Alan Blinder writes: Thursday’s surprising report on first-quarter gross domestic product may contribute to a feeling of déjà vu all over again. High inflation reminds many Americans of the unhappy 1970s, when a series of food-price shocks in 1973-74 and a huge oil-price shock late in 1973 drove inflation through the roof—and a serious recession followed. Are we headed for a repeat performance? Not quite. One big difference is that now the Federal Reserve and other central banks understand stagflation much better. In 1973 it was a puzzling new phenomenon, and no one knew how to think about it. Economists and central bankers of the day had lived through a history in which booming economies brought on rising inflation and sluggish economies brought on rising unemployment. The two maladies didn’t occur simultaneously. (italics added) This is from Alan S. Blinder, “If We Get a Recession in 2022 or 2023, It’ll Be a Mild One,” Wall Street Journal, April 28, 2022. (April 29 print edition.) But here’s what Milton Friedman said in his presidential address to the American Economics Association in December 1967: Let us assume that the monetary authority tries to peg the “market” rate of unemploymentat a level below the “natural” rate. For definiteness, suppose that it takes 3 per cent as the target rate and that the “natural” rate is higher than 3 per cent. Suppose also that we start out at a time when prices have been stable and when unemployment is higher than 3 per cent. Accordingly,the authority increases the rate of monetary growth. This will be expansionary. By making nominal cash balances higher than people desire, it will tend initially to lower interest rates and in this and other ways to stimulate spending. Income and spending will start to rise. To begin with, much or most of the rise in income will take the form of an increase in output and employment rather than in prices. People have been expecting prices to be stable, and prices and wages have been set for some time in the future on that basis. It takes time for people to adjust to a new state of demand. Producers will tend to react to the initial expansion in aggregate demand by increasing output, employees by working longer hours, and the unemployed, by taking jobs now offered at former nominal wages. This much is pretty standard doctrine. But it describes only the initial effects. Because selling prices of products typically respond to an unanticipated rise in nominal demand faster than prices of factors of production, real wages received have gone down-though real wages anticipated by employees went up, since employees implicitly evaluated the wages offered at the earlier price level. Indeed, the simultaneous fall ex post in real wages to employers and rise ex ante in real wages to employees is what enabled employment to increase. But the decline ex post in real wages will soon come to affect anticipations. Employees will start to reckon on rising prices of the things they buy and to demand higher nominal wages for the future. “Market” unemployment is below the “natural” level. There is an excess demand for labor so real wages will tend to rise toward their initial level. Even though the higher rate of monetary growth continues, the rise in real wages will reverse the decline in unemployment, and then lead to a rise, which will tend to return unemployment to its former level. In order to keep unemploymentat its target level of 3 per cent, the monetary authority would have to raise monetary growth still more. In other words, Milton Friedman, well before the 1973 stagflation, anticipated that one can get “stagflation,” the combination of high unemployment and high inflation. What misled Alan Blinder is that the economists he studied under, Robert Solow and Paul Samuelson, did not anticipate this combination because they were blinded by their Keynesian Phillips Curve way of thinking. But that wasn’t the whole universe of economists. Friedman saw it clearly over 5 years before the 1973 stagflation. Here’s my bio of Milton Friedman in David R. Henderson, ed., The Concise Encyclopedia of Economics. Here’s Kevin D. Hoover’s excellent entry on the Phillips Curve in the Encyclopedia. (1 COMMENTS)

