So-called ‘Team Transitory’ declared victors

On June 8, 2021, the UK Guardian published an Op Ed I wrote about inflation – Price rises should be short-lived – so let’s not resurrect inflation as a bogeyman. In that article, and in several other forums since – written, TV, radio, presentations at events – I articulated the narrative that the current inflationary pressures were transitory and would abate without the need for interest rate increases or cut backs in net government spending. In the subsequent months, I received a lot of flack from fellow economists and those out in the Twitter-verse etc who sent me quotes from the likes of Larry Summers and other prominent mainstreamers who claimed that interest rates would have to rise and government net spending cut to push up unemployment towards some conception they had of the NAIRU, where inflation would stabilise. I was also told that the emergence of the inflationary pressures signalled the death knell for Modern Monetary Theory (MMT) – the critics apparently had some idea that the pressures were caused by excessive government spending and slack monetary settings which demonstrated in their mind that this was proof that MMT policies were dangerous. Of course, they were just demonstrating their ignorance (deliberate or otherwise) of the fact that there are no MMT policies as such. MMT is an analytical framework not a policy regime. Anyway, in the last week, on mainstream economist seems to have recanted and has admitted that “Those who believed inflation would be transitory were proven right, and those who demanded the sacrifice of mass unemployment proven wrong”. For those E-mail warriors who think it is okay to send abusive messages to people you don’t know (or abusive messages in general) please do not send me apologies!

In the UK Guardian Op Ed, I noted the ‘inflation frenzy’ that the mainstream media promoted in 2021 – ‘fever pitch anxiety’ headlines and more were common.

They kept giving a platform toe the former US Treasury secretary Larry Summers who demanded that unemployment be pushed up significantly to quell the ‘demand pressures’ arising from President Biden’s fiscal injections during Covid.

He claimed that the US unemployment rate (then at 3.6 per cent) would have to rise higher than 5 per cent – in his words during a speech in London in June 2022:

We need five years of unemployment above 5% to contain inflation — in other words, we need two years of 7.5% unemployment or five years of 6% unemployment or one year of 10% unemployment … the gap between 7.5% unemployment for two years and 4.1% unemployment for one year is immense … Is our central bank prepared to do what is necessary to stabilize inflation if something like what I’ve estimated is necessary?

He thus demanded the US Federal Reserve push up interest rates to bring the unemployment rate up to some vague NAIRU estimate.

The mainstream of my profession mostly waded in supporting this prognosis and cure.

Inflation started declining in September 2022 or thereabouts.

I pointed out in various fora that unemployment rates in most countries had been relatively stable over an extended period yet the inflation rate was in retreat.

The point I was making in that context was that in that combination of events, the current (stable) unemployment rates had to be above any NAIRU (Non-Accelerating-Inflation-Rate-of-Unemployment) interpretation not below it, even if you believed in the veracity of the concept in the first place.

Why?

Orthodox theory says that if the unemployment rate is below the NAIRU, then inflation should be accelerating and vice versa.

So if the unemployment rate had been stable yet inflation was falling (decelerating) then the unemployment rate could not logically be below the NAIRU however estimated.

In other words, trying to run a conventional New Keynesian macroeconomic narrative to justify the central bank policy hikes – based on the ‘need’ to push the unemployment rate up to some NAIRU level and hence reduce aggregate spending – was not warranted.

The central bankers sho were champing at the bit to push up interest rates had no theoretical leg to stand on.

The more reasonable interpretation of the inflationary incidence was the one I outlined in the UK Guardian Op Ed, which pointed to the supply constraints due to the pandemic and subsequent profiteering by OPEC+ as the culprits.

I predicted that those causal factors would abate and that trying to equate the current episode with that which followed the OPEC hikes in October 1973 and the subsequent battle between labour and capital as to who would take the real income loss arising from the increased imported oil costs was a flawed argument.

I noted that the ability of workers to engage in that sort of distributional struggle has been constrained by the rise of precarious work, persistent elevated levels of unemployment and underemployment, and pernicious legislation that has reduced union capacity to pursue wage demands.

Thinking that unemployment had to rise to discipline wage demands from workers was faulty given there have been precious little wage movement since the pandemic even though unemployment rates have been relatively low.

When I wrote the UK Guardian Op Ed, Mr Putin had not yet launched his military action in Ukraine.

That clearly exacerbated the initial supply constraints and the world took time to adjust to the disruption to raw materials as a result of Black Sea blockades and production capacity destroyed in the conflict.

Which is why I was careful to condition my narrative by emphasising that ‘transitory’ did not necessarily have a time dimension attache to it.

The point was that transitory meant that the there were no structural propagating mechanisms (such as a labour-capital struggles over the real pie) to extend the initial supply shocks that precipitated the inflation.

That meant that once those shocks were worked through the system and adjustments made the inflation would rather quickly dissipate.

Which is what has happened.

Joseph Stiglitz authored an Op Ed on January 4, 2024 which carried the title – Time for a Victory Lap?.

The sub-title was “Those who believed inflation would be transitory were proven right, and those who demanded the sacrifice of mass unemployment proven wrong.”

To be fair to Stiglitz, he was one of a few economists who considered the inflation to be largely driven by supply-side constraints and that trying to engineer a rise in unemployment to quell ‘demand pressures’ was not the correct policy direction.

