Liberals, including me, got inflation wrong

Author: Tejretics

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#1
Tejretics
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I’m socially progressive, and lean center-left on economic policy. In fact, I’m with Biden on most U.S. policy issues (despite what I view to be the massive failure in Afghanistan). 

I supported the American Rescue Plan, despite warnings from folks like Larry Summers, Olivier Blanchard, and Jason Furman that it might be inflationary:
  • I thought the plan was mostly relief—rather than leading to an unprecedented spike in nominal spending, it would probably just be used to pay off debt and supplement savings. 
  • I thought it was pretty plausible the output gap (the gap between how much the economy could produce and how much it was actually producing -- if the gap is big, closing the gap wouldn’t cause inflation to increase) was being underestimated. After all, high inflation was pretty much unprecedented post-2008; it seemed like some combination of a global savings glut and a productivity slowdown meant consumers weren’t spending as much, while economists consistently underestimated how much more employment the economy could take without causing much inflation. I didn’t trust traditional economic models as much. 
  • Even if it was stimulus, I suspected that monetary policy would successfully partially offset its effect on an output gap, without too much hassle or major rate hikes. 
  • I thought some of Blanchard’s predictions, like <2% unemployment to accompany the high inflation, just seemed pretty intuitively implausible. This turns out to be a problem with traditional models in general: the U.S. has >3% unemployment, but still has pretty high core inflation. 
In three of these four areas (#1, #2, and #3), I was dead wrong. So were many other liberals and progressives -- we vastly overestimated the economy’s ability to take money, as well as how expansionary the Fed was gonna continue being. It was a tough psychological shift for me. I was pretty frustrated in ~2017-18 with the apparent unwillingness of U.S. policymakers to push really hard for full employment; I attributed some of Trump’s victory, and the frustration of blue-collar workers, to insufficient willingness to spend in the economy (rather than more structural issues, like trade policy) -- and I continue to believe this. I thought, and continue to think, that the Fed being expansionary in 2019 averted a small recession, and the Fed’s response to COVID in 2020 was fantastic (as was the first relief bill, which caused poverty to decline in 2020). So now, on seeing high inflation -- which, more and more, wasn’t seeming like a transitory thing, nor a response to merely supply chain issues or gas prices -- I had to reckon with the downsides of deficit spending. 

This is a real potential cost of the Democrats moving further left. Even though, on some margins, I welcome it (e.g., taking clean energy investments and R&D seriously, wanting more immigration, pushing for anti-poverty measures, and, relative to -- say -- 2015-16, a more pro-worker monetary policy), it’s undeniable that it’s time for the Fed to tighten (and the warnings of progressives like Elizabeth Warren against this terrify me) and for the U.S. deficit to reduce (as someone who hasn’t been particularly worried about deficits before). Moderate Democrats, by reigning in inflation, could be electorally stronger in an entirely different way now. 


#2
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@Tejretics
I would suggest that inflation is fuelled by global events.

And rather than viewing  it as a case of a right or wrong expectation........Current  inflation was in fact, unpredictable.
#3
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Printing 30 trillion dollars of worthless dollars and flooding the fiat currency system with it will have no effect on inflation in the country that does it. OK. Thanks for clearing that up. For awhile there I thought the US was a carbon copy of the pre WW2 Weimar republic as it is doing the exact same thing they did.
#4
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@zedvictor4
Current  inflation was in fact, unpredictable.
Seeing as how I predicted inflation in Spring of 2020, I must disagree with your claim of fact.

#5
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@Tejretics
During the stimulus and quantitative easing of the Obama administration, I was hearing talk of inflation… inflation which never materialized. Looking back, I think that is because Obama was dealing with a general weakness in demand from the Great Recession and its high unemployment.

What has happened during the COVID era is totally different— demand has been artificially and temporarily restrained, like a compressed spring. Meanwhile, production slowed down immensely from lockdowns, artificially low demand, and labor illnesses. Governments were literally paying people not to produce— a perfect storm for inflation:  low supply and demand just waiting to be freed from lockdown.

The Biden admin mistook the COVID economy for the Great Recession economy, and the results speak for themselves. 
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#6
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@cristo71
During the stimulus and quantitative easing of the Obama administration, I was hearing talk of inflation… inflation which never materialized. Looking back, I think that is because Obama was dealing with a general weakness in demand from the Great Recession and its high unemployment.

