If inflation is caused by the Fed, how do you explain it being a world-wide phenomenon? Imagine OPEC restricts the supply of oil for political reasons, as in the 70s. This supply shock raises input costs of many goods. How is the Fed needed? Your approach simply assumes a (Fed caused) solution and I don’t see how the data is consistent with it….
I see I did not do a good job explaining myself. :( I'm grateful for your comment for letting me better express my views. :) :)
A supply shock sets up a situation in which a central bank has either to inflate to let relative prices adjust or allow allow relative prices not to adjust (adjust very slowly) and see market not clear = more unemployment. Any sensible (non Bernanke!) central bank will create the inflation, and that means it can make a mistake and crate more than needed.
COVID/Putin was a world wide phenomena and central banks acted similarly.
If THAT is all that is meant by "supply disruptions/shocks caused" inflation then my disagreement is semantic about the word "cause."
But that same kind of skipping over the central bank also leads to saying that "deficits cause inflation." What deficits do is create a situation in which the central bank must chose between inflation and higher interest rates/maybe unemployment. Once upon a time it was assumed that central banks would always chose inflation so for all practical purposes it _was_ true that "deficits cause inflation;" there was no intervening decision point. But today most central banks run some variation of inflation targeting so that deficits mainly "cause" higher interest rates. In all cases it is the central bank that is _causing_ the inflation or higher interest rates or unemployment or whatever becasue the central bank moves last.
Thanks. So your retort is that multiple central banks made the same ‘error’ so inflation was worldwide…. Doesn’t seem likely. Given a supply shock what is the transmission mechanism? Fed does not print money it sets interest rates and reserve requirements. If it lowers rates, money supply MAY or may not increase depending on loan demand. Prediction sounds tricky different environments different economies. Non action means gas soaks up consumer dollars away from other items which MAY reduce employment if consumers were not saving or investing. My point is there is no way to remove psychology from economics, no way to remove uncertainty. Any statement of ‘X is responsible for y’ is an over-simplification in economics.
No all over target inflation is a "mistake." Different central banks made an at least partially correct decision to inflate when faced with shocks. Some may have inflated too much (Fed?) other too little (ECB?) and still others just right (?).
My initial read of Thomas resembled the Milton Friedman "the Fed was responsible for the Great Depression" story, and I still think the Fed's scope of action on the side of supporting the economy in a shock that pushes r* down below zero is much more limited than he seems to think it is. Standard monetary policy ends up "pushing on a string" -- raising the quantity of money simply causes cash to accumulate on balance sheets.
(That may merely be because the things they could do which would be effective are unconventional in a way that would cause conventional bankers to panic, or cause political actors to interfere. But it is nonetheless true, and I think Bernanke was muddling through the best he could. If we created universal Postal Bank checking accounts, and a UBI deposited into those accounts, and then gave the Fed the power to do helicopter drops by modifying the UBI, that would give them a tremendously powerful new fiscal policy tool that would let them stabilize during recessions.)
Nonetheless, I think he is correct that when you get shocks that push r* _up_, the question of whether this results in accelerating inflation (1), or a sharp recession (2), is within the power of the Fed. If they had perfect wisdom, they would be able to make this choice with precision.
(1) That is: the prices that "want" to be relatively-higher jump higher, while the prices that "want" to be relatively-lower stand pat.
(2) The prices that "want" to be higher stand pat, or at least continue only at the standard 2%-ish rate, while the markets for the goods whose prices "want" to be lower refuse to cut prices, and that results in oversupply until some firms go bust and tons of people end up unemployed.
In our real world, I judge that:
(a) In the wake of the COVID and Ukraine shocks, with fiscal stimulus more-than-filling the hole in Aggregate Demand, the Fed faced a choice of more inflation or more unemployment, and they chose inflation. They could've raised rates even faster and more sharply to contain inflation, but this would've neutralized fiscal policy, leaving us with mass unemployment and a slow, grinding recovery, akin to what we experienced after the Great Financial Crisis. We would've run the economy below potential output for many years, sacrificing trillions of dollars in aggregate lost income.
(b) This choice was in some utilitarian-ish sense "morally correct" -- it spread the suffering out, and reduced the total amount of suffering in the long term.
However, (c) given that they wanted to choose more inflation, they should have been more decisive about what they were doing. This was probably hindered by dissension among the board about what they're even trying to do. But in any case, they probably should have started raising rates a month or two sooner than they did, and they should've started cutting rates something like six months before they did. Even so, they clearly out-performed their peers around the world.
