I got into an argument on a popular tech news aggregator about this point, my comment dubbed "...one of the most inane things I've read on HN", and accused of trying to engineer unneeded problems. I guess I really stuck my foot in it, because I think even a month or two ago I think it would have been met with disregard rather than be internet mobbed.
You write:" The Volcker recessions of the early 1980s that ended the 70s inflation didn’t last as long, but the second one was deep and painful and probably left permanent scars on the Rust Belt.". There is no probably about the scars in the Rust Belt. I lived in northeast Ohio until my mid-thirties. The industrial heart of the region was crushed by the Volker Depression. The county which I grew up in, formerly a prosperous manufacturing area, is now a near ghost town with Appalachian levels of opioid addiction. Also, as Brad Delong has pointed out, the long run consequence was the destruction of communities of engineering practice. That is very damaging to the long run performance of the US economy. I agree that inflation is currently too high. However, it doesn't seem to me to be a "hair on fire" emergency.
That Keynes quote was a strange place to start: as you mention, we don't have hyperinflation right now. But the risks to progressive popularity are real and present. Caring about how prices impact public opinion seems very different from caring about how they impact relationships between debtors and creditors. The latter would have us focus on median PCEPI perhaps. The former would have us focus on the most salient prices that are least elastic to demand. Folks don't know their real wage, but they do know when salient prices of stuff that's important to them goes up. Relevant study that looks at both food and gas prices:
"gas prices did exert an independent effect on presidential approval above and
Also, it seems like a jump to just assume that the Fed raising rates will increase real wages for most folks in the short term. Sure it will lower inflation, but it does that by lowering wage growth-I'm not sure which effect will win out. And that lower wage growth will hurt Democrats electorally.
I'm not sure what would lead you to think that the pain of a recession is "a problem that goes away relatively quickly". Perhaps the recession itself ends quickly (we would hope!), but from past recessions, I would expect the labor market damage to last for around a decade (I'm just looking at prime-age EPOP here). Since we're nowhere near hyperinflation, and inflation expectations aren't far off from where they should be, it seems clear that the Fed rapidly increasing rates would cause long-term pain in exchange for some short-term gain. That's not always a bad tradeoff, of course. But what makes you think the reduction to inflation will be large within the next 2 years? Just looking for a model to quantify this stuff.
To a scientist using monetary policy to control inflation and unemployment seems irrational. The Fed funds rate is not directly coupled to either one and can only work with a long lag. If a skilled experimental scientist was asked to write a control program for the economy they would measure some form of the inflation rate and make continuous marginal changes in government spending and taxes. You would never design a system where you were making changes in something as indirect as the Fed funds rate.
I basically agree that the Fed should do a rate hike that surprises people on the upside, like doing a 0.5% hike instead of 0.25%. But 2% seems excessive.
And I think you're still under-rating the arguments that inflationary pressure is already reduced (because fiscal policy has swung into contraction), and the fact that you can't have a wage-price spiral without rising wages. Runaway inflation in the '70s was driven by the fact that wages chased prices upwards, thanks to COLA agreements (mainly driven by unions). Without COLAs, an inflationary surge lowers real wages, and that will erode aggregate demand.
Again, I think you're right that Team Transitory was insufficiently alarmed, and the Fed should nudge things a little faster. But yes, recessions are worse than inflation. The post 2010 slow recovery lost _millions_ of person-years of production that we'll never get back, and permanently harmed the life trajectories of millions of young people whose careers failed to launch.
To the extent that you have to choose between fiscal policy that overshoots a GDP consistent with the NAIRU by $X billion, or undershoots by $X billion, you _100%_ should choose to overshoot and then clean it up later. I'm not sure what the right ratio is where overshooting by $cX billion is worse than undershooting by $X billion, but I'd guess something like 2-3.
While I am broadly in agreement with this post, one thing is missing, imho, though.
How does inflation get entrenched in the economy at a high but not hyperinflation level for several years?
IIRC, inflation in the 70s stayed high because of the wage price spiral. It seems hard to argue we're seeing one now as wages consistently stay below inflation. Is it nonetheless enough to feed price hikes cycles? IDK. Right now, it seems high prices are starting to generate demand destruction by themselves.
I am not saying we do nothing; Personally, I prefer fiscal austerity/tax hikes but I understand that's less politically plausible and palatable to most to people. So FED hikes it is. But a few 50bps hikes do seem the most reasonable way to go forward if high prices and lack of disposable income are already curtailing demand...
I see one remarkable flaw in this analysis, which is that the response to unemployment is managed by the states, whereas the response to inflation is managed by the Fed. Consequently, the effects of unemployment are more uneven.
I don't have a solution, other than to make unemployment benefits something that's managed at the federal level (fold it into Social Security?), but that's likely a non-starter in free current political environment.
Reich came up on my timeline with a different view. He seems to think inflation is caused by price gouging which is the Whitehouse view. The solution he gives includes a tax on the oil company profits. But such a tax doesn't change the oil price or inflation.
That link for the Keyne’s quote from the series The Commanding Heights reminded me that I wrote to Paul Krugman about the show when it was first released, and he graciously replied! (This was pre-Twitter, and before his popularity and notoriety exploded) I no longer have the email, but he remarked that he was baffled that Hayek would be placed on equal footing to Keynes. That’s certainly stuck with me since, so I’m looking forward to reading Brad DeLong’s book to see why Hayek would be a reliable navigator of political economy.
I got into an argument on a popular tech news aggregator about this point, my comment dubbed "...one of the most inane things I've read on HN", and accused of trying to engineer unneeded problems. I guess I really stuck my foot in it, because I think even a month or two ago I think it would have been met with disregard rather than be internet mobbed.
