Never Bark At the Big Dog. The Big Dog Is Always Right.
I have been warning for months now about the inflationary effects of last year’s massive money printing. I have outlined in my Economic Newsletter exactly how the monetized inflation gap in our economy threatens to trigger inflation in the 9.5-10 percent bracket.
Initially I was virtually alone in raising the inflation red flag. For the longest time, in fact, economists were smiling at the inflation threat, missing no opportunity to explain why trillions of dollars of stimulus spending would not cause inflation. In fact, I had an email exchange with a reputable economist last fall where this person basically laughed in my face (as much as you can do that over email…) explaining that I was crazy thinking that we would see any kind of noticeable inflation.
Well, as they say, the only thing worse than being right is being right first… But that is what we do here at the Liberty Bullhorn: we don’t wait for the choirs to chime in. We go where scholarship and experience take us, and if that means that we sound the alarm bells over high inflation, then we do so.
Since we first did that, others have come along. So far, though, we are the only publication that has put any kind of analytically based number on the inflation threat. Others refrain from doing so, probably because they live by the credo that it is better to be approximately right than exactly wrong. I share that sentiment, but there are times when you have to risk being just that – exactly wrong – because the consequences of everyone waiting for everyone else are greater than the consequences of me being exactly wrong. If inflation turns out to be 8.9 or 12.2 percent by the end of this year, and not within the bracket I have predicted, I can live with that; what matters is to present good arguments as backup for facts and conclusions that many others consider to be uncomfortable or even provocative.
The worry that many people feel over inflation – and inflation forecasts – cannot get in the way of a vigorous debate over its risks and consequences. It is problematic that the inflation warning bells are still not sounding loudly enough to wake up Congress to the dangers of runaway prices.
But all is not lost. More voices are chiming in. Behold Larry Summers, former Secretary of the Treasury and long-time Democrat affiliated economist. In a Washington Post op-ed on February 4 he warned about inflation and made a telling comparison between the 2009-10 stimulus spending during the Obama administration and what President Biden and the Democrats in Congress have now worked out. The comparison, he explains,
is instructive. In 2009, the gap between actual and estimated potential output was about $80 billion a month and increasing. The 2009 stimulus measures provided an incremental $30 billion to $40 billion a month during 2009 — an amount equal to about half the output shortfall. In contrast, recent Congressional Budget Office estimates suggest that with the already enacted $900 billion package — but without any new stimulus — the gap between actual and potential output will decline from about $50 billion a month at the beginning of the year to $20 billion a month at its end. The proposed stimulus will total in the neighborhood of $150 billion a month, even before consideration of any follow-on measures. That is at least three times the size of the output shortfall.
Economists should be careful with the term “output gap”, as it rests on dicey economic theory. However, the problems associated with this theory are a topic for another day; what matters here is the conclusion that Summers draws:. Cautioning – as economists always do – that there are “enormous uncertainties” associated with every forecast, he notes that
there is a chance that macroeconomic stimulus on a scale closer to World War II levels than normal recession levels will set off inflationary pressures of a kind we have not seen in a generation, with consequences for the value of the dollar and financial stability. This will be manageable if monetary and fiscal policy can be rapidly adjusted to address the problem. But given the commitments the Fed has made, administration officials’ dismissal of even the possibility of inflation, and the difficulties in mobilizing congressional support for tax increases or spending cuts, there is the risk of inflation expectations rising sharply.
Summers is the first economist after me to actually point to inflation levels around ten percent. That is literally what he means with “inflationary pressures of a kind we have not seen in a generation”. He is welcome onboard.
Of course, you don’t criticize a Democrat president for possibly causing inflation and just walk away from it – especially not if you are “one of them”. Soon after Summers’ op-ed, Jared Bernstein another long-time Democrat economist and member of Biden’s Council of Economic Advisors, fired back:
Bernstein, a member of the Council of Economic Advisers, told reporters at a White House press briefing that he disagreed with Summers’s op-ed and that the former Treasury secretary was “flat-out wrong” to suggest Biden administration officials were dismissive of the inflationary risks.
So on the one hand Summers is wrong in pointing to the inflationary risks of more stimulus spending, but on the other hand he is right and President Biden is very well aware of those risks.
One of many economists who said last summer that we had no reason to worry about inflation was former IMF chief economist Olivier Blanchard. Now, all of a sudden, Blanchard has come around and seen the light – or at least part of it. Tweeting his opposition to the Biden stimulus package, Blanchard explained
that the size of the stimulus injected into the economy would be too large, especially when added to the measures taken last year. The additional spending power created by the additional $1.9 trillion budget deficit would drive up prices and force the Federal Reserve to hike interest rates.
In his tweet series, Blanchard concluded that the latest stimulus spending
would lead to strong inflation (not the 2.5% that some predict, but potentially much more), and, likely a strong reaction of the Fed to limit the overheating, a very large increase in interest rates, again far more than is currently priced in.
Of course, as we have already noted here at the Liberty Bullhorn, the Federal Reserve will not allow interest rates to go up. They believe the economy is incapable of reaching, let alone maintaining full employment without very low interest rates. On February 2 we explained that
the Federal Reserve says outright that in order to help keep the economy at a high level of activity – maximum employment – the bank has to keep interest rates low. Currently, the Federal Funds Rate, the central bank’s key policy indicator, stands at 0.25 percent, and we still have unemployment lingering from the 2020 artificial economic shutdown. Simply put, the Federal Reserve says that higher interest rates will hamper economic activity and prevent “maximum employment” (which is a less ambitious policy goal than “full employment”). Therefore, we can expect that the Federal Reserve will keep interest rates well below two percent for the foreseeable future.
Blanchard is welcome onboard with us inflation alarmists, but he might want to take a broader look at just how complicated the current fiscal and monetary policy situation is. To expect the Federal Reserve to quell inflation with higher interest rates is to expect the impossible. Blanchard and Summers both admit that the central bank has major commitments to the U.S. Treasury in terms of deficit monetization, but they do not take the next step and point to the painful yet urgently necessary policy measures needed to prevent that high inflation that they both hint at (and we here at the Liberty Bullhorn have put numbers on).
With all that being said, it is welcome to see economists with a Democrat party affiliation starting to worry about high inflation. It won’t stop the stimulus bill from going through Congress and the Oval Office, but hopefully it will help bring about a discussion about counter-measures to prevent runaway inflation.
The problem is that so far, we here at the Liberty Bullhorn are the only ones who have explained why and how our looming inflation experience can turn into a hyperinflation nightmare. However, we maintain hope that our just-woke-up fellow economists will see that light as well…