But more importantly, (d) it turns out that inflation is _wildly_ toxic politically. From the perspective of an incumbent political party facing an upcoming election, it is _much better_ to immiserate 10% of the population who are younger and lower-income, many of whom don't vote, than to cause inflation that affects 100% of the population in any serious way. I am worried that the next time we face a problem like this, the incumbent party (even if it's a competent / sane party, not lunatics like the MAGA GOP) will throw those at risk of unemployment under the bus. Obama, after all, was re-elected.
The reality was that by mid-2024, real wages had caught up to or passed their 2019 trend level, across most of the income distribution. But the way people _feel_ about inflation is, "I earned this raise, but inflation snatched (most of) it away! You made me poorer!" They are in some sense wrong, but it's basically impossible to persuade them of that. Hence the enormous backlash we saw globally.
As far as inflation being a worldwide phenomenon -- yes, the shocks that forced the Fed to make difficult choices _also_ forced central banks around the world to make similar difficult choices. And most of them seem to have done _worse_ on the test than the Fed did, delivering a _greater_ increase in point-years on the "misery index" (inflation + unemployment).
Almost complete agreement. I'd only say I just do not know the tradeoff the Fed faced in 2021, but it is not _my_ job to know. :)
Hence my plea in the coda of the post for anyone who has the technical skill [my PhD is 52 years old and I did not specialize in macroeconomics.] to do post mortem on the Fed's decision, something I woud hope the Fed staff is doing internally. And why not publicly as Scott Sumner advocates?
I even suspect that some of the techniques that Orszag, Albrecht, Blanchard, and even Isabel Weber have mis-applied to finding the "cause" of inflation, would be useful in judging the Fed's response to shocks.
On that note I'd love to get Scott's take on this (very interesting) question and may try to pull him in. But first I'm going to sit down with ChatGPT this evening and see if I can come up with some good thoughts together with its help.
I've never been successful in dialoging with Scott. I think I come across as hostile when it's just failure to understand his preference for NGDPLT over FAIT.
I have tried to use those tools to consolidate my multiple posts int oa coherent framework, but can't get enough text into the free bot. :)
If inflation is caused by the Fed, how do you explain it being a world-wide phenomenon? Imagine OPEC restricts the supply of oil for political reasons, as in the 70s. This supply shock raises input costs of many goods. How is the Fed needed? Your approach simply assumes a (Fed caused) solution and I don’t see how the data is consistent with it….
I see I did not do a good job explaining myself. :( I'm grateful for your comment for letting me better express my views. :) :)
A supply shock sets up a situation in which a central bank has either to inflate to let relative prices adjust or allow allow relative prices not to adjust (adjust very slowly) and see market not clear = more unemployment. Any sensible (non Bernanke!) central bank will create the inflation, and that means it can make a mistake and crate more than needed.
COVID/Putin was a world wide phenomena and central banks acted similarly.
If THAT is all that is meant by "supply disruptions/shocks caused" inflation then my disagreement is semantic about the word "cause."
But that same kind of skipping over the central bank also leads to saying that "deficits cause inflation." What deficits do is create a situation in which the central bank must chose between inflation and higher interest rates/maybe unemployment. Once upon a time it was assumed that central banks would always chose inflation so for all practical purposes it _was_ true that "deficits cause inflation;" there was no intervening decision point. But today most central banks run some variation of inflation targeting so that deficits mainly "cause" higher interest rates. In all cases it is the central bank that is _causing_ the inflation or higher interest rates or unemployment or whatever becasue the central bank moves last.
Thanks. So your retort is that multiple central banks made the same ‘error’ so inflation was worldwide…. Doesn’t seem likely. Given a supply shock what is the transmission mechanism? Fed does not print money it sets interest rates and reserve requirements. If it lowers rates, money supply MAY or may not increase depending on loan demand. Prediction sounds tricky different environments different economies. Non action means gas soaks up consumer dollars away from other items which MAY reduce employment if consumers were not saving or investing. My point is there is no way to remove psychology from economics, no way to remove uncertainty. Any statement of ‘X is responsible for y’ is an over-simplification in economics.
No all over target inflation is a "mistake." Different central banks made an at least partially correct decision to inflate when faced with shocks. Some may have inflated too much (Fed?) other too little (ECB?) and still others just right (?).
I agree about uncertainty.
