Inflation panic mongers should not declare victory


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Those who warn that current macroeconomic policies may lead to permanent increases in inflation are eager to win this week.Both the United States and the United Kingdom have released very high inflation data: the British Consumer Price Index in just one month Up 1.1%, United States CPI 0.9% Harmonized Consumer Price Index with the Eurozone 0.7% (The last two are seasonally adjusted). If this price change continues for more than a year, we will see an annualized inflation rate of more than 10%.

hint Lawrence Summers calls for “team transition” “stand up”, Martin Wolf guides the 1970s And my swamp note colleague Agree “Summer is right”The implication of these views is that the Fed should control its monetary stimulus, which is the policy conclusion comprehensively elaborated by Jason Furman in a report. Recent lectures.

These are keen critics, and they are well aware of the uncertainty of their own judgments. But in the broader and lazier public debate, one can feel a growing consensus that calling this level of inflation “temporary” has now become a bit absurd. This means that those who want macroeconomic policies to continue to stimulate the economy have made a serious mistake. Sustained demand stimulus may lead to a permanent increase in inflation or economic recession, because interest rates have to be substantially increased after it is too late.

What can I answer for the short-term team of which I am a member? The honest approach is to re-examine what we have said in the past and check whether the current rise in inflation proves us wrong. In my case, my most relevant contribution is in April 2020. I wrote We should expect inflation to rebound, which will be a good thing:

“We should not worry too much about this suppressed inflation. If production cuts subsequently catch up with sustained demand, inflationary pressures will be eliminated-and it is by maintaining nominal income that we will be able to maintain production capacity in the crisis. Indeed, we It should even be hoped that when pent-up demand is released from effective rationing, demand pressure will encourage production beyond normal capacity, because companies and people may be willing to make extra efforts to make up for lost time.

From this perspective, if the standard inflation indicator is to accelerate, we should regard it as a victory. This means that we will not let demand fall below the supply capacity of the economy; in other words, once the crisis has passed, we are maximizing the chances of a rapid recovery. Instead, we should worry about whether inflation is too low, because it means that we are letting demand fall even more than supply. “

It may be too early to announce my victory, but I certainly won’t be embarrassed by the latest inflation data. I am also not embarrassed by another related article. I pointed out in it that as of two months ago, Inflation is actually falling On both sides of the Atlantic. This is still correct-the October rise came after months of slowing inflation. I wrote at the time, “Inflation may still become unstable.” But the fact that the slowdown in inflation did not stop today’s rise should make us realize that one month’s rise does not mean that inflation will not slow down again soon.

Think it might be due to what I described in May “Ketchup bottle economy”Many obvious reasons for the current high inflation-extraordinary fiscal stimulus and bottlenecks in the manufacturing supply chain-are likely Reversing. This has not changed.

Quite the contrary; if we notice that bottlenecks and inflation occur mainly in the production of goods, rather than in the production of services, the argument for the ketchup bottle will be strengthened. (The UK is a bit different, probably because it decided to leave the EU and brought trade frictions to itself.) A new one, essay This is emphasized in the Bulletin of the Bank for International Settlements (please also read the excellent Twitter topic Written by Hyun Song Shin, head of BIS research).It states that the pandemic has changed work From service to commodity demand, and commodity production is more prone to bottlenecks and “bullwhip” effects, that is, manufacturers hoard inventory in various places in the supply chain to avoid shortages. But for the same reason, if the demand is transferred back to the service, the opposite mechanism will be activated:

“As bottlenecks and preventive hoarding are weakened, some price trends may even be reversed. In the second stage, the mechanical effect on the CPI is likely to lead to deflation.”

Look at the extent of this influence in the United States. This is the evolution of personal consumption expenditure on goods and services.

Please note two things about this chart. People have been able to maintain consumption-and the graph shows nominal consumption expenditure, Personal consumption expenditure adjusted for inflation Since the pandemic began, it has also increased by 3.5%. This in itself is a policy victory celebrated in the worst economic turmoil in a century. But secondly, the shift from consumption to commodities is huge. Since February 2020, the share of services in personal consumption expenditure has fallen from 69% to 65%. During the same period, the nominal demand for goods grew by about 22%, which was much higher than the boost provided by fiscal stimulus to the economy. all.

Therefore, it is not surprising that prices in the commodity sector have soared. By extension, inflation is largely a product of changes in the composition of demand, rather than a product of total demand. Take a look at the chart below, and if you can spot any acceleration in service prices, please write to me. The entire rise in inflation in the United States is attributable to commodity prices.

The line chart of US consumer price indices for various industries, February 2020=100, shows that service price inflation has not

So, the most important question in the inflation debate should be whether the demand pattern will shift to the service industry.There are signs that this is happening: spending on durable goods Down 8% Since April.

What about the policy? Those who warn about inflation believe that delaying monetary policy tightening would be a policy error. In the spirit of holding myself accountable, let me share a letter I wrote to a colleague who is on the other side of the inflation debate:

“As for me, I am happy to admit that I was wrong under the following circumstances: a) By the beginning of 2023, the inflation rate has continued to be higher than 5%; b) The Federal Reserve has substantially tightened its policy in 2022; c) Employment has stagnated or even declined , There is almost no sign of inflation abating.” In other words, inflation will not go away on its own, and the Fed will act too late to cause damage.

Inflation worries hope that the Fed will now avoid this situation by preemptively tightening. But let us be clear about what this means. Monetary policy reduces inflationary pressures by reducing the amount of economic activity. The hawks’ appeal amounts to suggesting that the US economy—still below the pre-pandemic trend, with millions of fewer jobs—should be less than people’s current consumption or investment (or both).

To me, this looks like a worse mistake. It ignores the possibility that ketchup bottle dynamics are very likely. It does not recognize that the reduction in consumption and investment means a reduction in economic welfare. Most importantly, people seem to turn a blind eye to the expected effect that high demand is producing to boost supply. Despite talking about shortages, people actually succeeded in consuming far more goods than pre-pandemic trends. The Bank for International Settlements pointed out that East Asia’s semiconductor exports are larger than in 2019. In short, capitalist globalization is working!

The supply is expanding because the demand is there. If manufacturers expect demand to remain strong, they will still invest in greater capacity. On the contrary, if they are taught again, once demand exceeds demand, expert decision makers will cut demand and the motivation for growth will disappear. This is a mistake we have been making for the past 30 years. When we learn that we can actually do better, it will be a tragedy if we go back to it.

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