Reliving the '70's
The biggest reason to fear higher inflation is if expectations become unanchored, and that’s a serious risk – and the Fed is playing with fire when it comes to its credibility.
Capital Thinking · Issue #950 · View online
I wrote a review on Nicholas Wapshott’s book about the Samuelson/Friedman rivalry. It was a good read and timely. It feels like we are reliving many of the same policy mistakes we made in the 1970s.
We are doomed to forget the past
Allison Schraeger | Known Unknowns:
Inflations is up because of supply shocks; the Fed is insisting it will go away if we ignore it and also justifying ignoring it even if it doesn’t go away.
My latest Bloomberg column explores why we may not be doomed to repeat the 1970s. It is not because I put so much faith in policy.
There have been structural changes to the economy that make prices less likely to spiral out of control. Most of them have to do with trade and technology. We get more stuff from abroad and can observe prices across different sellers on the Internet.
Both of these factors exert deflationary pressure – or they do 98% of the time. But I also wonder if there’s a tail case where they can cause inflation to spiral upward. If trade shuts down, then we’ll have more severe shortages, since our economy has become more dependent on trade.
Online platforms can also mean a bigger population of buyers for a small amount of goods. I don’t think we’ll get into those tail cases for long. But it is worth thinking about.
The biggest reason to fear higher inflation is if expectations become unanchored, and that’s a serious risk – and the Fed is playing with fire when it comes to its credibility. Though it may not have much choice, since Powell would be replaced if he gave off the slightest whiff of a hawkish tendency.
So much for independence.
I would not be surprised if there’s more price volatility, more uncertainty, and 3% to 4% inflation in our future. Which is not a trivial increase compared with what we are used to.
Anyhow, back to Nicholas’ book. It is a great time to read about how the Philips curve broke down and economists learned that the trade-off between inflation and unemployment was actually a false choice. If you think you can exploit the Philips curve to lower unemployment, you just get stagflation.
Expectations matter – and so does appreciating the limits of monetary policy.
And make new mistakes
I have a many thoughts and feelings about the $3.5 trillion budget. I could get behind some of the expansions to our entitlement state. As I’ve argued before, it could use some revising, and many people are falling through the cracks.
But the actual substance of the bill feels like an after-thought. It is not enough to offer child-having tax refunds, housing, childcare, pre-K, community college, electric cars for the upper-middle class, tax cuts for the upper-middle class, and much more.
How you structure these benefits really matters – not only in terms of expense but also in terms of the incentives they create for work, marry, and take risks.
Allison Schrager
Photo credit: Amos Bar-Zeev on Unsplash