Three reasons why inflation is not permanent

Por Tyler Cowen

With inflation reports so high, it is increasingly difficult to defend my membership in the “Transitional Equipment”. However, I still believe that the rise in inflation is in fact transitory: after a few years of above-average price inflation, prices will return to a steady state of growth of around 2% per annum, as has been the case. largely the case since the early 1990s.

The Transitional Team’s argument does not refer to whether the next inflation figures to come will be high or low. Rather, it consists of the following two propositions:

• The Federal Reserve can control the rate of price inflation.
• The Federal Reserve you don’t want inflation to be too high.

The first statement seems obviously true. For many years, central banks targeted price inflation rates of 2% or slightly lower. They did this regularly, although, after the Great Recession, some scholars insisted that Western economies were caught in liquidity traps.

But central banks have many policy instruments at their disposal, including managing expectations, and it is often a mistake to bet against them. And the implication of a liquidity trap is that the Fed cannot increase the rate of inflation in times of deflation, not that it cannot reduce it in times of inflation.

If there is a reason to disagree with the Transitional Team, it is with the second statement. The fact that the Fed wants to reduce inflation is true in the abstract, but the political price of doing so may be too high. After all, reducing price inflation requires the Fed to pursue a tight monetary policy, which risks causing a recession. Tight monetary policy reduces aggregate demand and, in a world of sticky wages and prices, can lead to a reduction in output and employment, as happened in the early 1980s.

The key question, then, is whether Fed, with current margins, it is more concerned with fighting inflation or reducing the possibility of a recession. Admittedly, there is uncertainty about the answer to this question, as it should be, but I still end up on the Transitional Team.

One way to see the Fed it is like an independent institution with a mandate (half of a dual mandate) to keep prices stable. President Jerome Powell has made this goal more flexible by instituting “average inflation targets”, And this policy gives the Fed some leeway in deciding when to lower the rate of price inflation.

But it does not grant the Fed license to allow 5% annual inflation for the next five to 10 years. If the Fed breached its mandate, it would lose much of its credibility. So, from a political and institutional point of view, the Fed is interested in controlling inflation.

An alternative way of looking at the Fed is as a political entity, motivated by self-preservation or a desire to help the ruling Democratic Party. Regardless of whether this is true, voters correctly perceive that higher inflation reduces their standard of living.

A marginal increase in unemployment could affect 5% of the electorate and could disproportionately affect the low-skilled, who are also less likely to vote. Instead, inflation affects all voters, and most of them hate it. So even a cynical calculation also suggests that the Fed will cut inflation rates.

Perhaps most important is the market outlook, which expects the Fed to lower inflation rates. As I write, the 10-year Treasury yield is 1.64%. That yield has been going up, but it hardly seems to predict hyperinflation, or even 5% inflation over the next 10 years. The most negative test so far is that of the market for TIPS, which forecasts inflation of around 3% over the next five years.

You may wonder if “the market”Includes inflation and Fed. Well, investors are obsessed with Fed and they study it closely. When I meet skeptics of the Transitional Team, I ask them: “What do you guys understand about the Fed that the market in general doesn’t?“I still have not received a convincing answer.

On the other hand, the arguments of the “Permanent Team”Are based on a series of unlikely events: the Senate is unable or unwilling to confirm new candidates for the Board of Governors of the Fed (There are currently two vacant positions, in addition to the President and Vice President positions).

Meanwhile, a political crisis hits the White House, let’s say President Joe Biden falls ill, and does not offer any new candidates. Then there is a power vacuum in the Fed, which is less able to take decisive action.

In such a world, all bets would be off. But, for now, considering the institutional and political incentives of the Fed, as well as the market projections, I prefer the Transitional Team.