From Dylan Matthews at Vox: How I (and US policymakers) got inflation wrong
So I wrote a long piece last summer arguing that high inflation was unlikely in the 2020s. When fears arose last fall that rising inflation expectations — that is, people thinking inflation was going to be higher in the future — could in turn lead to more inflation now, I wrote a newsletter citing research that cast doubt on that theory. This January 1, I predicted that average US inflation for the year would be below 3 percent.
Well, in February, core inflation as measured by the personal consumption expenditures (PCE) index grew by 5.4 percent, and seems to still be heating up. That’s my preferred metric, but data released on April 12 showed that the more widely publicized consumer price index grew by 8.5 percent compared to the year before, the highest rate in four decades.
For those who are busy, here it is in a nutshell, from the article:
I unfairly dismissed the most boring, Econ 101 explanation for why inflation happens: that there was too much money sloshing around for the amount of stuff the economy was able to produce — meaning the price of that stuff went up.Report
Thanks for the summary – I always wonder how Jaybird picks his quotes and misses the meat of stuff like this.
As to the premise . . . . I’m not sure that what Econ 101 actually says.Report
Quite honestly? I don’t want to run afoul of Fair Use stuff.
Unless I can absolutely help it, I try to just put a couple of the opening paragraphs in the teaser and I trust the reader to click through and read the whole thing. I’ve posted more than that a handful of times but I generally just try to use these as a starting point saying “READ THE WHOLE ARTICLE” rather than “HERE’S THE PARAGRAPH I AM FOCUSING ON AND THEREFORE YOU MUST FOCUS ON IT TOO!”
(I debated putting a line that said “————-” in what would be the middle and putting another paragraph from the middle of the story in there but thought “nah… I should also take out that last sentence from the second quoted paragraph if I’m not going to include a few more paragraphs from the middle of the Vox story.”)
Plus there’s the whole issue of “what I think is meat, someone else might think is merely the garnish”.
“Read the whole thing” is my preferred starting point. “Here’s a teaser.”Report
Plus there’s the whole problem of “I think it’s really dishonest of him to quote the paragraph he quoted instead of the paragraph two paragraphs before that paragraph. He should have quoted the paragraph that I think is interesting instead of the one that he thought was interesting.”
So I quote something from the very beginning and ask you to read the article.
Or, hell, just skim the headline and say “Why are you arguing that inflation is bad? Seriously, this is so dishonest. Inflation is good for most debt-holders in this country and, let me point out, THAT’S EVERYBODY. Seriously, I am sick of this. I am so freaking tired of people attacking Joe Biden. HE’S JUST TRYING TO HELP! I hate Trump.”Report
I’ve got to agree with Philip; those two paragraphs weren’t much of a teaser. Beggars can’t be choosers, though, and I like the sidebar feature and have finally gotten in the habit of checking it. We’ve had a few pretty good discussions lately.Report
Hey, if you find a paragraph that you think is better, provide it!
That’s what the comments are *FOR*!Report
But bullying and complaining is what commenters are for!Report
(jaybird quotes the whole article)
“that’s TOO MUCH, jaybird, you should just SAY WHAT IT IS YOU MEAN”
(jaybird picks out an excerpt)
“well you didn’t provide the CONTEXT, jaybird, if you look at the WHOLE THING then it means JUST THE OPPOSITE”Report
not what I’ve ever said at any point.Report
Though all too often true.Report
He pointed out that while he did this, a *LOT* of other people did this too.
Additionally, there were people who were correct about inflation but there were reasons to think that they weren’t correct about it.
After he wanders through the “I may have been wrong, but I wasn’t wrong to have been wrong” part of the essay, he has a pretty decent explainer about Inflation Theory. Like, I was surprised that it was as good as it was.Report
You think he could have noted that one side got it more right than his did.Report
He gave it a paragraph:
Report
But only AFTER Trump’s stimulus had worked its magic and Biden was in office. Timing is everything I guess.Report
This is a pretty good example of what I reference below. People have stopped evaluating policy on its efficacy and instead view things almost purely in terms of political wins and losses.
