US economic policy in 2021 has drawn strong criticism from many economists. I’m not just talking about Republican loyalists, who always predict disaster when a Democrat takes the White House. Even democratic economists or relatively apolitical technocrats voiced sharp criticism.
For example, Larry Summers, effectively the Obama administration’s chief economist, called President Biden’s spending bills the “least irresponsible macroeconomic policies we’ve followed in 40 years.” Mohamed El-Erian, an economist who is usually cautious in his comments, explained that the Federal Reserve made a historic mistake by failing to raise interest rates in 2021.
Underlying those harsh words was not only the belief that we were going through a period of high inflation – which the critics got right and I got it wrong – but also that bringing inflation back under control would be extremely painful, and likely to be Years of very high inflation would require unemployment.
But the economy has defied this dire prediction. Inflation has fallen significantly despite persistently strong employment. It is not clear from the data whether the political decisions of 2021 have caused lasting damage. So let’s talk about where the economy is now and what lasting damage, if any, the early policies of the Biden administration have done.
The first point is that we have made remarkable progress in the fight against inflation, progress so great that it seems almost surreal even to optimists like me. A good way to spot the good news is to compare some standard estimates of “underlying” inflation (ie measures that try to extract the signal from the noise) over different time horizons. Here are two such metrics for the Fed’s preferred indicator of inflation, the personal consumption expenditure deflator — one that excludes volatile food and energy prices (below left), and one that excludes all large price movements (below right):
Both lead to almost the same result: inflation has been below 3 percent for the last three months, lower than the rate for the last six months, which in turn is below the rate for the past year. This is what you expect if inflation falls steadily towards the Fed’s 2% target.
I still see a lot of statements that while we’ve made progress in fighting inflation, there’s still a lot to do. But the data says we’re almost there, and inflation pessimists seem to me to be desperate to find justifications for their pessimism.
And all of this progress has been made with no visible cost to job creation. In fact, employment recovered surprisingly quickly from the Corona crisis. Here is one metric, the percentage of adults aged 25-54 who are in work, comparing developments since January 2020 to after the start of the last recession in December 2007:
Last time, it took more than a decade for employment to fully recover. This time we were above the pre-Corona employment rate in three years. Disinflation appeared to require no casualties at all, let alone the high “victim rate” that many predicted – lots of unemployment to keep inflation down.
But hasn’t inflation affected workers’ paychecks? Not really.
Wage data has been difficult in recent years. During the worst closures of the pandemic, job losses were concentrated in low-paid service workers, with average wages soaring simply because the lowest-paid were below average, and then falling as things returned to normal. At this point, however, most of these effects are likely to be behind us. And the real wage of the average worker — average hourly wage divided by consumer prices — is now higher than it was before the pandemic. Prices are higher, but wages have outpaced them:
So today’s economy seems to be in pretty good shape. Inflation surged in 2021 and 2022, but appeared to be temporary. So, have policymakers really made a historic mistake by not taking action on inflation sooner?
In fact, from an economic standpoint, there is a good case to be made that a temporary burst of inflation was just what the doctor ordered. The pandemic was a major shock, disrupting supply chains and changing the mix of goods and services consumers demand. This made it necessary for the prices of some goods to rise relative to the prices of others. And it was easier to achieve this relative price adjustment by raising the prices of goods that were in short supply than by lowering the prices of goods where there was no supply. A limited burst of inflation, such as that which took place after the Second World War, was probably the right response – at least in the strict economic sense.
If you’re going to argue that policymakers made a historical mistake in 2021, I think this case needs to be based on the thesis that even a temporary burst of inflation has caused lasting psychological, or perhaps even greater political damage.
There is no question that the public perception of the economy is far worse than the economic reality. As I began to make this argument, I encountered fierce opposition from journalists, who argued that the public has good reason to feel bad. At this point, however, it is hard to deny that there is something odd about the public’s negative attitude towards a very good economy.
There are likely several reasons for this discrepancy, but one possibility is that the sudden resurgence of inflation shocked Americans, who had become accustomed to price stability, and that they still have not recovered from the shock.
If that’s true, it could be that the policies of 2021 were good economic policies but bad policies. However, this view depends on the extent to which the acceleration in inflation is due to these measures, which is not entirely obvious.
There have been some attempts to model this question, such as a Bloomberg analysis suggesting that even if the Fed had acted sooner, it wouldn’t have made much of a difference. However, at this point there is so much disagreement among economic modelers that I don’t think citing model results will convince anyone.
An alternative is to compare inflation in the United States to inflation in other countries that have not implemented large amounts of fiscal stimulus. US policy critics previously cited lower inflation in Europe as evidence that excessive stimulus was the problem. At this point we actually have much lower inflation than Europeans, but in fairness they have been hit harder by the effects of the Russian invasion of Ukraine. Nonetheless, inflation in Europe was already rising before the invasion, albeit lagging behind inflation in the United States:
Note, by the way, that I’ve made sure to use comparable measures of inflation here.
This comparison suggests that America’s pre-Ukraine inflation was a few points higher than Europe’s inflation and might have been a few points lower had it not been for these expansionary policies. Would that have led to a radically different public view of the economy? I doubt it.
So should the fiscal stimulus have been less? Yes. Should the Fed have started raising rates sooner? Yes. Would any of that have made a big difference in the pretty good spot we’re in economically or the bad spot we’re in politically? Probably not.
Fast hits
June 2022 wants to be the subject of conversation again.
Business expectations of future inflation have fallen significantly.
This also applies to the percentage of companies reporting price increases.
Inflation figures: beware of noise.
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