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The deeper anxieties of inflation hawks
Following an increase in consumer prices during the first quarter of the year, commentators who were already wringing their hands about inflation have now doubled down on their position. But the economic arguments used to justify such fears simply do not stand up to scrutiny
7 Jun 2021 | James K. Galbraith

In a recent commentary for The Washington Post, former US Secretary of the Treasury Lawrence H. Summers stated that “the consumer price index rose at a 7.5% annual rate” in the first quarter of 2021. I could not reproduce this number from the Bureau of Labor Statistics CPI-U website, which reports a year-on-year increase (April 2020-April 2021) of 4.2%, driven largely by a sharp 49.6% rebound in gasoline prices from their pandemic crash. When food and energy prices are excluded, the inflation rate over the past year comes to just 3%.

“Inflationary pressures are mounting from the boost in demand created by the US$2 trillion-plus in savings that Americans have accumulated during the pandemic; from large-scale Federal Reserve debt purchases, along with Fed forecasts of essentially zero interest rates into 2024; from roughly US$3 trillion in fiscal stimulus passed by Congress; and from soaring stock and real estate prices.”

This is odd logic, beginning with the conjecture that savings cause inflation. John Maynard Keynes argued the reverse: excess savings are withheld from demand, causing unemployment. And Summers’s own neoclassical school normally holds that high savings are a good thing, because they sustain low interest rates and lead to more business investment. So far as I know, no economist has ever before suggested that savings, as such, cause inflation.

Likewise, while it’s true that when the Fed buys up unwanted private debts, mostly from banks, the sellers get cash, shielding them from losses they might otherwise have suffered, this protection has no direct connection to their lending habits. As the economist Hyman Minsky pointed out, banks make loans when they have creditworthy customers. They neither lend their reserves, nor do they need reserves in order to lend.

Next is the claim that the Fed’s forecasts of future low interest rates are inflationary. Actually, the Fed’s interest-rate forecast is contingent on its inflation forecast, and its current position is that it expects price pressures to be transitory, and will react by raising rates if that turns out to be wrong. If the Fed agreed with Summers about future inflation, it would have said so in its inflation forecast; the interest-rate forecast has no independent role.

Summers then points to the US$3 trillion of fiscal stimulus already enacted. But some US$2 trillion of this is stored in private savings for now, so this point is redundant with the first one. Finally, he mentions “soaring stock and real estate prices”. Yet we heard no such warnings from him in the late 1990s, when he was Treasury secretary during a massive stock boom. And rightly so: the boom did not cause an increase in inflation.

What is really at work here? Summers may simply be attempting to revive the old Phillips curve concept, which states that, as unemployment falls, wages – and therefore prices – rise. But if this pattern ever existed, it disappeared 50 years ago, and even the slowest-thinking economists largely abandoned the Phillips curve by the mid-1990s. Since then, almost all new US jobs have been created in the services sectors, where “tight” labour markets have little effect on wages and none on consumer prices.

Moreover, today’s US labour markets aren’t even close to tight. The ratio of employment to population is still at least four percentage points below where it was a year ago, and it seems to be flattening after a sharp rebound. That means there are still about five million people who were working in 2019 but are not working today. The reasons are unknown. Perhaps employers haven’t wanted them back, or the jobs on offer aren’t very good. Maybe they will return later – this year or beyond – when the buffer provided by all those savings runs low.

What, then, is driving Summers’s inflation fear? When an economist of his stature makes such specious claims, one can only wonder if there isn’t something else on his mind.

To be sure, there are some actual price risks. A big one is financial speculation – in oil, metals, timber for home construction, and so forth. It is not uncommon for financial players to bid up prices by taking these goods off the market early in a boom. (The Chinese know this and are duly cracking down on the hoarding of copper and other metals.)

Another risk would emerge if the Fed took the advice of inflation hawks. For most businesses, interest is a cost like any other, and an increase in that cost would be passed through, in part, to consumer prices. It is interesting that Summers doesn’t mention either of these, which could be mitigated with tough financial-sector regulation – and, of course, by not raising interest rates.

But deeper worries may be lurking beneath the surface of Summers’s essay. One concerns that US$2 trillion in savings. Through direct payments and expanded unemployment insurance, a fair amount of that sum went to working-class households – the first big chunk of change for many such families in decades. Having some cash could make them less likely to borrow – and thus less dependent on banks. Workers might even hold out for higher wages, creating the “labour shortage” of which Summers speaks (at least temporarily). More generally, when people have a bit of a financial cushion, they are harder to boss around.

A second source of anxiety may be spotted in Summers’s call for “clear statements that the United States desires a strong dollar”. This is the secret angst of the hard-money men, an insecure lot who fret that their position on the global totem pole might not be entirely secure. Perhaps they are right. Today’s dollar-centred world reflects the power alignments of the period between the end of World War II and the end of the Cold War in 1989. US power has since eroded, opening the possibility that the world’s monetary system could one day flip.

That may not happen anytime soon. But if and when the moment comes, it will follow from decades of decline, from better strategies pursued elsewhere, from the self-inflicted wounds of the Reagan, Clinton, and Bush eras, from the sacrifice of America’s industrial base in the 1980s, from the fragility of the global order that emerged in the 1990s, and from the military overreach of the 2000s. Against all that, a few “clear statements” won’t mean much.

James K. Galbraith is a professor of government and chair in government/business relations at the Lyndon B. Johnson School of Public Affairs at the University of Texas at Austin. From 1993-97, he served as chief technical adviser for macroeconomic reform to China’s State Planning Commission.

Copyright: Project Syndicate