I don’t think this is the best way.Report
He named prestige moderates, ignoring the conservative voices. He can make the argument that Republicans always worry about inflation, but he’d have to actually make the argument. Instead it’s -neither I nor other sophisticated liberals saw this outcome in our sophisticated models, and there are only a few sophisticated people who thought differently-.Report
I was wrong, but I was *RIGHT* to be wrong. Some other folks were right, but they were wrong to have been right.
This is a recipe for being wrong next time too.Report
Models are beliefs + logic. If the models led you astray, then you’ve got some bad code or a mistake in your beliefs. Or, and this would be the most unforgivable thing, you don’t understand the limitations of modeling.Report
A LOT of economists fail to grasp the limits of modeling. Its one of the biggest complaints against the discipline, since a lot of economic behavior is not, in fact, rational.Report
I applaud any media mea culpa, but getting inflation wrong was part of a larger story. For the past several years, centrist and left-leaning economists and wonks have been advocating for running the economy hot in the belief that a tight labor market would bring large benefits for workers. There is some sense behind tis view. A booming economy increases the demand for labor, which increases the bargaining power of workers, which should translate to higher real wages. But this story only works if inflation doesn’t come along and erode those real wage gains.
This has been a classic case of motivated reasoning. These folks waved away inflation because it got in the way of their plans for indefinitely loose monetary policy and MOAR fiscal stimulus.
I don’t really blame them for the theory, but it’s been wrong in obvious ways for some time.
Why were people still pushing for BBB in early 2022 even as it should have been obvious that we had already over-stimulated the economy? Probably because people were so focused on getting a political win that they stopped thinking critically about the soundness of the policy.Report
At the time of the first stimulus under Trump the economy was locked down or nearly so. Sustaining large segments of the business sector was a sad necessity, as they had little in reserves they could be made to tap especially in the retail and food services segments. It was good policy, albeit in a sea of bad misdirections designed to prevent the then current Administration from taking lumps over handling other parts of the crisis.
The second stimulus was probably good policy as well in as much as it passed when the US was in its uneven and politically driven reopening. Many states were still quasi closed and needed the infusion of funds; other states (like Mississippi) were fully open without having handed out much of the first stimulus package (most of the rent support funds we received STILL have not been disbursed). I’d argue it was still sound policy, but it does show the limits of what the federal government can do when states are the primary mechanism for implementation.
Much like the Infrastructure bill, BBB was all about investing in the economy long term. Its the counter weight to the 2017 Tax cuts, where Democrats are making the case that if we can hand a trillion dollars in tax benefits to the rich and corporations – who mostly banked it in one way or another – we can hand another Trillion dollars to Americans to support a whole variety of neglected investments that markets are clearly unwilling to make.Report
This is the chart you need to see to understand what’s going on. Or what was going on until the end of 2021—unfortunately GDP numbers for Q1 aren’t out yet.
What the Fed needs to do is make the blue line (actual nominal GDP) stick to the red line (GDP trend line) as much as possible. When the GDP dips too far below the trend line—or worse, actually goes down—bad things happen. There’s not enough money for everyone to pay their bills. Businesses close down. Workers get laid off. Evictions increase. And this is a vicious cycle, because every time someone can’t pay a bill, someone else’s income decreases. In short, you get a recession.
On the other hand, if nominal GDP goes too far above the trend line, you get excess inflation. Spending is going up, but the real productive capacity of the economy can’t keep up. Too much money is chasing too few goods and services.
In theory, if real GDP is keeping pace with nominal GDP, there won’t be excess inflation, but it’s tough to sustain real GDP growth in excess of 2-3% in a leading-edge economy.
Anyway, what we see in the chart is that the inflation we had up to Q3 last year was making the best of a bad situation. It was the amount of inflation needed to prevent a recession. It wasn’t until Q4 that it became clear that the Fed had overshot.
