Lawrence Summers set off a storm of criticism from progressives last month when he warned that President Joe Biden’s $1.9 trillion “Go Big” stimulus might set off serious inflation.
What also stung is that Summers served as treasury secretary under President Bill Clinton and is an economist with impeccable liberal credentials.
When average folks see that the price of lumber tripled during the pandemic, Summers’ caution enters the realm of the everyday.
The bond market has been unsettled lately, too, with long-term yields creeping higher. Inflation is the enemy of bonds because it undercuts the real value of the fixed interest that investors collect.
A classic inflation definition of “too much money chasing too few goods” doesn’t quite capture the lived experience of high inflation.
Those of a certain age remember the 1970s, when prices tripled from the 1973-74 oil embargo and tripled again from a second oil-price shock caused by the Iranian revolution of 1979. Paychecks couldn’t keep up. People saw their savings shrivel (with less purchasing power than when they put it in the bank a few years before). The consumer price index grew at a staggering 13.5% in 1980.
This wasn’t comparable to the hyperinflation of Weimar Germany in the early 1920s when bank notes became so worthless they were used as wallpaper, but it was enough to help unseat President Jimmy Carter.
The medicine employed by Carter’s new Federal Reserve Chairman Paul Volcker (kept on by President Ronald Reagan) to break inflation — a massive hike in interest rates — seemed worse than the illness in the severe recession of 1981. But Volcker succeeded and inflation was tamed.
Back to now.
The worries of Summers and some others is that much of the economy is recovering from the pandemic recession. A massive stimulus, combined with low interest rates and unconventional help from the Fed, along with an expected snapback in consumer and business spending as the pandemic comes under control, risks setting off inflation, they argue.
Mary Daly, president of the Federal Reserve Bank of San Francisco, pushed back in a recent speech.
“I see this as the tug of fear,” Daly said. “The reaction to a memory of high and rising inflation, an inexorable link between unemployment, wages and prices, and a Federal Reserve that once fell behind the policy curve.
“But the world today is different, and we can’t let those memories, those scars, dictate current and future policy. We need to learn from history without letting it drive our actions. We must consider all the lessons from our past, not just the ones that frighten us.”
Indeed, the key measure by which the central bank measures inflation was only 1.68% as of January. In recent years, inflation has rarely surpassed 2%, the Fed’s Goldilocks target for “not too cold, not too hot, just right.”
Federal Reserve Chairman Jerome Powell is comfortable with the central bank’s stance, even with the bond jitters. “In a way, it’s a statement of confidence on the part of markets that we will have a robust and ultimately complete recovery,” he said about the bond market’s behavior this past week in congressional testimony.
People not of a certain age remember only the post-Volcker world, “the great moderation,” which saw low inflation and decent growth.
The reasons behind the phenomenon are complex. But one anchor is monetary policy that doesn’t let inflation fester for years, as happened in the late 1960s and 1970s. Another driver of low inflation doesn’t quickly come to mind: Globalization, which lowered prices.
A consequence of globalization has been lower wages, lost jobs and rising inequality in most advanced Western economies. Donald Trump campaigned against it, specifically China.
Biden, too, warned that China “will eat our lunch,” although specifically referring to the need for an increase in U.S. infrastructure spending.
Yet too great a backlash against China could seed higher inflation. As Harvard economist Kenneth Rogoff put it, “Westerners need to recognize that when it comes to global manufacturing, China is the one making lunch, and the meal would cost a lot more if it wasn’t.”
Maybe the more expensive “meal” is a price we need to pay to reduce inequality and create more and better jobs here. But it must happen in a policy environment where the central bank keeps its independence and can stay ahead of inflation with gradual rate hikes that keep inflation moderate. The alternative is ignoring inflation until a slam-on-the-brakes recession is caused by the Fed intervening too late.
Based on what we know, Biden’s stimulus is badly needed; so is investment in infrastructure.
Too many people are unemployed, too many sectors are hurting, and demand is too weak to worry about inflation hypotheticals. We’re not yet out of the danger of a long “pandemic depression.”
Powell argues that any inflation from a recovery would be short-lived. And Biden’s stimulus would be steered by a former Fed chair, Treasury Secretary Janet Yellen.
As for lumber, it’s not a canary in the coal mine. This price spike can be explained by soaring demand — including booming housing construction, as well as boarding up businesses against looters and vandals in cities such as Seattle and Portland — running up against mills hobbled by the pandemic.
The bond market is another matter. Yields on 10-year Treasurys are quite low. The biggest risk isn’t inflation but that “bond vigilantes” spook the Fed into pulling back support of low interest rates. Then inflation would be the least of our worries.