Reviews | Revisiting the summer of stagflation

I don’t know if there will be any surprises in the State of the Union address. I know that the context of the speech will be very different from what a large majority of experts expected just a few months ago.

After all, at this point, Joe Biden’s presidency was supposed to be effectively over – his political influence destroyed by a devastating midterm red wave, his political credibility eviscerated by a recession and high inflation.

Well, the red wave was more of a ripple. And recent economic numbers have been surprisingly supportive. Half a million jobs were added last month, bringing total job creation under Biden to 12 million so far, with the unemployment rate falling to 3.4%, its lowest level since 1969. inflation was high in 2021 and part of 2022, but has since plunged; over the past six months, consumer prices have risen at an annual rate of less than 2%.

If economic news sounds too good to be true, it probably is. Most of the experts I talk to think January’s monstrous jobs report was a statistical anomaly. Inflation figures reflect various temporary factors, although these go both ways; I wouldn’t be surprised if inflation picks up somewhat in the coming months, but that’s by no means certain.

What is clear, however, is that until a few months ago many, if not most, economic forecasters were far too negative about America’s outlook. In particular, we went through what I consider to be the summer of stagflation – a period that actually extended into the fall, when many influential economists were making extremely bleak statements about what it would take to control inflation.

And I think it’s important to ask why they got it so wrong.

Now show me an economist who didn’t make wrong predictions and I’ll show you someone who doesn’t take enough intellectual risks. I’ve made a lot of bad calls over the years; in particular, I did not expect inflation to explode as it did.

That said, I revisited the most influential of these pessimistic analyses, and it’s truly amazing how bleak they were compared to what really happened. Even more famously, last June Larry Summers said – with laudable precision – that containing inflation would require five years of unemployment at 6%, two years of unemployment at 7.5% or one year of unemployment at 10%.

Another influential paper, presented at the Brookings Institution in September, also predicted that inflation would remain very high unless there was a huge increase in unemployment.

To be fair, inflation may not yet be fully under control. But it has fallen enough, without any increase in unemployment, to make it clear that such forecasts were extremely pessimistic. So why did people believe them?

Not everyone in Team Stagflation used the same approach. But much, if not all, of the pessimism was based on the assumption that inflation in 2021-22 was similar to the inflation of the 1970s, which was indeed only contained by a long period of very low unemployment. pupil.

The thing is, there was always good reason to believe it was a bad analogy. Economists who were mostly right, like Joseph Gagnon of the Peterson Institute, argued early on that the Korean War – which produced a sharp but short burst of inflation – was a better model than the 1970s. for what was going on. Others and I have pointed out that disinflation was difficult in the 1980s, largely because expectations of persistent inflation had become entrenched, which clearly was not the case this time around.

Why, then, have economists made such confident doomsday predictions, and why have so many others – especially in the news media – accepted them? We’re not talking intellectual dishonesty here: the inflation pessimists have been admirably clear about their data and their assumptions. But there was and is a mindset – perhaps affecting economists themselves, certainly affecting much of their audience – that is always ready to see any economic setback as a replay of that spectacle from years ago. 70, which still sees stagflation looming.

This mindset is not explicitly political; I’m not talking about the guys at the Heritage Foundation who have spent much of the last year proclaiming a Biden recession and will never, ever apologize.

But it reflects, I think, the desire to see economics as a game of morality, in which attempts by policy makers to make things better are severely punished (while doing too little is not). The Biden administration’s initial spending program was larger than it should have been; the Federal Reserve was slow to realize how much inflation was rising. Such sins must surely invite terrible retaliation from the gods of macroeconomics!

But they didn’t. So, will the prophets of fatal inflation admit that they were wrong? More importantly, will policymakers, especially at the Fed, who underestimated inflation risks in 2021, be flexible enough to accept that they overcompensate in 2022? Because if they don’t, the policy response to imaginary stagflation could still produce an unnecessary recession.


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