Why I’m not Apologizing for Calling Recent Inflation Transitory

I’ve written three recent blogposts explaining why the inflation that began accelerating in the second half of 2021 was likely to be transitory (High Inflation Anxiety, Sic Transit Inflatio del Mundi, and Wherein I Try to Calm Professor Blanchard’s Nerves). I didn’t deny that inflation was accelerating and likely required a policy adjustment, but I also didn’t accept that the inflation threat was (or is) as urgent as some, notably Larry Summers, were suggesting.

In my two posts in late 2021, I argued that Summers’s concerns were overblown, because the burst of inflation in the second half of 2021 was caused mainly by increased consumer spending as consumers began drawing down cash and liquid assets accumulated when spending outlets had been unavailable, and was exacerbated by supply bottlenecks that kept output from accommodating increased consumer demand. Beyond that, despite rising expectations at the short-end, I minimized concerns about the unanchoring of inflation expectations owing to the inflationary burst in the second half of 2021, in the absence of any signs of rising inflation expectations in longer-term (5 years or more) bond prices.

Aside from criticizing excessive concern with what I viewed as a transitory burst of inflation not entirely caused by expansive monetary policy, I cautioned against reacting to inflation caused by negative supply shocks. In contrast to Summers’s warnings about the lessons of the 1970s when high inflation became entrenched before finally being broken — at the cost of the worst recession since the Great Depression, by Volcker’s anti-inflation policy — I explained that much of 1970s inflation was caused by supply-side oil shocks, which triggered an unnecessarily severe monetary tightening in 1974-75 and a deep recession that only modestly reduced inflation. Most of the decline in inflation following the oil shock occurred during the 1976 expansion when inflation fell to 5%. But, rather than allow a strong recovery to proceed on its own, the incoming Carter Administration and a compliant Fed, attempting to accelerate the restoration of full employment, increased monetary expansion. (It’s noteworthy that much of the high unemployment at the time reflected the entry of baby-boomers and women into the labor force, one of the few occasions in which an increased natural rate of unemployment can be easily identified.)

The 1977-79 monetary expansion caused inflation to accelerate to the high single digits even before the oil-shocks of 1979-80 led to double-digit inflation, setting the stage for Volcker’s brutal disinflationary campaign in 1981-82. But the mistake of tightening of monetary policy to suppress inflation resulting from negative supply shocks (usually associated with rising oil prices) went unacknowledged, the only lesson being learned, albeit mistakenly, was that high inflation can be reduced only by a monetary tightening sufficient to cause a deep recession.

Because of that mistaken lesson, the Fed, focused solely on the danger of unanchored inflation expectations, resisted pleas in the summer of 2008 to ease monetary policy as the economy was contracting and unemployment rising rapidly until October, a month after the start of the financial crisis. That disastrous misjudgment made me doubt that the arguments of Larry Summers et al. that tight money is required to counter inflation and prevent the unanchoring of inflation expectations, recent inflation being largely attributable, like the inflation blip in 2008, to negative supply shocks, with little evidence that inflation expectations had, or were likely to, become unanchored.

My first two responses to inflation hawks occurred before release of the fourth quarter 2021 GDP report. In the first three quarters, nominal GDP grew by 10.9%, 13.4% and 8.4%. My hope was that the Q4 rate of increase in nominal GDP would show a further decline from the Q3 rate, or at least show no increase. The rising trend of inflation in the final months of 2021, with no evidence of a slowdown in economic activity, made it unlikely that nominal GDP growth in Q4 had not accelerated. In the event, the acceleration of nominal GDP growth to 14.5% in Q4 showed that a tightening of monetary policy had become necessary.

Although a tightening of policy was clearly required to reduce the rate of nominal GDP growth, there was still reason for optimism that the negative supply-side shocks that had amplified inflationary pressure would recede, thereby allowing nominal GDP growth to slow down with no contraction in output and employment. Unfortunately, the economic environment deteriorated drastically in the latter part of 2021 as Russia began the buildup to its invasion of Ukraine, and deteriorated even more once the invasion started.