It’s not entirely clear to me what’s happening now. Is this just another supply shock from the situation in Europe, or has the Fed overshot by even more? There does seem to be some slowdown in the growth of the money supply, so that’s a good sign, but I’m not sure whether it’s enough.Report
I think the Fed undershot by not ramping up interest rates earlier. Corporations were making huge profits, only marginally passing them to labor, while drastically increasing prices to – in their own words – claw back profits they had failed to get during the initial stages of COVID. The Fed could easily have done what they just did in March – raising rates by 25 basis points – in October of last year with little downside. They are now playing catchup on this, and I don’t think the limited tools they have in monetary policy are going to make it a smooth deceleration.
That of course brings up the other elephant in the room that if all the government has to respond is fed monetary policy, we really have to ask if the less fettered market economy we have now remains such a good idea.Report
To be clear, when I said they overshot, I meant that they kept monetary policy too loose too long to prevent NGDP from overshooting the trend line, which is essentially the same thing you meant when you said they undershot.
I can’t endorse the rest of your comment, but there’s no disagreement regarding the first part.Report
Got it.Report
I’m glad the vox crowd and inflation doves are explaining why they were incorrect for slightly under a year in dismissing inflation concerns. I’m curious if the inflation hawks have ever fessed up similarly for being egregiously more wrong in the other direction for *checks calendar* around 12-13 years?Report
I have an answer!
They weren’t. It was merely unevenly distributed.
Heheh, yeah, selective inflation. That’s about the kind of excuse making I’d expect from those inflation hawks. After all their own predictions waxed and waned in perfect synchronization with who the president was.Report
That’s just not true, at least on the conservative side. inflation hawks complain about government spending all the time.Report
They complain about spending all the time, though more quietly during Republican administrations, but they shriek about inflation reliably loudly through Democratic administrations and fall mum during Republican ones. Remember the hyperinflation hyperbole in ’08? I do.Report
You’re equating Republican office-holders, conservatives, and inflation hawks, I think.Report
I’m thinking specifically about the so called economists who’re inflation hawks. You can expect partisan variation from any office holders as a matter of the job and partisanship from partisans as a matter of course. It’s the inflation hawk economists who utterly beclowned themselves on the subject of inflation from ’08 on. Inflation is here now though so they finally get to be right- stopped clocks and all that.Report
I look at the stuff above the 0 line and see inflation.
I will admit that the predictions from the inflation hawks did tend to wax and wane based on who the president was, though.
But, still, I look at that chart and see a bunch of prices going up at least 50%.
(And “new cars”? Pull the other one. I got my Saturn for ~12,000 in the early oughts. You can’t get a Yugo for that today!)Report
You know, prices for specific things can go up without it being caused by inflation right? Inflation is a measure of the general erosion of the purchasing power of the currency, not the prices in specific sectors. Housing prices, for instance, have been increasing since the ’08 crisis because of idiotic housing policy which has constrained supply of new housing, not because of inflation. Education prices have been increasing because higher ed is being absolutely devoured by a parasitic metastasizing administrative element that sucks up endless quantities of money, not because of general inflation.Report
Which line do you think should be the Zero line?
Average Hourly Earnings?Report
That would make more sense if what you care about is the impact of inflation on real people. If your income goes up as fast as prices, overall, your real buying power hasn’t changed, overall. But your particular consumption needs may vary.Report
Since I don’t think your proffered chart is particularly germane to inflation I’m going to go with “none of the above”.Report
OK, price changes aren’t germane to inflation? I’m sorry, but you’ve got to explain that. The chart isn’t perfect or up-to-date, but it’s price changes, including CPI.Report
The chart presented isn’t about inflation, it’s about how different goods have changed prices. Some of them have gone up, some of them have gone down. Perhaps a very skilled economist could crunch those numbers and draw some kind of adjusted regression line through that chart that factors out specific price changes and shows what inflation was but I’m doubtful. Suffice to say a line isn’t presently in that chart that I’d think measures inflation.
But the idea that inflation actually was crazily out of control in the 08-2020 period because a few specific items went up enormously in price (while many other items went down in price) is fishin nonsense on stilts.Report
CPI?