Today, I’d like to explain the cause of the current high inflation. Not the part of inflation caused by supply problems; rather the portion caused by excessive nominal spending, sometimes called excessive aggregate demand.The proximate cause of this excessive spending is obviously an overly expansionary monetary policy. But I’m interested in the deeper cause; why did the Fed allow spending to grow so rapidly?  I’ll show that the fundamental problem is that the Fed has the wrong policy framework.  In 2020, the Fed adopted flexible average inflation targeting (FAIT).  That’s actually a great idea!  So why didn’t it work?  The problem is that the Fed interpreted FAIT in a very strange way.  They decided to correct undershoots of their 2% inflation target with higher than 2% inflation in the future, but decided against correcting overshoots of 2% inflation with below 2% inflation in the future.  That’s why we are where we are—the Fed didn’t make the policy symmetric. But why did the Fed make this mistake? The deeper problem is that the Fed doesn’t understand its role in the economy.  It sees itself as a sort of fireman, fixing mysterious “shocks” that occasionally hit the economy.  In fact, the Fed is more like an arsonist, occasionally over or under-stimulating nominal spending. This creates business cycles and unstable inflation.   But why should confusion over the Fed’s role have led them to the asymmetric form of FAIT, correcting inflation undershoots but not overshoots?  The answer is not at all obvious, and indeed didn’t occur to me until today.  So here’s my theory: Suppose you adopted the fireman view of the Fed.  Why might that make asymmetric FAIT seem more appealing?  The answer is pretty simple; recessions are much more painful than booms.  If the economy is in a recession, output is low and hence living standards suffer.  You’d like to correct that problem as quickly as possible, and FAIT allows for a more rapid recovery than a simple “let bygones be bygones” inflation targeting approach.  In contrast, periods of economic overheating are much less costly, as employment and consumption are quite high.  Indeed the main problem with overheated booms is that they make future recessions more likely.   [As an aside, supply side inflation is more painful than demand side inflation (and is politically very unpopular as we now see), but in this post I’m only addressing excess nominal spending, i.e. the inflation from excess demand.] If I believed that the Fed was a sort of fireman, fixing problems caused by mysterious economic “shocks”, then I’d also support asymmetric FAIT.  In that case I would be less critical of the Fed’s mistake in 2021.  Even in that case they would have raised rates too slowly (in retrospect), but the error would have been forgivable. But I believe the Fed is more like an arsonist, creating economic shocks through unstable monetary policy.  That’s unforgivable.  And as we will see, this is why the Fed needs to adopt a symmetric FAIT policy. The real reason to adopt FAIT (or better yet NGDP level targeting) is not to get a faster economic recovery; it’s to prevent the recession from occurring in the first place.  I use italics, as this is the central point of this post, and indeed of much of my blogging over the past 13 years.  The mere expectation that the Fed will quickly push the economy back to the trend line will make the recession much milder than otherwise, as current nominal spending depends heavily on future expected nominal spending.  Investment projects cancelled in a deep prolonged recession will not get cancelled if the recession is expected to be followed by a quick recovery back to the trend line. But this argument is entirely symmetric.  If the Fed were expected to offset a period of above normal NGDP growth with a future period of below normal NGDP growth, then the initial overheating will also be less dramatic.  Even if the Fed is slow to raise rates during an unexpected upswing in inflation, the markets will do their work for them.  Longer-term interest rates will rise sharply in anticipation of the future Fed policy moves required to hit the 2% average inflation target.  You correct overshoots with future undershoots not because overshoots are painful, but to prevent overshoots from occurring (or at least make them milder). In 2021, I was too complacent about inflation because I thought the Fed actually had a symmetric policy in place.  (Indeed some people at the Federal Reserve also seemed to view the policy as symmetric.)  I assumed that the Fed would do whatever it takes to assure that inflation averaged roughly 2% in the longer run.  I thought average inflation targeting meant average inflation targeting.  In retrospect, the Fed did an exceedingly poor job in communicating its policy change.  There was very little discussion of the fact that the new policy would mean that future inflation would average more than 2%.  Most discussion implied that this would assure an average inflation rate of 2% over time, instead of the below 2% inflation experienced during the 2010s.  Instead, they went from one extreme (too low inflation in the 2010s) to the other extreme (too high inflation in the 2020s.)  They should have gone from below 2% inflation to 2% inflation, on average. Jim Bullard once suggested that the “flexible” part of FAIT should be interpreted as something like NGDP level targeting.  I wish that were what the Fed intended.  Under NGDPLT, you do allow average inflation to occasionally vary from 2% during supply shocks, as long as NGDP growth stays on track. This would have allowed for somewhat higher inflation during the current supply shocks, but without the current overheating.  If the Fed wants to fix what went wrong in 2021, then they should announce that henceforth FAIT will be symmetrical, and also that the “flexible” part of FAIT implies that some variation in inflation will be allowed as necessary to stabilize NGDP growth.  Of course the simplest solution would be to move directly to NGDPLT.  But the politically easier path would be to do a FAIT that mimicked NGDPLT for a decade or two, and then formally switch over if the policy seems effective.  Given that the Fed screwed up its inflation targeting policy over the past 12 months, now’s not the time to formally abandon inflation targeting.      (0 COMMENTS)

