Some economists think that we're running the risk of overheating the economy due to the huge amount of stimulus spending that Congress has approved. Maybe so. But how will we know? What exactly is a sign that the economy is ready to spiral out of control?
The New York Times asked ten economists about this and their answers were surprisingly vague. Olivier Blanchard, former chief economist of the International Monetary Fund, literally just shrugged. Apparently his view is that he'll know it when he sees it.
But not me! I'll put a marker down:
If core PCE inflation is over 3% and and 5/5 inflation expectations are over 4% for a full year, then we've overheated. There's nothing magical about these numbers, but they seem reasonable to me.
It's worth acknowledging something, though. An awful lot of progressives take the attitude that, hey, there's no real danger here. If we overheat, the Fed knows how to bring inflation down. We'll be OK even if we do go a little too far.
And that's true. The problem is that the Fed's method for bringing down inflation is to engineer a recession. This is not exactly cost free, and the cost is paid primarily by the working class. So even if you think the current stimulus is OK, it's still worth it to keep the economy reined in enough that the Fed doesn't have to bring things to a grinding halt.
I wouldn’t mind receiving some interest on my cash hoard.
When inflation hits three or more percent what does that mean for interest payments as government debt is rolled over? How much debt is at what rate?
Doesn't mean much. A lot of debt is held by the fed, which just deposits the interest back with the Treasury. It will increase the debt payments on the government balance sheet - which is a problem only if we care about a balanced budget.
But what are the inflation expectations based on?
In order to actually see inflation, we would need to see unused manufacturing capacity disappear, and we would need to see the percentage of the labor force that is not employed become very small. And, since the economy is much more global than it used to be, this needs to happen globally.
We used to be able to bottleneck the global economy on oil, but it's much harder to do that these days: oil is a smaller fraction of the economy and any increase in price simply causes the alternatives to be delivered faster. Zimbabwe was able to bottleneck their economy on farming, but the United States is not primarily a farming economy.
So, what's the bottleneck you forsee that is going to deliver this high inflation?
I've heard some say that commodity prices, oil and copper, e.g., will be inflated and unless they get that ship in the Suez canal unstuck, shipping is going to be a problem. In fact shipping and subdued manufacturing due to the virus are already causing shortages in some goods (window AC units is what I'm aware of).
99-00 run is a good composite. Core inflation rose to 3+. Mainly driven by Y2K spending capex.
Shootie fall down! Would you please please please stop commenting on matters you know nothing about?
The problem is that the Fed's method for bringing down inflation is to engineer a recession. This is not exactly cost free, and the cost is paid primarily by the working class.
Um, the cost will be paid by the COUNTRY if a recession delivers the White House back to Donald Trump in 2024. I'm not overly worried about inflation*, but to the extent I do worry, THAT is what I worry about.
*America's prime age worker participation rate is really anemic compared to many other high income countries, so, unemployment statistics in America as a general rule understate the slack in the economy. So that's a big part of why I think a serious, problematic uptick in inflation isn't likely.
I don't think Kevin was talking about 2024, but 2025-28 period.
Based on what?
Outside of his conquering hero schtick at CPAC Orlando, El Jefe has remained oddly (too?) quiet.
& his one other public appearance of note, at his future Senator from North Carolina daughter-in-law's animal rescue charity event, he looked very doddering.
The biggest shock, though, was the absence of a CPACHIAN drop-in at the TPC in Jacksonville. Professional Golfers for Trump PAC is a natural building block for the Groverclevelandian move in 2024.
That former guy works in mysterious ways, don't you know? I've been getting robo calls from him, one last night thanking me for voting for him. He clearly isn't checking voter registrations and voting records. Maybe he just wants to annoy and aggravate all the people who _didn't_ vote for him.
The trigger for action should not be anything less than an inflationary spiral -- there is no need to take action if the rise in prices is self-limiting. And that will certainly be the case. If there is a spike in prices in the next several quarters due to Covid-relief spending, we can be sure that the last thing Congress will do is to pass another huge relief bill. So what else could provide the positive feedback that would sustain inflation for an extended period? In the past, the fear was that rising prices would bring demands for wage increases, which would further drive up prices, and so on. That wasn't unreasonable when many private-sector workers were organized. Has anyone seen evidence over the last four decades that wage- and salary-earners have the leverage to demand raises?
Right, but inflation at 3.5% will basically cull consumer spending and freeze growth. This is partially what happened in 2000-2001 triggering a growth recession.
there is no need to take action if the rise in prices is self-limiting. And that will certainly be the case.
Agreed -- this seems highly probable. Price rises are likely to be followed by an increase in mortgage rates (which will cool the economy) and/or a sell-off on Wall Street (ditto).
The FED knows how to control inflation.The FED does not know how to control deflation. Ref: Japan.
You seem to be unsure about what you're looking for. Is it an "overheated" economy, one that is "ready to spiral out of control", or simply just a persistently hot economy?
I ask because if PCE is fairly steady at over 3% for a year (or longer) *but* the employment rate keep increasing, that's ideal NAIRU, isn't it?
Not sure how to ask this question, but what is the macroeconomic benefit here if a lot of the covid 19 relief money to people is spent on reducing personal / consumer debt? (Including mortgage debt, car loan debt, student loan debt, credit card debt etc.) I suppose this is one for Krugman, and he's probably already answered it. Where can I find this information without paying NYTimes for subscription or taking a class in economics?
Kevin -
Are you basing your definition on over heated on the classic way of measuring inflation? If so if may be flawed:
https://www.bloomberg.com/news/articles/2021-03-24/inflation-is-harder-to-measure-after-a-year-of-pandemic-spending?srnd=premium
{snip}
First, gauges like the Consumer Price Index are based on a “basket” of stuff that Americans typically spent their money on in the past –- which looks quite different from what people have been buying in the pandemic year
Second, the standard way of compiling inflation numbers is to visit stores and check their asking prices. Researchers haven’t been able to do that during lockdown, leaving holes in the data. And a lot of shopping has in any case shifted online, where prices can be tailored to individual shoppers and subject to rapid change –- making them harder to measure
{snip}
And this as an example:
{snip}
“In effect, CPI weights suffered sudden obsolescence when the pandemic arrived,” Marshall Reinsdorf, an economist in the International Monetary Fund’s statistics department, said in a November presentation.
For example, dining out accounts for 6.3% of the U.S. CPI basket –- but Reinsdorf estimates that a measure of spending habits during the pandemic would have lowered that weighting by almost half. Meanwhile, Americans have been spending more on food at grocery stores, where prices accelerated last year.
{snip}
Just a personal observation. The Mrs and I had been using my daughter for most shopping but after receiving our first dose of the vaccine we finally did a major grocery shop ourselves. It seems like prices have risen substantially on many food items. This is anecdotal of course but coupled with the above story I would say all bets are off on measuring inflation accurately this year
Good points.
Engineering a recession is the Fed's big gun. They used it in the early '80s to break a self-reinforcing inflationary spiral. That doesn't mean it's the only tool at their disposal. A modest interest rate hike should be able to curb moderate inflation without triggering a recession.
The mechanisms that formerly sustained inflationary spirals have been dismantled. Global labor arbitrage and union-busting thwart any wage-price spiral. Energy-efficiency and the development of domestic gas and alternative technology prevent even a cartel from price-setting.