You write:" The Volcker recessions of the early 1980s that ended the 70s inflation didn’t last as long, but the second one was deep and painful and probably left permanent scars on the Rust Belt.". There is no probably about the scars in the Rust Belt. I lived in northeast Ohio until my mid-thirties. The industrial heart of the region was crushed by the Volker Depression. The county which I grew up in, formerly a prosperous manufacturing area, is now a near ghost town with Appalachian levels of opioid addiction. Also, as Brad Delong has pointed out, the long run consequence was the destruction of communities of engineering practice. That is very damaging to the long run performance of the US economy. I agree that inflation is currently too high. However, it doesn't seem to me to be a "hair on fire" emergency.
Really excellent writing: very clear and easy to understand yet still insightful.
That Keynes quote was a strange place to start: as you mention, we don't have hyperinflation right now. But the risks to progressive popularity are real and present. Caring about how prices impact public opinion seems very different from caring about how they impact relationships between debtors and creditors. The latter would have us focus on median PCEPI perhaps. The former would have us focus on the most salient prices that are least elastic to demand. Folks don't know their real wage, but they do know when salient prices of stuff that's important to them goes up. Relevant study that looks at both food and gas prices:
"gas prices did exert an independent effect on presidential approval above and
beyond traditional economic measures"
https://pprg.stanford.edu/wp-content/uploads/Presidential-Approval-and-Gas-Prices.pdf
Also, it seems like a jump to just assume that the Fed raising rates will increase real wages for most folks in the short term. Sure it will lower inflation, but it does that by lowering wage growth-I'm not sure which effect will win out. And that lower wage growth will hurt Democrats electorally.
I'm not sure what would lead you to think that the pain of a recession is "a problem that goes away relatively quickly". Perhaps the recession itself ends quickly (we would hope!), but from past recessions, I would expect the labor market damage to last for around a decade (I'm just looking at prime-age EPOP here). Since we're nowhere near hyperinflation, and inflation expectations aren't far off from where they should be, it seems clear that the Fed rapidly increasing rates would cause long-term pain in exchange for some short-term gain. That's not always a bad tradeoff, of course. But what makes you think the reduction to inflation will be large within the next 2 years? Just looking for a model to quantify this stuff.
To a scientist using monetary policy to control inflation and unemployment seems irrational. The Fed funds rate is not directly coupled to either one and can only work with a long lag. If a skilled experimental scientist was asked to write a control program for the economy they would measure some form of the inflation rate and make continuous marginal changes in government spending and taxes. You would never design a system where you were making changes in something as indirect as the Fed funds rate.
I basically agree that the Fed should do a rate hike that surprises people on the upside, like doing a 0.5% hike instead of 0.25%. But 2% seems excessive.
And I think you're still under-rating the arguments that inflationary pressure is already reduced (because fiscal policy has swung into contraction), and the fact that you can't have a wage-price spiral without rising wages. Runaway inflation in the '70s was driven by the fact that wages chased prices upwards, thanks to COLA agreements (mainly driven by unions). Without COLAs, an inflationary surge lowers real wages, and that will erode aggregate demand.
Again, I think you're right that Team Transitory was insufficiently alarmed, and the Fed should nudge things a little faster. But yes, recessions are worse than inflation. The post 2010 slow recovery lost _millions_ of person-years of production that we'll never get back, and permanently harmed the life trajectories of millions of young people whose careers failed to launch.
To the extent that you have to choose between fiscal policy that overshoots a GDP consistent with the NAIRU by $X billion, or undershoots by $X billion, you _100%_ should choose to overshoot and then clean it up later. I'm not sure what the right ratio is where overshooting by $cX billion is worse than undershooting by $X billion, but I'd guess something like 2-3.
While I am broadly in agreement with this post, one thing is missing, imho, though.
How does inflation get entrenched in the economy at a high but not hyperinflation level for several years?
IIRC, inflation in the 70s stayed high because of the wage price spiral. It seems hard to argue we're seeing one now as wages consistently stay below inflation. Is it nonetheless enough to feed price hikes cycles? IDK. Right now, it seems high prices are starting to generate demand destruction by themselves.
I am not saying we do nothing; Personally, I prefer fiscal austerity/tax hikes but I understand that's less politically plausible and palatable to most to people. So FED hikes it is. But a few 50bps hikes do seem the most reasonable way to go forward if high prices and lack of disposable income are already curtailing demand...
I see one remarkable flaw in this analysis, which is that the response to unemployment is managed by the states, whereas the response to inflation is managed by the Fed. Consequently, the effects of unemployment are more uneven.
I don't have a solution, other than to make unemployment benefits something that's managed at the federal level (fold it into Social Security?), but that's likely a non-starter in free current political environment.
https://www.theguardian.com/commentisfree/2022/jun/16/is-the-us-heading-for-a-recession-heres-what-you-need-to-know?utm_source=facebook&utm_medium=news_tab
Reich came up on my timeline with a different view. He seems to think inflation is caused by price gouging which is the Whitehouse view. The solution he gives includes a tax on the oil company profits. But such a tax doesn't change the oil price or inflation.
That link for the Keyne’s quote from the series The Commanding Heights reminded me that I wrote to Paul Krugman about the show when it was first released, and he graciously replied! (This was pre-Twitter, and before his popularity and notoriety exploded) I no longer have the email, but he remarked that he was baffled that Hayek would be placed on equal footing to Keynes. That’s certainly stuck with me since, so I’m looking forward to reading Brad DeLong’s book to see why Hayek would be a reliable navigator of political economy.