Let us be completely clear: No one in the Republican Party has offered even the hint of a plan that could reduce inflation. Why not? First, they think that they can blame President Joe Biden and the Democrats for inflation (and everything else under the sun) because it is happening “on their watch.” Second, conservatives have nothing substantive to contribute to the discussion, because they have no good policy responses to inflation, full stop.
This has been obvious for months, if not longer. Indeed, I wrote a two–part Verdict column and a companion column on Dorf on Law back in February of this year, discussing all of this and more. In the four months since then, the inflation rate in the United States has leveled off at around eight percent on an annual basis, Republicans have continued to fulminate without offering any solutions, and the press has not relented in overhyping the problem.
So nothing has changed, except that anything resembling a problem has now been stabilized. Why, then, should I write about this again? It is necessary to revisit the farcical US inflation debate for both political and analytical reasons. As the headline of this column suggests, the political posturing about inflation in this country has devolved to an ever-lower level, even as it becomes clearer that the economic case for a return to the old version of normal makes almost no sense.
Admitting “Error” and Acknowledging Reality
One of the best things that President Biden did when he took office was to name the renowned economist Janet Yellen as his Treasury Secretary. Yellen, a former chair of the Federal Reserve (also known as the Fed, which is our central bank), is the rare economist with orthodox academic credentials who has transitioned into policy roles without bringing a heavy dose of theoretical pretentiousness to her work. She looks at evidence with an open mind and adjusts her thinking when appropriate.
This was once viewed as an admirable trait in public servants. Although the quote is often misattributed, it was the economist Paul Samuelson who once offered this withering retort to a critic who had accused him of inconsistency: “When the facts change, I change my mind. What do you do, sir?” That quote (from 1970) reminds us that charges of flip-flopping are hardly new, and Samuelson’s response has resonated in the ensuing half-century because people understand the value of being responsive to reality. Pragmatism is preferable to dogmatism.
Because our public discussion is, however, constantly plunging to new lows, the inflation discussion in the US in 2022 has reached the point where simply saying out loud that one’s expectations have not been met is quickly turned into a Republican talking point. Specifically, Secretary Yellen was recently asked in an interview about her earlier prediction that the recent uptick in inflation would have subsided by now.
It is undeniably true that inflation has not followed the path that Yellen and others (including me) expected in 2021 and earlier this year. Because Yellen is not a member of the political party that insistently denies the truth (about the outcomes of elections, climate change, vaccines, and so much else), she did not deny that her prediction was off. She said forthrightly: “I think I was wrong then about the path that inflation would take.”
Based on the howls from Republicans, one would think that a Democrat had said that she did not know that two plus two equals four. A spokesperson for the Republican National Committee snarked: “How can Americans trust the Biden administration when the same people that were so wrong are still in charge?” But of course, if Yellen had said that her prediction was not wrong, that would have been taken as evidence that she was a liar. The talking point in either case would be that—again, even though Republicans have offered no reason to believe that they could have done any better—every time a Democrat turns out to be wrong about anything, they should be fired.
Because Yellen is an honest pragmatist, however, she is precisely the best kind of person to have in charge of the country’s economic policymaking process. She is busy trying to learn from her honest mistake, as a good policy analyst should. Whereas she once thought that the increased inflation that we were seeing was not because of excess demand, she is now saying that there are reasons to try to cool off the economy. I happen to disagree with her about that, but that is all the more reason to think that she is not adhering to any kind of liberal groupthink. Even those of us who believe that she might be overreacting can be confident that she is doing her level best, bringing her considerable knowledge and skills to the table.
Again, it is in some sense unsurprising that the party out of power is trying to lay the blame for a public problem on the president’s doorstep. But we are far beyond that point. As a New York Times article reported: “The Treasury Department has scrambled to clarify Ms. Yellen’s remarks, saying her acknowledgment that she misread inflation simply meant that she could not have foreseen developments such as the war in Ukraine, new variants of the coronavirus or lockdowns in China.”
So being honest—acknowledging that one’s prediction turned out to be wrong—now results in Yellen’s public relations team having to scramble and do damage control. What kind of incentive does that create for people in dealing with questions in the future? Deny, deny, deny.