When I was young, people on the left used to refer to right wing authoritarian governments in places such as Latin America as “fascist”. Scholars would occasionally point out that the term “fascism” has historically meant something more than just right wing authoritarian, citing specific examples such as Mussolini’s Italy and Hitler’s Germany. Timothy Snyder is one of the world’s leading experts on fascism.  He suggests that today’s Russia meets the standard definition of the term: As a cult of irrationality and violence, it could not be vanquished as an argument: So long as Nazi Germany seemed strong, Europeans and others were tempted. It was only on the battlefields of World War II that fascism was defeated. Now it’s back — and this time, the country fighting a fascist war of destruction is Russia. Should Russia win, fascists around the world will be comforted. We err in limiting our fears of fascism to a certain image of Hitler and the Holocaust. Fascism was Italian in origin, popular in Romania — where fascists were Orthodox Christians who dreamed of cleansing violence — and had adherents throughout Europe (and America). In all its varieties, it was about the triumph of will over reason. Because of that, it’s impossible to define satisfactorily. People disagree, often vehemently, over what constitutes fascism. But today’s Russia meets most of the criteria that scholars tend to apply. It has a cult around a single leader, Vladimir Putin. It has a cult of the dead, organized around World War II. It has a myth of a past golden age of imperial greatness, to be restored by a war of healing violence — the murderous war on Ukraine. Fascist governments also tend to favor a mixed economy, with a nationalistic attitude toward foreign trade and investment.  The interests of the state take precedence over the human rights of individuals or even entire minority groups. No country fits perfectly into any single category.  Thus while Cuba and North Korea are generally regarded as “communist”, neither country is exactly what Karl Marx had in mind when he wrote the Communist Manifesto.   In my view, today’s China is better described as fascist rather than communist, despite the fact that the country is ruled by the Chinese Communist Party. Like Russia, China has a mixed economy with both the state and the private sector playing a major role in many sectors. China is a bit less militaristic than Russia, but shares many of the other traits of fascist governments, including a personality cult around its leader and an obsession with an historical narrative where China is once great nation victimized by outsiders.  On domestic human rights, China is arguably even more repressive in some respects, especially in the Uyghur region.  (I say “domestic human rights”, because Putin obviously places little value on the rights of Ukrainians.)   I still don’t believe it makes sense to use the term “fascism” to describe every right wing authoritarian government.  But in the case of Russia and China, the label is increasingly apt—much more so than 20 years ago. (0 COMMENTS)

Many of us often refer to “the good old days” and the era we have in mind seems to be anywhere from thirty years ago to one hundred years ago, depending in part on our age. But Franklin Pierce Adams, one of the most prominent American columnists in the early twentieth century, noting the same tendency back then, put it best when he wrote, “Nothing is more responsible for the good old days than a bad memory.” Fortunately, almost no one refers to the medieval era as the good old days. But it’s still worth seeing how people lived back then. This is from David R. Henderson, “The Wonders of Economic Growth,” Defining Ideas, June 2, 2022. Another excerpt: In 2000, Brad DeLong, an economist at UC-Berkeley, wrote a great paper titled “Cornucopia.” In it is a bar graph showing economic growth per capita over ten centuries from the eleventh century to the twentieth century. It bumps along close to zero for many centuries (except for the fourteenth century, when there’s more than a blip), increases substantially in the nineteenth century, and then explodes in the twentieth century. In that same paper, DeLong pulls off a marvelous stunt. He takes the 1895 Montgomery Ward catalogue and, instead of comparing prices of various items then and in 2000, gives data for the number of hours one would have had to work at average 1895 US wages to buy various items versus the number of hours one would have had to work to buy those same items in 2000. The results are astounding. Consider four of his ten examples. To buy six volumes of the Horatio Alger novels in 1895 took 21 hours of work, versus 0.6 hours in 2000. A one-speed bicycle took 260 hours of work, versus 7.2 hours in 2000. An office chair? Twenty-four hours then, versus 2 hours in 2000. A set of the Encyclopedia Britannica cost 140 hours of work, versus 33.8 in 2000. That last number dramatically understates the progress to today because almost no one wants to buy the Encyclopedia today, which is why it is no longer published, and we can get Wikipedia at a zero price. Except on controversial issues, Wikipedia is quite good. The only item that was more expensive in hours worked in 2000 than in 1895 was a sterling silver teaspoon, which took 26 hours in 1895 and 34 hours in 2000. But here DeLong tells an interesting story. Why did people want a sterling silver teaspoon in 1895? he asks. The answer: they wanted something that wouldn’t corrode. Now we have eating utensils that are very cheap and don’t corrode. Read the whole thing.   (0 COMMENTS)

