It’s been a good week on the inflation front. First, we had a flat month for CPI – zero inflation in July. Then we saw an actual drop in the PPI.
Of course, there is a lot of opposition to the good news. I have seen many warnings against believing those who claim that the problem of inflation has been solved. The thing is, I don’t know who is supposed to make that claim. Every economist I know thinks that America is still suffering from high inflation. The real question is how difficult it will be to bring down this core inflation – whether we will need an extended recession like the one we experienced in the 1980s. And the answer to that question depends a lot on whether you think our current situation resembles that in 1980.
First, about the good news: One of the most enduring and successful concepts in macroeconomics is the distinction between headline inflation and “core” inflation, which excludes highly volatile prices. The traditional calculation of core inflation excludes food and energy; This account has been called into question given the weird turmoil and price action we’ve seen in the Covid era, but the traditional metric is good enough for today’s newscast. Here are the latest monthly rates of headline and core inflation:
Until July, core rates were more or less above core inflation. Now, with lower gasoline prices, easing supply chain problems and so on, we’re seeing this difference mirroring itself. The result is likely to be several months, at least, of relatively low inflation.
But, as I said, core inflation remains high, at least by the standards of the last 30 years or so. There are many competing estimates for this base rate, but in general it tends to be in the 4 to 5 percent range, compared to the Fed’s 2 percent inflation target.
So how difficult is it to achieve this goal?
The last time we saw inflation rates this high was in the early 1980s. Comparisons between data then and now are a bit tricky, because the Bureau of Labor Statistics has changed the way it estimates inflation. But it did produce estimates of inflation rates that it would have reported in the past had modern methods been used. If we compare these estimates for 1980 to recent inflation – this time over the past year – you can see that inflation today is lower than it was in 1980, but not all of it. who – which Much less:
Reducing inflation in the 1980s was a painful process. We tend to view the Reagan-era economy through rose-tinted glasses, in part because conservatives have spent decades glorifying it. But the truth was that America went through a long period of extremely high unemployment after the Federal Reserve started cracking down on inflation:
And one of the points I didn’t see was that all of this unemployment didn’t bring inflation down to 2 percent; In the 1980s, the Federal Reserve was satisfied with inflation stabilizing at around 4 percent. So we are now faced with the need to achieve an inflation rate similar to that designed by Paul Volcker (unless the Fed changes its target – but that’s a discussion for another day).
So why do you imagine that this time will be easier? The answer goes back to why (most) economists think inflation was very difficult in the 1980s. At the time, the story goes, everyone was expecting high inflation forever. Wages and prices were set based on this expectation, so inflation became self-sustaining. De-inflation required the economy to be squeezed hard and long enough to break the cycle of self-sufficiency.
And while actual inflation now does not look very different from what it did in the 1980s, expectations for future inflation do look very different. We can compare projected inflation rates over the next year and the next five years from then and now; The 1980 data (for February 1980) is from the Michigan Survey, and the 2022 data is from the Federal Reserve Bank of New York:
At the time, the public expected 10% inflation almost forever. Today, the public is expecting inflation to rise somewhat in the near term but fall back to normal levels soon.
The story of professional economic forecasters is similar. In the early 1980s, blue chip forecasters projected inflation of about 8 percent over the next 10 years. Now they are forecasting less than 3 per cent, and financial markets are expecting inflation of less than 2.5 per cent.
You may be wondering why, if projected inflation remains low, actual inflation is so high. The answer, most likely, is that the US economy is currently overheating in a way that it was not in 1980. If this is true, lowering inflation requires cooling the economy down, but not putting it into an extended recession.
So this is the case to say that in 2022 no 1980. Should we believe him?
Well, this relatively optimistic story is not set up right away to downplay our problems; It is directly based on standard economic models. And my own experience is that when I make big prediction errors, it’s usually because I’ve decided the standard models won’t apply, and then I’m unfavorably surprised when I find it works after all. So I believe in an optimistic (relatively) inflation scenario…I think so.
But even this optimistic scenario still includes calming the US economy by raising interest rates. So, if there are indeed economists who believe that the problem of inflation has already been solved, I am not one of them.