of phase. Are you treating that as “not mild”?)
On the way down private savings increased in line with public dissaving. When things get better, will the private dissavings be met with public saving? I doubt it.
This is so much the important macro issue, as Mason said (last post).
But you say:
This wealth now hangs over an economy with some supply bottlenecks
Where is your data? What supply, other than highly skilled software coders willing to work for less than $100k, is causing any “bottleneck”.
No Hyperinflation without food shortages.
The rich only spend “gradually” – but they invest the rest. In stocks & housing in nice areas and in $50k/ year K-12 prep schools for their slightly above average intelligent kids hoping that great tutors and great cash can get them into Harvard or Stanford.
I don’t believe you meant the bottleneck of buying ammo for guns, but that’s about the only bottleneck I know of that normal folk are seeing.
The only real bottleneck is STATUS. Only 10% can ever be in the top 10%, no matter what the absolute level of economic wealth is.
“Fair is foul, and foul is fair, hover through fog and filthy air.”
WS
I am entirely convinced, beyond the merest shadow of a doubt, that inflation and interest rates should have been much, much higher from 1980 to 2020 than they were.
Ergo, I see big inflation ahead.
There is a puzzle. We see from the chart below that Japan has obtained that most wonderful of all goals—no inflation—from 1997 to present. That is 33 years of almost dead-on perfect no inflation. You could make a pool table from that graph, the last 33 years (ok, a little hyperbole there, but I liked the expression).
Index of 100 on the CPI in 1997, and then 101.6 in Jan. 2021. Nirvana!
https://fred.stlouisfed.org/series/JPNCPIALLMINMEI
OK, should the question be: What has Japan done right?
How would ASK answer that question?
If the Japan policy works, should we copy the Japan policy?
Would the US be better off “fighting inflation” by eliminating property zoning?
Does the fact that Japan run state-managed trade surpluses play into the picture?
How about this. We will all get rid of single family zoning when you give us school vouchers and safe streets. Get rid of the externalities and people will stop fighting so hard to keep the one protections against them. You first.
“The case against minding your own business.”
The fact you have to care about this at all is an analytic proof that the final policy decision will be harmful. Central planning fallacy. Anyone have a list of what prices are being fixed at which amounts?
>I think of inflation in terms of phase changes. Just as water changes properties when it boils, an economy changes properties when it goes from low and steady inflation to high and variable inflation.
I agree with your theory and that we shouldn’t be complacent. My theory as to why we haven’t seen a lot of inflation *thus far* is that we have had some strong “heat sinks” in place:
1) Demographics trending older creates incentives to save instead of spend. “Excess savings” tends to push down interest rates as well.
2) The employment population ratio has been declining instead of increasing as in the late 60s thru 70s period. We don’t have a firehose of new employees we can hire who are mostly young and more willing to spend.
3) Consumption of foreign produced manufactured goods that have been declining in price.
4) Consumption of domestic services in the big two sectors (healthcare and education), IMO have begun to saturate.
However… with big supply disruptions in foreign produced goods, the producers might find some pricing power that sticks and set off inflation into a different “quantum state”. If the US government spends more money (the pacing really) than the domestic economy can absorb (infrastructure – education) that could do it. If the US government finds incentives that work to get people back to work in large numbers, that could do it. Possibly a big increase in younger immigrants that spend instead of save and sending money back home could do it.
One issue: that “wealth” appears likes to be disproportionately spent on housing…which we know is not well captured in our inflation stats. Housing provides the plausible deniability for the Fed.
But scarce observ’d the knowing and the bold,
Fall in the gen’ral massacre of gold;
Wide-wasting pest! that rages unconfin’d,
And crowds with crimes the records of mankind,
For gold his sword the hireling ruffian draws,
For gold the hireling judge distorts the laws;
Wealth heap’d on wealth, nor truth nor safety buys,
The dangers gather as the treasures rise.
– Samuel Johnson