Treasury Secretary Janet Yellen has finally admitted to Federal Reserve Chair Jerome Powell that she was wrong last year when she thought inflation would be a temporary phenomenon rather than becoming the country’s number one economic problem. This is to be welcomed, especially given how hard it is for economists to admit they were wrong. However, like Mr. Powell of the Federal Reserve, she has been careful not to admit that her Treasury Department’s policies had anything to do with accelerating inflation to a decade-high of about 8½ percent.
This lack of genuine assumption of debt is very much to be regretted. There is a risk that nothing has been learned from what former Treasury Secretary Larry Summers warned earlier last year as the most irresponsible fiscal policy of the last forty years.
Janet Yellen’s worldview doesn’t help
In Ms Yellen’s worldview, the main cause of the unwelcome acceleration in inflation was factors beyond her control and which were very difficult to predict. How could she reasonably know that an Omicron variant would prolong the Covid-19 pandemic, disrupting global supply chains and international shipping for such a long period of time? Also, how was she supposed to reasonably know that Russia would invade Ukraine on February 24, 2022, sending international oil and gas prices skyrocketing?
Sure, a disrupted global supply chain and a Russian oil and food price shock have played some role in today’s higher inflation, but they can’t explain why inflation has become as pervasive as it is today, or why it has hit a 40-year high. Nor can they explain why the economy is overheating, indicated by a very tight labor market and a sharp rise in wage inflation.
The truth is that at a time when the US economy was experiencing reduced supply as a result of global supply chain disruptions and the Russian commodity price shock, both the Treasury Department and the Federal Reserve were fueling a sharp increase in aggregate demand with their very expansionary macroeconomic policies.
The Treasury Department did this by cheering on President Biden’s March 2021 US $1.9 trillion bailout plan. In addition to last year’s $3 trillion of bipartisan budget stimulus in response to a Covid-induced recession, the Biden stimulus meant the economy would receive nearly $5 trillion, or about 20 percent of GDP, in budget stimulus two years from now would. With estimates that early 2021 production was only about 4 percent below its potential, it’s no wonder such a large amount of budget stimulus should result in economic overheating by the end of last year.
Not to be outdone by the Treasury Department, Jerome Powell’s Federal Reserve stayed on the money metal all last year even as the economy rebounded strongly and received the largest peacetime fiscal stimulus on record. It did this by keeping interest rates at the zero floor and buying $120 billion a month in Treasuries and mortgage-backed securities while the stock and real estate markets were on fire.
The only real line of defense for Ms. Yellen’s inflationary negligence is that she should not know that the Powell Fed would be even more irresponsible than her Treasury Department by letting the inflationary genie out of the bottle. However, I would not recommend this line of defense to Janet Yellen if she wants to remain Treasury Secretary for a longer period of time.
Desmond Lachman joined AEI after serving as Managing Director and Chief Emerging Market Economic Strategist at Salomon Smith Barney. Previously, he was Associate Director in the International Monetary Fund’s (IMF) Policy Development and Review Division and was active in the staff formulation of IMF policies. Mr. Lachman has written extensively on the global economic crisis, the US housing market bust, the US dollar and tensions in the eurozone. At AEI, Mr. Lachman focuses on global macroeconomics, global currency issues and the multilateral credit agencies.
Comments are closed.