He says that:

Since the onset of post-pandemic inflation, there have been two schools of thought about the causes and the cure. One was based on standard macroeconomics: There had been excessive aggregate demand, fueled by excessively generous relief money to those struggling during the pandemic. The cure was standard too: tight monetary policy, until workers felt enough suffering to cry uncle, accepting declines in living standards and lower real wages, thereby reducing wage and price pressures …

The other school of thought focused on the unique characteristics of the pandemic and the war in Ukraine—the way in which these events induced changes in where people wanted to live and how they worked, as well as the extent of supply chain interruptions. Once the pandemic passed and markets had a chance to adjust, the surge in inflation would pass.

I somewhat disagree with the impression that these ‘schools of thought’ were somehow evenly balanced in the debate.

The standard view overwhelmingly dominated, which is why almost all central banks have hiked interest rates and fiscal authorities have pursued cut backs.

The ‘other school of thought’ was in a very small minority of economists.

The other point is that when Stiglitz writes “The debate this school had with those arguing for interest rate increases was not about whether normalizing interest rates above zero was a good thing, but whether the Federal Reserve and other central banks should go beyond that, raising interest rates to in excess of 5 percent, which they have now done.”

I accept that is the view he took when he was in “Team Transitory” as he termed the alternative view.

But I was not in that ‘Team’ even though I shared the same views about the causal factors driving the inflationary pressures.

As regular readers will know, Modern Monetary Theory (MMT) economists support a permanent zero nominal interest rate target (Japanese style) so any notion that rates of around 5 per cent would represent a ‘normal’, does not apply to this segment of the profgession.

That aside, Stiglitz concludes that:

… from the moment inflation broke out it was clear that Team Transitory was right.

I agree with that assessment obviously.

It was clear to me (and the other transitory crew) that the economy would adjust relatively quickly to the supply disruptions if only because the initial sickness arising from the pandemic would decline through vaccines and some immunity buildup (the latter which appears to be transitory itself).

It was also clear that shipping companies and related transport systems would develop workarounds to overcome the bottlenecks that developed.

The timing was uncertain for sure – but as we have seen (from around mid-2022) – “once the predicted responses took hold, inflation came down more quickly, without the alleged necessary increase in unemployment” (to quote Stiglitz).

Joseph Stiglitz writes that:

Seldom in history do we see such a quick test of alternative theories … But we’re at a place where we in Team Transitory can rightly claim victory. And credit for this achievement goes not to the Federal Reserve and central banks around the world. Their misdiagnosis of the problem, egged on by the other school … imposed enormous, continuing risks on the global economy and those least able to bear the weight.

I will mention the other great experiment that has been undertaken before our eyes in the current period later.

But he correctly noted that the inflationary pressures were not due to excessive “aggregate demand, of macroeconomics, but of pandemic-induced shifts in patterns of demand.”

The restrictions shut down the service sector yet provided income support to households who diverted their expenditure to goods, which could not be supplied fast enough.

Overall demand in most nations never really exceeded trend.

It was just the pattern of demand that – temporarily – changed.

I wrote about that in this blog post among others – Central banks are resisting the inflation panic hype from the financial markets – and we are better off as a result (December 13, 2021).

I followed up the data analysis in this blog post – The current inflation still looks to be a transitory phenomenon (March 28, 2022).

The other thing that we have observed in this current episode is the blatant misuse of market power by corporations – the so-called profit-gouging.

Joseph Stiglitz writes that:

Something else happened. Students of the American economy have noted the significant increases in market power in many sectors in the last two decades. Supply shortages increase market power, and predictably, this led to an increase in markups.

I wrote about that phenomenon in a series of blog posts among which were:

1. Banks gouging super profits, yield curve inversion – nothing good is out there (October 19, 2022).

2. The inflationary episode is being driven by profit gouging and interest rate hikes won’t help much
(March 27, 2023).

3. Electricity network companies profit gouging because government regulatory oversight has failed (November 22, 2023).

So far from a wage-price spiral emanating from a distributional struggle between workers and capital occurring, what we have observed is corporations using the increased price-setting power in the face of weaker unions and hostile industrial relations legislation, to increase their profit margins and undermine the real wages of workers even more than the initial rise in prices coming from the supply constraints.

As to the other ‘experiment’ – I identified it in this blog post – We have an experiment under way as the Bank of Japan holds its cool (March 31, 2022).

A later blog post continued the narrative – Two diametrically-opposed approaches to dealing with inflation – stupidity versus the Japanese way (October 6, 2022).

We had one central bank – the Bank of Japan – defying the consensus of central banks, the IMF, and taking on the financial markets and holding interest rates unchanged for the duration of this episode to date.

Not only that, the Japanese government expanded fiscal spending to help ease the cost of living pressures on households and firms.

Investors (aka gamblers) in the financial markets couldn’t believe their eyes each month when after they had placed all sorts of bets (short selling etc) on yen-based financial assets the Bank of Japan didn’t cave in and increase interest rates.

The constant stream of bets resulted in losses but still they came – which is testament to how ingrained the mainstream view was.

The Bank of Japan officials made it clear at the beginning that they would not be increasing rates to ‘fight’ and inflation that they knew was transitory in nature.

The evidence clearly validates their judgement and condemns the policy judgement of the rest of the central banking fraternity.

Conclusion

So we have now kicked off 2024.

We will see where that take us.

That is enough for today!

(c) Copyright 2024 William Mitchell. All Rights Reserved.