Not only are they paying more for things than they were a year ago, but the consistently higher-than-expected CPI reading continues to ravage the stock market, sending the S&P 500 down over 1,000 points on Tuesday, its worst day since June 2020.
One of America’s leading financial historians says this moment requires a lesson in economics.
“The reopening of inflation that we’ve had so far has been a very good thing,” Brad DeLong, a UC Berkeley professor, told Fortune. His comments contradict the more restrictive stance on inflation famously advocated by Harvard economist Larry Summers, who worked alongside DeLong at the Treasury Department during the Clinton administration.
DeLong argues that there is a big economic change happening that people should welcome. It all has to do with our weird but somehow wonderful post-pandemic economy.
The Zoom World
The new economy, DeLong says, is one where more time is being spent online, fewer jobs that require face-to-face interactions, and a much higher rate of commodity production.
It’s like we’ve zoomed decades into the future in just a few years.
“A couple of decades,” DeLong said when asked how many years of economic change chopped up into a little over two: “A couple of decades of structural change and social and economic learning about how to be online as an enduring thing. “
“Fewer personal workers in retail stores, a lot more delivery orders, a lot more goods production and also a lot more information entertainment and production,” DeLong recently described his vision for the New Economy Week about his new book Slouching Totopia in a separate interview with Fortune. The meeting took place via Zoom, DeLong noted, proving his point.
According to DeLong, inflation in the US currently serves two functions that could help the economy over the long term: helping to build new sectors of the economy poised for big growth, and uncovering and optimizing supply chain imperfections that have been bugging us since the beginning of the economy year accompany pandemic.
Unemployment is now at its lowest level since before the pandemic, but the full employment we’re returning to isn’t the same as what we left behind in 2020, DeLong said.
“We want to quickly return to a full-employment economy. But it’s a very different full-employment economy when we get back there,” DeLong said.
According to DeLong, the migration of workers from industries such as retail and hospitality to expanding sectors must be accompanied by incentives in the form of higher wages, which means inflation.
“If you want to create economic incentives for people to move into the expanding sectors where we actually need more workers, their wages have to go up,” he said.
“When you come out of a major recession, the natural inflation rate has to be above the normal 2%,” he added. “The rate of inflation that the market really wants to see in order to efficiently allocate production, distribution and transportation needs to be more than 2%.”
Not only is DeLong helping to propel the economy into the new era, but he sees another benefit in today’s inflation: It could help solve crippling supply chain bottlenecks by tapping into the business adage of high prices are often the best cure for high prices.
As supply chain issues contribute to high prices and make people less likely to buy, it could be the impetus for a revival and ultimately a strengthening of the industry, according to DeLong, who says inflation is getting more people involved in figuring out how to make more be able to produce what we need or less of what we don’t need.
“That’s the absolute beauty of the market,” he said. “When prices are aligned with social values, it means there isn’t just one or more brains working on the problem. All brains are working on the problem. And everyone is doing what they can to resolve it in their immediate situation.”
But as always, there’s a catch.
Risks of stagflation
The positive inflation outlook comes with a caveat, concede DeLong and other economists. The expectation that inflation will take root in the economy and continue could become a self-fulfilling prophecy, leading to even worse things for the economy.
The word for this is stagflation: the worst-case scenario of slow economic growth combined with high inflation. DeLong says it’s still very possible.
“The worst thing is that you get stuck in the 1970s stagflation,” he said. “If inflation gets stuck in expectations, that’s a very bad thing.”
The ideal situation, DeLong says, would be a repeat of the recessions that hit the US in the late 1940s and early 1950s, both of which were relatively brief before inflation eased.
But even a worst-case scenario of stagflation remains possible, DeLong warned, especially if inflation expectations solidify in the economy.
“Anchored” has been a bugbear for the Fed this year and a situation it is keen to avoid. Stuck inflation refers to people who expect prices to keep rising, which can cause inflation to last much longer than it would otherwise.
Should inflation solidify during a recession, it would be a “very bad thing” for the economy, DeLong said. Whether that will happen will likely depend on the direction of gasoline and energy prices, which have been very unpredictable so far this year.
“Whether expectations solidify and we get a problem from the 1970s really depends on how energy prices evolve,” he said. “Inflation expectations are always driven by what people see at the pump.”
Top economists and bankers – including Allianz and Gramercy chief economic adviser Mohamed El-Erian and Goldman Sachs CEO David Solomon – have warned that global inflation is already entrenching and becoming stubborn. And the World Bank has warned several times this year that persistent inflation combined with slow economic growth is creating a very real risk of stagflation in several countries around the world.
Also, not every economist shares DeLong’s view that there is much good in the current inflation, with many saying it is a much more pressing problem that the government is not adequately controlling.
Steve Hanke, an economist at Johns Hopkins University, recently criticized the Fed for “incompetence and mismanagement” that have led to inflation and predicted that if the Fed tightens US money supply, it will become a “whopper” next year -Recession could result.
Former DeLong boss Larry Summers has been singing a somber tune on inflation for over a year, warning last year that the Federal Reserve is too passive on rising prices. Released this week’s CPI report, Summers wrote that the Fed faces a “serious inflation problem” and warned that unemployment would likely have to rise again before inflation fell significantly.
Many economists fear that today’s high inflation and the Fed’s commitment to containing it could trigger a recession as early as next year, although whether that would constitute a deep or shallow downturn is undecided.
In a blog post last year, when inflation was already a concern, DeLong likened the recovering US economy to a suddenly accelerating engine. The skid marks left on the tarmac represented inflation – a blemish and a nuisance, to be sure – but it pays to get the economy back on track.
A year later, inflation can still only be a temporary slowdown on the road to recovery, he says. But between the war in Ukraine and uncertain energy markets for the foreseeable future, DeLong admits the outlook is much bleaker now.
“We have energy price inflation and food price inflation stemming from Russia and its attack on Ukraine. It complicates the picture significantly and makes the situation much more tense,” he said.
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