What has happened during the COVID era is totally different— demand has been artificially and temporarily restrained, like a compressed spring. Meanwhile, production slowed down immensely from lockdowns, artificially low demand, and labor illnesses. Governments were literally paying people not to produce— a perfect storm for inflation:  low supply and demand just waiting to be freed from lockdown.

The Biden admin mistook the COVID economy for the Great Recession economy, and the results speak for themselves. 
This is a fair point. 

In fact, I'd say the Obama Administration and particularly the Fed went the wrong way during the Great Recession. Christy Romer recommended a larger stimulus, which was only necessary because the Fed’s monetary policy was excessively tight for a large fraction of the period. 
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#7
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@cristo71
Seeing as how I predicted inflation in Spring of 2020, I must disagree with your claim of fact.
Don’t think this is a prediction of 2021–22 inflation though. Bryan Caplan also thought the COVID recession would primarily be a “real business cycle,” and shock inflation upward alongside a reduction in output. Instead, throughout 2020, we saw inflation well below the Fed’s 2% target. 

But yeah, I agree it was very much predictable -- Larry Summers and Olivier Blanchard predicted it. I will say that their models were still a bit off, because they also predicted much lower unemployment than actually materialized. 
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#8
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@zedvictor4
I would suggest that inflation is fuelled by global events.
I’ve got to catch a flight, so I’ll respond to this in more detail soon, but while the invasion of Ukraine and supply chain pressures have some influence on inflation, I’d say “aggregate demand is too high” is the primary factor. In specific, I think the Fed’s monetary policy has been much too loose, and hence, it hasn’t offset the effects of inflation brought on by increases in government spending. 
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@Tejretics
Hope you had a good flight!

In fact, I'd say the Obama Administration and particularly the Fed went the wrong way during the Great Recession.
By “the wrong way,” do you mean not far enough in the proper direction? If not, I’m not getting what you’re saying…

Don’t think this is a prediction of 2021–22 inflation though.
It sure is— I wasn’t saying that I predicted inflation would occur in the Spring of 2020. To be clear, I was saying that in the Spring of 2020, I was predicting high inflation would occur later— which is now.
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@cristo71
By “the wrong way,” do you mean not far enough in the proper direction? If not, I’m not getting what you’re saying…
I mean the Fed actively tightened policy when they should have been loosening (no, “cutting rates” isn't loosening, because the natural rate of interest fell sharply during the recession, so insofar as you keep the rate above the natural rate, you’re actively reducing how much money there is in the economy relative to a counterfactual where the Fed “did nothing”), for a brief period. 

It sure is— I wasn’t saying that I predicted inflation would occur in the Spring of 2020. To be clear, I was saying that in the Spring of 2020, I was predicting high inflation would occur later— which is now.
Okay; I thought you meant you predicted inflation in late 2020, which was Caplan’s prediction.

I still think this is less useful than someone seeing the specific policy that was passed, and predicting later inflation due to it. 
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you are right kid. In fact liberals get the entire economy more wrong than the word wrong can express.
#12
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@zedvictor4
I disagree that inflation is primarly fuelled by global events. It seems like federal reserve policies affect inflation the most directly, for example attempting to get inflation down to a steady rate of 2% per year.  Why do you argue that global events are the primary driver as opposed to national policy and events? 
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@Tejretics
I mean the Fed actively tightened policy when they should have been loosening (no, “cutting rates” isn't loosening, because the natural rate of interest fell sharply during the recession, so insofar as you keep the rate above the natural rate, you’re actively reducing how much money there is in the economy relative to a counterfactual where the Fed “did nothing”), for a brief period. 
Ah, ok. Wouldn’t inflation have been a greater danger if they loosened policy?

I still think this is less useful than someone seeing the specific policy that was passed, and predicting later inflation due to it.
But that’s precisely what I laid out in post 5. Government gave money to citizens to keep them from producing goods and services and put moratoriums on rent payments— those are specific policies. Hence, I predicted inflation would result when stifled demand was unleashed, which is exactly what resulted.
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@Tejretics
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@Kritikal
Economics is like monetary philosophy.

A lot of  specialist waffle, for those that indulge in the practice

Nonetheless, in the long term inflation can always be predicted to fluctuate, which is obvious....Though inflate it will, relative to it's cause..... And after the event pseudo-economists will say I told you so....Especially if they have a political axe to grind.