The price of Brent crude, just over $50/barrel in January 2021, rose to over $80/barrel in November of 2021. Tensions between Russia and Ukraine rose steadily during 2021, so it is not easy to determine the extent to which those increasing tensions were causing oil prices to rise and to what extent they rose because of increasing economic activity and inflationary pressure on oil prices. Brent crude fell to $70 in December before rising to $100/barrel in February on the eve of the invasion, briefly reaching $130/barrel shortly thereafter, before falling back to $100/barrel. Aside from the effect on energy prices, generalized uncertainty and potential effects on wheat prices and the federal budget from a drawn-out conflict in Ukraine have caused inflation expectations to increase.

Under these circumstances, it makes little sense to tighten policy suddenly. The appropriate policy strategy is to lean toward restraint and announce that the aim of policy is to reduce the rate of GDP growth gradually until a sustainable 4-5% rate of nominal GDP growth consistent with an inflation rate of about 2-3% a year is reached. The overnight rate of interest being the primary instrument whereby the Fed can either increase or decrease the rate of nominal GDP growth, it is unnecessary, and probably unwise, for the Fed to announce in advance a path of interest-rate increases. Instead, the Fed should communicate its target range for nominal GDP growth and condition the size and frequency of future rate increases on the deviations of the economy from that targeted growth path of nominal GDP.

Previous monetary policy mistakes that caused either recessions or excessive inflation have for more than half a century resulted from using interest rates or some other policy instrument to control inflation or unemployment rather than to moderate deviations from a stable growth rate in nominal GDP. Attempts to reduce inflation by maintaining or increasing already high interest rates until inflation actually fell needlessly and perversely prolonged and deepened recessions. Monetary conditions ought be eased as soon as nominal GDP growth falls below the target range for nominal GDP growth. Inflation automatically tends to fall in the early stages of recovery from a recession, and nothing is gained, and much harm is done, by maintaining a tight-money policy after nominal GDP growth has fallen below the target range. That’s the great, and still unlearned, lesson of monetary policy.

7 Responses to “Why I’m not Apologizing for Calling Recent Inflation Transitory”


  1. 1 Kevin Erdmann April 19, 2022 at 2:41 pm

    Great stuff.

    Like

  2. 2 Benjamin Cole the Tin-Foil Hat Economist April 19, 2022 at 4:35 pm

    Excellent blogging.
    BTW, the macroeconomics profession is often dispiriting. The best labor markets in 60 years and all we can hear from the titans of the industry is how miserable everything is everywhere.

    Like

  3. 3 Jhow April 22, 2022 at 11:11 am

    “Inflation automatically tends to fall in the early stages of recovery from a recession”

    I don’t think any central bank would agree with that

    Like

  4. 4 marcus nunes April 23, 2022 at 4:33 am

    I did a breakdown of inflation. It appears the Fed is already taking action (outside of the interest rate “hysteria”) to tame inflation.
    https://marcusnunes.substack.com/p/a-definitive-breakdown-of-inflation?s=w

    Like

  5. 5 David Glasner April 25, 2022 at 6:26 pm

    Kevin, Thanks.

    Benjamin, Thanks, I agree that the reaction to inflation has been been excessive, but, for a number of reasons, it’s not surprising, especially since the public seems to be genuinely upset by inflation because of a kind of money illusion in which inflation is blamed for raising prices but not credited for raising incomes.

    Jhow, You may be right, but if so, it’s on them.

    Marcus, I would be surprised if they weren’t and I assume they will do more.

    Like

  6. 6 joe camel May 10, 2022 at 5:13 pm

    you refuse to acknowledge the effect of massive increase in money supply demand shock. hand up your degree on a broken elk antler

    Like

  7. 7 David Glasner May 11, 2022 at 12:16 pm

    Joe, I actually have acknowledged it and I’ve written a number of times that demand stimulation and monetary expansion occurred during the pandemic. In an unprecedented situation, that expansion may have been appropriate, but perhaps there was too much of a good thing. Given the many uncertainties in the current economic environment, I have urged caution in scaling back the stimulus, but clearly the stimulus now does need to be scaled back.

    Like


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About Me

David Glasner
Washington, DC

I am an economist in the Washington DC area. My research and writing has been mostly on monetary economics and policy and the history of economics. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey’s unduly neglected contributions to the attention of a wider audience.

My new book Studies in the History of Monetary Theory: Controversies and Clarifications has been published by Palgrave Macmillan

Follow me on Twitter @david_glasner

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