Financial panic

Inflation isn’t a real danger. But its prophets may hold the economy back.
Financial Panic illustration by Raul Arias

It is, perhaps, predictable. A large price tag comes attached to the latest federal proposal, and a familiar chorus emerges: But what about inflation?

There was Sen. Pat Toomey (R-Pa.) last month, warning Federal Reserve Chair Jerome Powell of “a real danger that we have overheating.” Economists like Larry Summers, Olivier Blanchard and Greg Mankiw opined that the administration risked pushing the economy too fast. And there were perma-hawks, like economist Peter Schiff and President Donald Trump’s would-be Fed nominee, Steve Moore, who saw potential inflation lurking in any government attempt to resuscitate the economy. “It worries us that he’s not worried,” Moore said of Powell in his newsletter last week.

Lizzie O’Leary is an economic and policy journalist. She hosts the podcast What Next TBD for Slate.

This time, the proximate cause is the Biden administration’s $1.9 trillion coronavirus rescue package, coupled with the Fed’s new approach, which aims to let inflation hover near 2 percent (and go slightly above it when necessary), instead of strictly targeting 2 percent. What happens, the inflation hawks ask, if we emerge from the pandemic with an economic boom? If everyone gets back to work and uses that government money, will wages and prices suddenly shoot up? It’s not an outrageous question: Theory holds that goods will cost more and our money will buy less.

But that’s not happening yet. And it hasn’t happened in a very long time. Our understanding of inflation has changed, our ability to control it has improved and the danger is more remote than we once believed. Yet the hawkishness is reflexive — an immutable instinct, no matter what more than a decade of data says. Every spending measure, especially during a Democratic administration, meets the same response: Pundits and politicians assume a familiar stance born out of a generational way of economic thinking that no longer holds. The result is a futile debate that risks leaving millions of Americans in deep financial ruin if the United States doesn’t respond aggressively enough to the pandemic.

The government has pumped massive amounts of money into the economy to combat the pandemic recession. Near-zero interest rates from the Federal Reserve have lowered the cost of borrowing for businesses and consumers since last March, in an echo of the central bank’s strategy after the financial crisis in 2008. The Fed also expanded lending to a wide array of businesses, committed to $120 billion in asset purchases each month and now has a balance sheet of $7.6 trillion. Add a $900 billion bipartisan aid package passed in December, just six months after the first $2 trillion coronavirus relief package. Even in Washington, that’s a lot.

And yet by any measure, there is still no reason for panic. The consumer price index rose a laggardly 1.4 percent over the past year. Core personal consumption expenditures (or PCE, the Fed’s preferred measure of inflation) rose 1.5 percent. Both are far below the Fed’s goal of holding inflation to an average of 2 percent a year.

In fact, the last time the United States felt even a hint of the kind of inflation the Fed worries about was in the third quarter of 2008, when core PCE (a measure of the price of basic goods and services, not counting food and energy) hit 2.2 percent, hardly the double-digit inflation that became a crisis in the 1970s. Since then, the lack of inflation has essentially been a get-out-of-jail-free card for policymakers to try any number of stimulus measures, such as the Fed’s bond-buying program. That’s meant cheaper money for businesses and consumers, lower mortgage rates and a soaring stock market. “We’ve averaged less than 2 percent inflation for more than the last 25 years,” Powell told the Senate Banking Committee last month. In January, speaking at a session presented by Princeton Univerisity, Powell was explicit: “If inflation were to move up in ways that are unwelcome, we have the tools for that. And we will use them. No one should doubt that.”

The Fed says it’s paying attention to inflation. The economic stats look fine. And economists are beginning to agree that the labor market is weaker than it appears. Yet the warnings persist — even though they’ve been proved wrong. Why?

One reason is a belief that, after a certain point, government spending is counterproductive. In November 2010, just as the economy was pulling out of the Great Recession, a group of right-leaning wonks and investors signed a letter warning Ben Bernanke, the Fed chairman at the time: The central bank’s massive bond-buying program, meant to spark demand, risked both causing inflation and devaluing the U.S. dollar against other currencies, they said, and the policy wouldn’t lift employment anyway. They were wrong. Unemployment dropped from 9.8 percent that month to 6.6 percent in January 2014 at the end of Bernanke’s term. And a worrying level of inflation never showed up — not during Bernanke’s term, and not afterward.

Kevin Hassett, Trump’s former economic adviser, signed the letter back then. “It turned out that risk wasn’t realized,” he says now. (He believes that the Biden administration’s coronavirus rescue plan is too large but says, “It would be foolish not to have some fiscal policy right now” that pumped money into the economy.)