Let Us Be Clear About What Yellen Was Wrong About
One of the reasons that Democrats have offered policy ideas to fight inflation that would (as I made clear in my February columns) at best reduce prices only on the margins is that today’s inflation—and especially its path over the space of the coming months or even a few years—is almost impervious to policy intervention.
After all, if the rise in inflation had been the result of Democrats’ policies, which Republicans could promise to reverse after being returned to power in free and fair elections (if only they were committed to democracy), then different countries would not have seen their inflation rates rise, too. But in fact, inflation has gone up by roughly the same amount, over the same time period, in nearly every country to which we might want to compare the United States. British voters have soured on Prime Minister Boris Johnson for plenty of good reasons, but they are also blaming his Conservative government for the same increase in inflation that the rest of Europe (along with the US, Canada, Australia, and New Zealand) is experiencing.
A big part of the explanation for the cross-national similarity in inflationary paths is that food and energy prices are set on global markets, and those two important sectors account for about one-third to one-half of inflation in the richest countries. The remainder of the recent increase in inflation is also traceable to non-US factors, most obviously the now-infamous supply-chain backups that have bedeviled global production and the delivery of goods since the COVID-19 pandemic began.
This, in fact, is why I (respectfully) disagree with Yellen when she says that we need to tamp down aggregate demand in the fight against inflation. She is careful to stipulate that doing so risks causing a recession, but she hopes—as do we all—that the Fed will be able to thread the needle without throwing millions of people out of work. I think that doing so is unnecessarily risky, but reasonable minds can differ.
In any event, Yellen’s “mistake” was to base her predictions on the assumption that supply-chain problems and other issues would clear up sooner than they have. (One supposes that she was also wrong because of her mystifying inability to predict that Vladimir Putin would start a land war in Europe. What was she thinking?) She did not misdiagnose the causes. She simply did not anticipate that those causes would linger as long as they have.
What Should We Want the Inflation Rate to Be?
But there is a larger issue here beyond the political blame game and even the analytics of trying to reduce inflation: What would victory in the fight against inflation look like?
A person could be forgiven for thinking that the answer to that question is obvious: If inflation is bad, then things are good when inflation is zero. Even on its own terms, however, that is an unsatisfying answer, because if all prices were to stop rising tomorrow and stay at their current level forever, inflation would be zero even as prices remained “too high.”
I used scare quotes in that last sentence to emphasize a point that I made in my February Verdict column, which is that people become angry about inflation not because they see an inflation rate of eight percent versus a rate of two percent. They become angry when they notice that it has become more expensive to buy a tank of gasoline, or rent an apartment, or bring home groceries. The inflation rate is a weighted average of those different price increases, but it is the sense of paying too much for specific goods and services that makes people furious.
But if some prices are now too high, would victory instead require us to bring those prices back down to some lower level? What level would that be: prices in January 2021, or prior to the pandemic, or perhaps when Ronald Reagan was president? There is no touchstone to which we can return, when “the prices were right.” It is all a matter of what we come to accept.
Speaking of Reagan, Paul Krugman made a great point in a recent newsletter (behind a subscription paywall, unfortunately), noting that in the 1980s the Republicans “were strutting around boasting about their victory over inflation, and the public didn’t see inflation as a major concern.” What was that glorious inflation rate? Four percent. That is less than today’s rate, but it is still double what the conventional wisdom tells us is the “right” inflation rate to which the Fed should be guiding the economy, with the current consensus for some reason being that a two percent inflation rate is just right.
But what is so great about two percent inflation? As Krugman points out, that became the target rate only as a result of a tacit compromise between people (like Krugman, as well as current inflation hawk Larry Summers) who thought that a four percent target was best and bankers who wanted to default to zero percent.
Why might Krugman and others think that four percent is a good idea? They are certainly right that zero percent inflation would be bad for the country and the world. The fact is that inflation acts as a lubricant to the economy, in two ways. First, employers can take inflation into account when setting wages for workers, allowing them to reduce the real buying power of some workers by not increasing their compensation to make up for inflation. In plain English, they can cut some workers’ inflation-adusted wages, but they can do so passively rather than actively.