My initial read of Thomas resembled the Milton Friedman "the Fed was responsible for the Great Depression" story, and I still think the Fed's scope of action on the side of supporting the economy in a shock that pushes r* down below zero is much more limited than he seems to think it is. Standard monetary policy ends up "pushing on a string" -- raising the quantity of money simply causes cash to accumulate on balance sheets.
(That may merely be because the things they could do which would be effective are unconventional in a way that would cause conventional bankers to panic, or cause political actors to interfere. But it is nonetheless true, and I think Bernanke was muddling through the best he could. If we created universal Postal Bank checking accounts, and a UBI deposited into those accounts, and then gave the Fed the power to do helicopter drops by modifying the UBI, that would give them a tremendously powerful new fiscal policy tool that would let them stabilize during recessions.)
Nonetheless, I think he is correct that when you get shocks that push r* _up_, the question of whether this results in accelerating inflation (1), or a sharp recession (2), is within the power of the Fed. If they had perfect wisdom, they would be able to make this choice with precision.
(1) That is: the prices that "want" to be relatively-higher jump higher, while the prices that "want" to be relatively-lower stand pat.
(2) The prices that "want" to be higher stand pat, or at least continue only at the standard 2%-ish rate, while the markets for the goods whose prices "want" to be lower refuse to cut prices, and that results in oversupply until some firms go bust and tons of people end up unemployed.
In our real world, I judge that:
(a) In the wake of the COVID and Ukraine shocks, with fiscal stimulus more-than-filling the hole in Aggregate Demand, the Fed faced a choice of more inflation or more unemployment, and they chose inflation. They could've raised rates even faster and more sharply to contain inflation, but this would've neutralized fiscal policy, leaving us with mass unemployment and a slow, grinding recovery, akin to what we experienced after the Great Financial Crisis. We would've run the economy below potential output for many years, sacrificing trillions of dollars in aggregate lost income.
(b) This choice was in some utilitarian-ish sense "morally correct" -- it spread the suffering out, and reduced the total amount of suffering in the long term.
However, (c) given that they wanted to choose more inflation, they should have been more decisive about what they were doing. This was probably hindered by dissension among the board about what they're even trying to do. But in any case, they probably should have started raising rates a month or two sooner than they did, and they should've started cutting rates something like six months before they did. Even so, they clearly out-performed their peers around the world.
But more importantly, (d) it turns out that inflation is _wildly_ toxic politically. From the perspective of an incumbent political party facing an upcoming election, it is _much better_ to immiserate 10% of the population who are younger and lower-income, many of whom don't vote, than to cause inflation that affects 100% of the population in any serious way. I am worried that the next time we face a problem like this, the incumbent party (even if it's a competent / sane party, not lunatics like the MAGA GOP) will throw those at risk of unemployment under the bus. Obama, after all, was re-elected.
The reality was that by mid-2024, real wages had caught up to or passed their 2019 trend level, across most of the income distribution. But the way people _feel_ about inflation is, "I earned this raise, but inflation snatched (most of) it away! You made me poorer!" They are in some sense wrong, but it's basically impossible to persuade them of that. Hence the enormous backlash we saw globally.
As far as inflation being a worldwide phenomenon -- yes, the shocks that forced the Fed to make difficult choices _also_ forced central banks around the world to make similar difficult choices. And most of them seem to have done _worse_ on the test than the Fed did, delivering a _greater_ increase in point-years on the "misery index" (inflation + unemployment).
Almost complete agreement. I'd only say I just do not know the tradeoff the Fed faced in 2021, but it is not _my_ job to know. :)
Hence my plea in the coda of the post for anyone who has the technical skill [my PhD is 52 years old and I did not specialize in macroeconomics.] to do post mortem on the Fed's decision, something I woud hope the Fed staff is doing internally. And why not publicly as Scott Sumner advocates?
I even suspect that some of the techniques that Orszag, Albrecht, Blanchard, and even Isabel Weber have mis-applied to finding the "cause" of inflation, would be useful in judging the Fed's response to shocks.
On that note I'd love to get Scott's take on this (very interesting) question and may try to pull him in. But first I'm going to sit down with ChatGPT this evening and see if I can come up with some good thoughts together with its help.
I've never been successful in dialoging with Scott. I think I come across as hostile when it's just failure to understand his preference for NGDPLT over FAIT.
I have tried to use those tools to consolidate my multiple posts int oa coherent framework, but can't get enough text into the free bot. :)
American Yale Professor Irving Fisher figured it out long ago. The math is science. The lags are constants.