And ok so in fairness, I do suppose that any pessimist with an eye for geopolitical affairs could have predicted the recent global surge in inflation.

Optimists might have been more hopeful.



So, let's put you all to the test.

Geopolitically can you predict what will happen in the next 5 years?

And factoring in the next election also.

How will this effect U.S. domestic fiscal planning and outcomes?
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@zedvictor4
It’s pretty straightforward, really. I will explain again:

When governments pay people essentially to hibernate instead of producing goods and services, inflation is the inevitable result when hibernation ends and pent up demand (for goods that have not been produced, with money given rather than earned, saved up during lockdown) is unleashed.
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@cristo71
Well obviously it would have been foolish to think that the Covid pandemic wouldn't affect  National and  Global economies.

But as I sated previously, we can all predict relative inflation with hindsight.


OK. So history should tell us to expect periods of global instability. But I 'm not sure how precisely we can predict such events.

Of course, it might all be one big global conspiracy.


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@zedvictor4
The pandemic AND the policies enacted in response to the pandemic— such as lockdowns and paying citizens NOT to produce goods and services— affected economies globally. Sure, it was arguably the right thing to do for a limited time, but that time was extended well past its due date.

“Predict… with hindsight”? That is contradictory and nonsensical. What I am saying— and I don’t know why this is so groundbreaking and difficult to accept— is that once people were being paid not to produce, which started in the Spring of 2020, I predicted that inflation would markedly increase once demand resumed, which happened once the vaccines were distributed and societies reopened. That was a prediction looking forward (not a particularly miraculous one), not an observation in hindsight.

Once inflation did materialize, why did so many officials who should have known better label it “transitory”? Got me…
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@Tejretics
To be fair, everyone got inflation wrong for quite a while other than dedicated fiscal conservatives. And they got it wrong in the opposite direction so often that they were basically the boy who cried wolf at this point. And Trump bears some responsibility for blatantly pressuring the fed not to raise interest rates in 2017-19 when they absolutely needed to and had the opportunity to. I don’t feel bad for him because I hate him but it is objectively true that to some extent Biden got caught holding the bag for a mess Trump made 

That said the American rescue plan was definitely too big. At the time the vaccine was rolling out rapidly (and we didn’t actually know there would be so many breakthrough infections), we knew that consumer savings were huge, we knew supply chain issues were coming (did the bill do anything to address these? I don’t remember), the incredibly generous unemployment benefits were extended way too long… I am wary of making predictions on this sort of thing but I knew immediately that inflation was going to come. There was simply so much money sloshing around. Now the fed has to raise rates during a recession :( 
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@Kritikal
I disagree that inflation is primarly fuelled by global events. It seems like federal reserve policies affect inflation the most directly, for example attempting to get inflation down to a steady rate of 2% per year.  Why do you argue that global events are the primary driver as opposed to national policy and events? 
Both are true, if you look at other developed countries they are suffering from inflation but more in the realm of 4-6% while the US is pushing 9% as of today. Policy and the world at large are to blame
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This is the economics forum and not the politics forum but man 2020 really was the election to lose, imagine how much of a blow out 2022 would be if DJT were still in office 
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#21
Tejretics
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@thett3
To be fair, everyone got inflation wrong for quite a while other than dedicated fiscal conservatives. And they got it wrong in the opposite direction so often that they were basically the boy who cried wolf at this point. And Trump bears some responsibility for blatantly pressuring the fed not to raise interest rates in 2017-19 when they absolutely needed to and had the opportunity to. I don’t feel bad for him because I hate him but it is objectively true that to some extent Biden got caught holding the bag for a mess Trump made 
I strongly disagree that the Fed needed to raise rates 2017-19, I think the Fed being expansionary then actually averted a recession in 2019, and I think Fed policy was solid in 2020 as well -- if anything, I think Trump screaming at the Fed 2017-19 to keep policy loose, even though I think was a bad precedent Fed independence-wise, was necessary to ensure the strong pre-Covid economy (with inflation still well below 2%). I think the problem is the Fed didn’t follow average inflation targeting in 2021, and way overcompensated for its past failures on inflation, despite warnings from folks like Summers and Blanchard in the other direction; aggregate demand right now is quite a bit higher than in 2019 (and I also don’t view the effects of Fed policy in 2019 to be as persistent as you seem to). 