Why is that a good thing? I am hardly an apologist for wage-slashing employers (being, among other things, a strong advocate of labor unions and increasing the minimum wage), but the key in the paragraph just above is that I said that some workers’ wages can be reduced by inflation. That is, at any given time some workers will deserve raises while others will deserve pay cuts, and inflation makes it easier for employers to do the latter without being in-your-face about it.
Second, and more importantly, if the inflation rate is four percent and the Fed sets the interest rate at zero percent, that means that the “real interest rate”—the difference between the two numbers—is negative four percent. That means that the Fed is making it possible to borrow money and to be paid to do so, which is often needed to bring an economy out of a slump. This can seem strange, but when the economy is suffering, it is necessary to induce businesses and people to borrow and spend, which is needed to bring the economy back to life. Effectively paying them to borrow is exactly what is needed.
If the target inflation rate is zero percent, however, it is effectively impossible to create negative interest rates, because the interest rate that the Fed controls cannot go (much) below zero. If the target inflation rate is two percent, the lowest the real interest rate can go is negative two percent. But that might not be enough. In fact, the aftermath of the Great Recession dragged into the 2010s because the inflation rate was so low that the Fed could not make real interest rates negative enough to stimulate the economy.
Those are admittedly technical arguments, but they are hardly exotic or controversial. By contrast, as Krugman notes, what counts as the best argument for returning to the pre-pandemic target of two percent inflation is merely that we need to prove that we can do so, to prevent people from worrying that inflation will be allowed to climb up to unacceptable levels.
What is perhaps even more surprising is that we truly have no idea what is an unacceptable level of inflation. We know that hyperinflations are ruinous, but those are situations in which prices are rising by hundreds of percent per year, or even per month. And there are no historical examples of which I am aware in which a hyperinflation took hold merely because a government decided to adjust its target inflation rate by a couple of percent. In terms that lawyers will understand, inflation is often presented as a slippery slope—with interwar Germany or 1980s Argentina as the inevitable horror at the bottom of the hill—but that is not how hyperinflations happen.
To clarify, it might help to consider a thought experiment. Rather than arguing that we should accept an inflation rate of four (or five or three) percent annually going forward, what if we were to say that the current rate of eight percent is acceptable as a permanent annual target? The piece from The New York Times that I quoted above, discussing Secretary Yellen’s refreshing honesty, asserted casually that “prices are soaring” in mid-2022. Are they?
Not only is an eight percent annual inflation rate nowhere near an out-of-control conflagration, but it is easy to imagine living in a world where everyone simply becomes accustomed to eight percent rates. The average person would know that she will receive annual salary increases of eight percent (plus or minus her “real” raise or salary cut), the interest rates on deposit accounts would be eight percent higher than if inflation were zero percent, Social Security benefits and tax brackets would (continue to) be adjusted upward for inflation, and so on.
No one, in other words, would think that prices were soaring, even though the inflation rate would clock in at eight percent, year after year after year. That is what it means to say that there is no natural baseline or starting point to which inflation or price levels should return. It is all a matter of getting to the point where people are used to what they are used to. And people can get used to inflation at rates above the currently sacred target of two percent, because their sources of income would adjust to a higher rate as well.
As it happens, however, we do not even need to decide to accustom ourselves to a permanent eight percent rate. Although the global economy is taking longer than we had hoped to work out its current inflationary triggers, they are indeed being worked out. When the inflation rate sinks back down, we can declare victory and move on. And again, there are good reasons to target inflation at something like four percent, which was not a problem when it was the norm in the Reagan Era.
None of this is to deny that people, especially poorer and middle-class people, are being harmed by price increases now. Again, however, the Republicans have no answer to that problem, and they do not even bother pretending that they do. There are perfectly good ways to help the people who need help, but the Republicans would rather scream about Joe Biden’s stellar top economic advisor.
Why am I not surprised that they are taking cheap, easy shots rather than dealing honestly with the situation and trying to help vulnerable people?