How not to panic in the face of inflation – 03/23/2021 – Paul Krugman

Do you remember the fear of the big inflation of 2010-2011? It’s an episode worth watching, as there’s a good chance we’ll see a rerun in about a year or so.

After the 2008 financial crisis plunged the United States into a deep recession, the then new Obama administration and the Federal Reserve (the Central Bank’s correspondent in the United States) attempted to stimulate the economy by spending hundreds of billions of dollars on various programs, while they bought billions of bonds.

Today, economists agree that these efforts were useful, but they are also believed to be insufficient (as some of us actively argued at the time).

On the right, however, there is an article of faith that an activist government is always bad, even in a crisis. That is why there have been many stern warnings that these economy rescue initiatives will lead to rampant inflation. In mid-2010, there was a palpable sense of frustration among some conservatives that expected inflation had not materialized.

Then came a few months where inflation seemed to be on the rise, after all. Consumer price inflation has reached almost 4%; wholesale inflation has gone to double digits; the average price of raw materials such as oil and soybeans has increased by almost 40% in one year. Republicans soon complain to Ben Bernanke, the chairman of the Fed, suggesting that his efforts could “degrade the currency.”

But the Fed stayed on track, correctly declaring that the price hike was a small, fleeting bubble and not a harbinger of 1970s-style stagflation. Inflation fell quickly and stuck. weak since.

Now here we are again. The US $ 1.9 trillion bailout will undoubtedly provide significant economic stimulus. Virtually everyone, from private predictors to the Fed itself, expects an economic boom, with the US economy growing at rates not seen since the 1980s. There will almost certainly be an increase in the economy. inflation too, perhaps well above the Fed’s 2% target. per year.

And the rise in inflation, in turn, will again provoke discussions about the return of stagflation. In fact, this conversation has already started.

So here’s how to keep a cool head when the inflation news heats up.

The main thing to understand is that there are actually two types of inflation.

The prices of some products, such as oil and soybeans, fluctuate constantly, changing from day to day or even minute to minute in response to changes in supply and demand. The inflation of these products is a back and forth; prices can rise quickly when demand is high or supply is fair, but they can drop just as quickly when market conditions change.

However, many other prices – including those of labor, i.e. wages and salaries – change much less frequently. Most workers’ wages are only adjusted once a year.

And stagflation, after all, is mostly about these “sticky” prices.

Imagine an economy in which everyone expects inflation to be high for the foreseeable future (Americans of a certain age don’t need to imagine that; for a while, we live in a such economy). In this economy, a company that sets its prices for the following year will do so taking into account the probability that the prices of all others – the prices charged by competition, the costs of raw materials, the wages offered by employers. rivals – will increase over time.

Reflecting this expectation, companies will mark prices higher than they would be if they weren’t expecting future inflation – and in doing so, fuel the very inflation they fear. In other words, when expectations of sustained inflation are anchored in the economy, inflation propagates on its own – and reducing it can be extremely difficult. This is what makes stagflation possible: inflation despite high unemployment.

The point is, however, that short-term fluctuations in volatile prices say little about whether stagflation becomes a risk. This is why the Fed’s policy generally ignores the general inflation index and focuses on a measure that excludes food and energy prices.

So what will happen in the next few months? We are likely to see several transitional price increases, not only because the economy is on the rise, but also because the long-term effects of the pandemic have caused unusual disruptions – for example, a global shortage of freight containers. .

The question will be whether these price increases are a small bubble of the 2010-2011 type or something more dangerous. Smart watchers will be looking past the headlines for measures of core inflation – not just the Fed’s “core” standard measure, but things like the Atlanta Fed’s sticky price index. Equally important will be the sporadic evidence, also known as “talking to people”: are companies really starting to set prices and wages based on expected future inflation?

If they aren’t – and I bet they aren’t – the 2010-2011 lesson will hold true: don’t panic.

Now, as then, there are people keen to speak out against the government’s attempts to help the economy. And it’s certainly possible that the US bailout will, in retrospect, end up being an excess of good things. But don’t let the usual suspects take advantage of inflation data from a few months ago as evidence of impending doom.

Translation by Luiz Roberto M. Gonçalves

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