The week the inflationary panic died – 6/22/2021 – Paul Krugman

Remember when everyone panicked about inflation, issuing ominous warnings about the danger of stagflation like that of the 1970s? Okay, a lot of people keep saying that sort of thing, some because that’s what they always say, some because that’s what they say when the president is a Democrat, some because which they extrapolate on the basis of the sharp price increases that have occurred in the first five months of this year.

But for people who are paying more attention to the flow of new information, the panic over inflation has become very big last week, you know?

Seriously, recent numbers and recent statements by the Fed (Federal Reserve), the US central bank, have seriously deflated the arguments underlying the story of a sustained surge in inflation. Because these arguments have always rested on the assertion that the Fed is deficient, either morally or intellectually (or both). In other words, to panic about inflation, you have to believe that either the Fed’s model of how inflation works is completely wrong, or that the Fed doesn’t have the political courage to cool it down. economy if it was dangerously overheated.

Both beliefs have now lost most of any credibility they might have had. Let’s start with the theory of inflation.

Since the 1970s, and especially since a major study published in 1975 by Robert Gordon, many economists have attempted to distinguish between transient fluctuations in the rate of inflation caused by temporary factors and an inflation rate below – much more stable behind – but also difficult to knock down if it gets too big. The idea is that monetary policy should generally ignore transient inflation, which comes easily and goes easily, and only worry if core inflation appears to be getting too high (or too low).

Since 2004, the Fed has regularly released an estimate of core inflation calculated by excluding changes in food and energy prices, which are notoriously volatile, and uses this indicator to counter demands for tightening monetary policy. in the face of inflation it deems temporary – particularly in 2010-2011, when the prices of oil and other commodities soared and Republicans accused the Fed of causing a risk of “currency depreciation.”

The Fed was of course right: it didn’t take long for inflation to drop. And the distinction between transient inflation and core inflation – a distinction which, judging by the emails I receive, spawns extraordinary hatred among some Wall Street numbers – has in fact turned out to be a huge practical success, helping the Fed to stay calm and keep going. their work in the face of inflationary and deflationary panics.

The Fed has argued that the recent price increases are also transient. It is true that they do not come from food and energy, but from the pandemic unrest that has caused the prices of used cars, wood and other sources of inflation to skyrocket. traditional. But the Fed’s position has been that the episode, like the small inflationary leap of 2010-2011, will soon be over.

And for now, it looks like the Fed was right. Wood prices have fallen in recent weeks. The prices of metals for industrial use such as copper are falling. Used car prices remain very high, but their rise has stopped and it is likely that they have already peaked. Another victory for the theory of core inflation.

What about the alternative inflation story? It works like this: The Biden administration’s US bailout has injected huge amounts of purchasing power into the economy, and affluent households, which racked up large savings during the pandemic, are now ripe. for a frenzy of consumption. As a result, critics warn, there will be a classic case of too much money for too few goods, which will cause not only volatile prices to rise, but core inflation as well.

To accept this story, however, it is necessary to assert not only that the coming boom will be truly huge – even bigger than most analysts predict – but also that the Fed, which has all the capacity to put the brakes on a uncontrolled boom, will remain inactive. while inflation is skyrocketing.
However, statements by the Fed’s open market committee (the body that sets monetary policy) last week make those claims less credible.

Reading central bank statements is often an exercise in “kremlinology”. The Fed hasn’t announced any concrete policy changes, so the goal is to identify changes in tone that offer clues for the future. But Fed watchers say the new releases tend to take the hard line, signaling an increased willingness to brake if the economy actually breaks speed limits.

In my opinion, it will not be necessary to apply the brakes. But by suggesting it would act if necessary, the Fed ended up dismantling any argument that one should be worried about a throwback to the 1970s.

So why all the fuss? Monetary pessimists have been wrong time and time again since the early 1980s, when Milton Friedman began predicting a rebound in inflation that never happened. Why so much will to party as if we were in 1979?

It’s fair to say that the government’s support for the economy is much stronger today than it was during the Obama years, and so it makes more sense to worry about inflation this time around – this. But the vehemence of the anti-inflationary rhetoric had been absurdly out of proportion to the real risks – and those risks were even lower than they appeared a few weeks ago.

Translation of Paulo Migliacci

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