For what it’s worth, I’d actually rather the status quo than a world where Powell behaved like Yellen and raised rates 2017–19. Inflation is bad, real wages falling is bad, but we aren’t in an inflationary spiral (10-year inflation expectations look fine), and more importantly, (1) the 2017–19 economy actually recovered from a bunch of serious problems that, during the 2016 election cycle, were blamed on trade and automation, and (2) the pandemic was not nearly as bad on the economy as it could’ve been without Powell’s actions. 
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#22
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@thett3
That said the American rescue plan was definitely too big. At the time the vaccine was rolling out rapidly (and we didn’t actually know there would be so many breakthrough infections), we knew that consumer savings were huge, we knew supply chain issues were coming (did the bill do anything to address these? I don’t remember), the incredibly generous unemployment benefits were extended way too long… I am wary of making predictions on this sort of thing but I knew immediately that inflation was going to come. There was simply so much money sloshing around. Now the fed has to raise rates during a recession :( 
This is all fair :/ 

I do think part of the recession is induced by expectations that the Fed will raise rates (i.e. I think the Fed, unfortunately, has to essentially induce a small recession), but yeah, sucks. Sad. I hope not too many people lose their jobs or fall back into poverty...
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@thett3
Core inflation has fallen for two months, so rate hikes seem to be working somewhat.

Perhaps one path out of all of this is if the Fed credibly commits to raise rates as high as necessary if push comes to shove (e.g., this Jason Furman tweet). Feels like the “hike rates” version of “credibly committing to being irresponsible” (the Krugman aphorism that led to ResponsiblyIrresponsible’s DDO username, though Krugman was talking about credibly committing to increase the money supply to prevent a deflationary spiral during the Great Recession). 
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@cristo71
Prediction with hindsight is saying I told you so when you already know.


Whether or not lockdowns were too long is really a decision for politicians, taking into account all relative issues, including economics.

I personally think (from a U.K. perspective), that decisions were correct and recovery was good.

And as I stated, I agree that an astute pessimist could have made a strong prediction in the run up to the Russia Ukraine crisis.
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@zedvictor4
Whether or not lockdowns were too long is really a decision for politicians, taking into account all relative issues, including economics.
\/\/

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@Tejretics
When do you think they shoudve raised rates? They needed some “dry powder” didn’t they? That wouldn’t have helped with our current inflation tho  
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#27
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@thett3
When do you think they shoudve raised rates? They needed some “dry powder” didn’t they? That wouldn’t have helped with our current inflation tho  
Not sure what “dry powder” means here -- do you just mean the cash they’d get by selling securities? Not sure why that was necessary/urgent then -- I’d argue reducing the pain of excessively tight policy in 2015-16, getting the economy to full employment between 2017-18, averting a recession in 2019 and responding to market indicators like the inverted yield curve, and softening the blow of the COVID recession in 2020 was the priority. 

They could’ve raised rates a quarter earlier. I don’t think the delayed rate hikes get at the heart of the problem, to be honest, though (in part, because earlier rate hikes may have just delayed inevitable inflation from the stimulus). I think (1) they needed to taper asset purchases quicker and (2), most importantly, they needed to re-anchor expectations -- clearly articulate that they understood higher inflation was, in significant part, a result of higher nominal spending, make it clear that rates would likely be on an upward trend throughout 2022 (unless, say, unemployment was above 4% or inflation was less than expected) even back in 2021. The Fed’s credibility is a serious part of medium-term inflation expectations -- even if this has only a small influence on medium-term inflation, it makes rate hikes less painful for the economy. The Fed claimed it was adopting flexible average inflation target, but it was okay to let inflation overshoot quite a bit without averaging it out, which is bad.
#28
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@thett3
The problems of a centrally planned economic market manifest themselves during moments of crisis.

The collective minds of millions of suppliers and consumers are far more responsive than a cabal of a dozen distant elites with their fingers on the economic scales.

Milton Friedman referred to this as the invisible hand vs the hands of a few.
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@Tejretics
What do you think the effect would be if the fed carted out 1 trillion paper dollars and had a bonfire outside the Capitol?
#30
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Multi trillion dollar deficit spending by govt as far as the eye can see and the Federal reserve being their enabler. How could anyone have predicted inflation. How did we all get it wrong?  I've been warning about it for years. Its as plain as the nose on your face. America is the Weimar Republic on steroids for Christ sake.