Consumer prices have increased 4.4% in the last six months; it is an annualized inflation rate close to 9%, which almost brings us back to the territory of the 1970s. And there are many who proclaim the return of stagflation. But those who can do something about it – especially Jerome Powell, chairman of the Federal Reserve – are pretty calm. They insist that we are observing a mere transitory irregularity caused by the disruptions associated with the United States’ exit from the pandemic. They are right? How can we find out?
To answer those questions, we must step back and ask what it means in any case that inflation is transitory. And for this it is useful to think in the long term. I have the feeling that many believe that inflation did not occur in the United States until the 1970s. But it is not true. We have had data on consumer prices for more than a century, and throughout that period there have been several episodes of high inflation. The 1970s was not even the peak.
What is the difference between the inflation of the seventies of the last century and the inflationary peaks associated with the First World War, the end of the Second World War, or the Korean War? The answer is that previous bouts of inflation came and went: The economy did not exactly painlessly regain price stability, but the recessions associated with disinflation were quite brief. By contrast, ending the inflation of the 1970s meant a prolonged period of really high unemployment.
But how is this difference explained? In the 1970s inflation was “built into” the economy. Those who set wages and prices did so with the expectation that there would be a lot of inflation in the future. For example, companies were relatively willing to raise their workers’ pay because they thought their rivals would end up doing the same, so that would not put them at a competitive disadvantage.
The question is whether inflation is now integrating as well. We used to have a fairly easy and impromptu way of answering that question: the concept of core inflation. In the 1970s, economist Robert Gordon suggested that we make a distinction between the price of commodities like oil and soybeans, which fluctuate constantly, and other prices that adjust less frequently. Gordon argued that a measure of inflation excluding food and energy would give us a much better indicator of core inflation — that is, integrated — than headline inflation.
The concept of core inflation has been one of the great success stories in data-driven economic policy. In the last 15 years we have seen several rises in consumer prices driven mainly by commodity prices, and a lot of hyperventilation, mainly on the political right, due to the return of stagflation or even imminent hyperinflation. Remember when Paul Ryan, then Republican Representative from Wisconsin, accused Ben Bernanke, former chairman of the Federal Reserve, of “downgrading the dollar”?
However, the Federal Reserve refused to abandon its easy money policy, pointing out as a reason for not being concerned that core inflation remained sluggish. And he was right. Unfortunately, at this time, the traditional measure of core inflation is not very useful, because the pandemic has caused price spikes in unusual sectors such as used cars and hotel rooms. So how can we guide ourselves?
The White House Council of Economic Advisers has been using a kind of “super-underlying” measure that not only excludes food and energy, but also sectors affected by the pandemic. Makes sense; in fact, I defended that measure months ago. But I am aware that by excluding more data from the Consumer Price Index, you expose yourself to being accused of saying there is no inflation if you ignore rising prices.
Powell has proposed a different measure: Wage hikes, which have been substantial in some of the sectors hit by the pandemic, but generally still appear moderate on scales like the Federal Reserve Bank of Atlanta’s wage hike tracker. However, lately, I’ve been wondering if the best way to find out if inflation is integrating is to ask who would do that integration. That is, are companies acting as if they anticipate sustained inflation in the future?
The answer, for now, appears to be no. Many companies face a labor shortage and try to attract workers with measures such as hiring bonuses. But, at least according to the Federal Reserve’s Beige Book – an informal survey that’s often helpful for getting a feel for business psychology – they are reluctant to raise wages.
For the record, I am not celebrating the corporate unwillingness to raise salaries. The point is, rather, that companies do not act as if they anticipate a lot of future inflation, in which they could raise wages without losing competitive advantage. Rather, they act as if they see current inflation as a passing incidence.
For the moment, therefore, I am still in the Transitional Team: I think the situation is more like that of 1951, when inflation briefly reached 9.3%, than it was in 1979. And if we finally manage to control this pandemic, the Memory of the inflation of 2021 will soon be erased from memory.
Paul Krugman He is a Nobel Prize in Economics. © The New York Times, 2021. Translation News Clips