I mean, I’m acknowledging that inflation is hard to measure (and your “oddly enough” comment below comes off as pretty obnoxious). If we can both recognize that inflation is hard to measure but can be approximated, you’ve got to grant me that CPI is a common estimate of inflation. And it’s on the chart.Report
It’s on the chart for a basket of food and beverage prices that are lumped in with housing costs which is one of the largest and most steeply increasing price categories, independent of inflation, that you can find. Which is why I didn’t pick it.Report
Isn’t the chart you linked to below also CPI?
ETA: Oh, no, I get it, you misread Jaybird’s chart. There are three lines close together. The lowest one is labelled CPI. That’s why it says “CPI for all items”. It’s not the clearest thing, but it has its own color and icon on the right.Report
Yes I did overlook it. Even that CPI line, if I’m reading it correctly, is simply the average CPI only of the specific items included on this chart.Report
I’m pretty sure it’s the overall change in CPI.
https://fred.stlouisfed.org/graph/?g=Oib8
As of December 2018, the CPI had increased 56% since January 1998, which looks consistent with the chart Jaybird linked.
That said, the CPI is only one measure of inflation, and it’s known to have certain biases that cause it to overstate the the increase in cost of living.Report
Yes and no. Inflation is tricky to define, but a pretty good approximation is an increase in the cost of a basket of goods. Prices for individual goods can rise relative to other goods without inflation. But that’s not what the graph implies. We know people spend more money on, say, hospital care than toys. Any estimate of inflation (such as CPI) will include some weighting of goods. The graph shows an increase. That’s the weighted accumulated effects of all those lines.Report
Sure, but oddly enough economists do manage to actually measure it. So, for instance, we know that in 08-09 as the inflation hawk economists shrieked about hyperinflation we actually got deflation. Then inflation wobbled up briefly to the towering (/sarc) heights of 3% in 2011 and then crashed back down to almost deflation again in 2015 at 0.12% and then bobbled around 1-2% from then until 2020.
https://www.macrotrends.net/countries/USA/united-states/inflation-rate-cpiReport
The chart originally came from Mark Perry at the AEI, and the first edition was specifically a criticism of universities, not inflation scaremongering. He updates it every six months, and his commentary doesn’t ever suggest that inflation is a bigger problem than it is. Even the newest edition from this January is fairly calm despite the fact that inflation actually is getting out of hand.
That said, the chart has gone viral and many other people in both the left and right have offered much less moderate commentary on it.Report
Sure, I’m not rendering any opinion on the charts use for what it was made for. Merely the use it was put to in the context of this specific conversation.Report
This is how inflation always works. Due to differential increases in productivity, the prices of different goods and services change at different rates, or even in different directions, over time. On top of this, a continuous increase in the money supply results in a general upward pressure on prices and wages.
This results in what we see above: Prices going in wildly different directions with a general upward bias.
The increase in the overall CPI is an average of the increases in prices of dozens of different categories of goods and services (and thousands of specific goods and services), weighted according to how much the average consumer spends on them, as determined by the Consumer Expenditure Survey.
Yes, college tuition has nearly tripled in the past 20 years. But since college tuition is a small percentage of total consumer expenditures (about 1.5%), this has a limited impact on the overall CPI, as it should. Even medical care is only 8.5%. You can see all the weights here:
https://www.bls.gov/cpi/tables/relative-importance/2021.htm
So there are some things whose prices have increased much faster than the overall CPI, but collectively the only account for about 15% of all expenditures. Some people want to say that the rate of price increases for these things is the only thing that really matters, but that’s silly. When a bunch of stuff gets cheaper, that really does offset the impact of other stuff getting more expensive. For example, in 1970, apparel was 10.6% of the CPI basket, and in 2019 it was 2.8%. The fall in the price of clothing relative to wages has been a huge deal for poor and middle-class families, and left them more money to spend on other things.Report
Okay. Fair enough.
So where is the “zero” line?Report
Not sure what you mean. In this chart, the zero line indicates no change in quality-adjusted price between 1998 and 2018. It would also be reasonable to create a chart that uses CPI as the zero line, so that the chart shows price changes for specific goods relative to changes in the overall CPI. Or one where the zero line is average or median wages. But this chart is the first one.Report