Another reason, fretted over by a different set of economists, concerns something called the “output gap.” That’s the difference between where the economy is running now and its ideal state. Summers and Blanchard argue, with numbers from the Congressional Budget Office, that the output gap is much smaller than $1.9 trillion, the amount President Biden wants to spend on stimulus. Pump that much money into the economy, they say, and wham — inflation. Other economists, like Paul Krugman and Wendy Edelberg, counter that the degree of damage done by the pandemic is uncertain and $1.9 trillion ensures that the economy will hit its stride.

Then there’s just, well, politics. Democrats — certainly centrist Democrats — have warned about deficit spending under Republican presidents, Hassett points out. And, as Austan Goolsbee, who chaired the White House Council of Economic Advisers under Barack Obama, puts it, “As soon as the Democrat’s elected, now [Republicans have] rediscovered that there’s a fear of inflation.”

The GOP worries about inflation more than unemployment because the party takes the side of capital. In an inflationary scenario, a debtor ends up repaying a creditor with money that is worth less than it was before. If you look at, for instance, the average income of the GOP, if you look at who gives to the GOP, if you look at the explicit preferences of your state or federal GOP lawmakers,” said George Pearkes, a macroeconomic strategist for Bespoke Investment Group, “these are people who are interested in protecting capital and protecting creditors.”

Ultimately, though, some of the fear of inflation just seems like a psychic hangover from another era — the 1970s and 1980s, when inflation drifted into double digits. That influenced a generation of policymakers, including many Democrats like Summers.

Beginning in 1979, Fed Chairman Paul Volcker undertook a program to crush inflation — at great cost. He decided to target the overall amount of money in the economy and allowed the interest rates that he helped set to rise above 19 percent, which curbed spending (imagine getting a mortgage at that rate) and brought inflation back down to a manageable 4 percent by 1983, though it also led to two recessions. He is rightly lionized, and people like Summers, Mankiw, former treasury secretary Robert Rubin, former White House chief of staff Erskine Bowles and former Council of Economic Advisers chair Glenn Hubbard came of age watching both an economic emergency and how Volcker reacted to it.

Looking at inflation through a 40-year-old lens is what Goolsbee, a Volcker protege, termed the “generational argument.” An entire cohort of economists was primed to see the slightest sign of inflation as a crisis, said Lisa Cook, a professor at Michigan State and a potential Biden Fed nominee: “If you were trained in, let’s say the 1970s, early ’80s, when this was such a big shock, this was such a focus of macroeconomic research and training, I think that you’re trained to look for it.” (Similarly, research shows that personal experience with inflation informed the behavior of hawks on the interest-rate-setting Federal Open Market Committee.)

This past week, the president of the Federal Reserve Bank of San Francisco, Mary Daly, said something similar, calling the swell of mutterings about inflation “the tug of fear.” In a speech to the Economic Club of New York on Tuesday, she described it as “the reaction to a memory of high and rising inflation . . . and a Federal Reserve that once fell behind the policy curve.”

That fear, that a Fed might fall behind the policy curve and miss the inflationary signals, is powerful — and not to be entirely discounted. “One should not go from saying, ‘Oh, we haven’t had inflation in a dozen years,’ ” says Narayana Kocherlakota, a former president of the Federal Reserve Bank of Minneapolis, “to ‘Oh, it’s impossible to have inflation.’ ” So far, though, the numbers just don’t support the kind of reflexive hypervigilance of the post-Volcker generation.

Some worrywarts might argue that they’re not just stuck in the past — they think that when the economy gets going again, the output gap will close much sooner than the Fed is banking on. But, says economist Cladia Sahm, who has written about the inflation fever dreams, they’re overestimating how precisely we can measure that gap — and the economy’s power. Sahm thinks the hawks are also underestimating the damage wrought by the pandemic and not worried enough about the 10 million Americans who are on the sidelines of the economy — and whether those people will ever return to the labor market, or have the opportunity to.

The pandemic, after all, isn’t just an input to plug into economic models. Michigan State’s Cook, who is Black, worries that some of her economist colleagues aren’t seeing just how bad things have gotten. She noted the number of members of her church who have died of covid-19: “I am just thinking that our worlds are so segregated by class and by race.” She worries in particular about people on the edge of the labor force and women who have been forced out of work to care for children. “Are many of these jobs going to come back?” she wonders. “Let’s say that 7 million people go back to work. That’s 3 million people who won’t.”

From a human standpoint, it seems like a no-brainer. Stop overly worrying about unlikely inflation and support a roaring economy, one that’s inclusive enough to pull people off the sidelines. It’s essential medicine. If only the hawks can be convinced to let us take it.

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