It used to be that one perk of power under Western democracies was to be more or less above the petty laws imposed on the commoners. Contrary to rulers and their cronies under tyrannies, a high-level democratic ruler (politician but sometimes high-level bureaucrat) could not (normally) commit murder or any other serious crime without penalty, but he could indulge in minor infractions to the myriad of little, vexatious laws that he contributes imposing on others. A democratic ruler could, say, attend an illegal birthday party or share an illegal meal. I am referring to the pandemic “Partygate,” in which the British prime minister has been fined for attending an illegal party and two Labor MPs are now investigated for sharing an illegal meal (“Boris Johnson’s Ethics Adviser Suggests Partygate Fine May Breach Ministerial Code,” Financial Times, May 31, 2022). Being above petty laws must have been a major political perk, and perhaps it still is or, obviously, some thought it still was. This phenomenon of rulers becoming harassed by the harassing laws they impose on ordinary citizens fits well in the model of the state developed by anarcho-liberal, or perhaps anarcho-conservative, theorist Anthony de Jasay. In this model, political competition gradually reduces the discretionary benefits of the actual rulers. Politicians can be counted on to exploit and publicize their competitors’ infractions in order to win voters’ support. They may realize that they are thereby cutting the branch of their future privileges, but they must play the competition game—just like, on the ordinary market, a firm that lowers its price against a competitor knows that its benefit will be short-lived. What’s the endgame? What happens as the discretionary benefits of being a ruler are undermined by political competition? In de Jasay’s model, democratic rulers will finally be led to abolish political competition. (0 COMMENTS)

Congress exempts STLDI [short term limited duration insurance] plans from all federal health insurance regulations. As a result, premiums are often 90 percent lower than ObamaCare premiums and ObamaCare’s preexisting‐​conditions provisions aren’t constantly making coverage worse for the sick in STLDI plans. In 2016, the Obama administration arbitrarily limited the duration of STLDI plans to 3 months. In 2018, the Trump administration issued a final rule that allows initial STLDI contracts to last up to 12 months; allows enrollees to renew that initial plan for up to 36 months; and allows consumers to stitch together as many 36‐​month plans as they like using “renewal guarantees” that protect them from underwriting after enrollment. This is from the always insightful health economist Michael Cannon today. His post, “GAO Report Neglects to Mention the Cruelty of Limiting Short-Term Plans,” Cato at Liberty, June 2, 2022. Another excerpt: Balvin soon required emergency surgery for diverticulitis. (Her STLDI plan paid promptly and fully for her hospital care.) At the time, federal rules required her insurer to cancel rather than renew her STLDI plan after three months. Those rules subjected Balvin to underwriting when she went to purchase a subsequent three‐​month plan, which meant that plan would not and could not cover her second hospitalization for a related condition. Those federal rules left Balvin to face $97,000 in hospital charges with no insurance. The NAIC foretold this consequence of limiting STLDI‐​plan durations and renewals. Those who seek to limit STLDI are literally trying to deny consumer protections and coverage to the sick. The whole thing is well worth reading. (0 COMMENTS)

I finally got around to watching this 16-minute talk by Stuart Kirk of HSBC on why climate risk is so small. It’s beautiful. I love the way he goes after Mark Carney. Later, Kirk considers the implications for GDP in 2100 if we do nothing. His numbers are substantially more optimistic than the ones I gave in my recent talk (starting at about the 44:00 point) and I’m not sure why. But Kirk and I agree that the effect of climate change will be to lead us to have a multiple of current GDP that is only a little lower than the multiple we would have had: virtually everyone will be substantially better off in 2100 than their counterparts today. He makes the point I made about the Netherlands (I made the point at about the 49:20 point of my talk.) Well worth watching. (0 COMMENTS)

A column in the Financial Times reminds us that data—and the more “big,” the better—are often seen as a sesame key to the door of knowledge. It is even imagined that small data are owned by the person who has chosen to share them on an open platform that belongs to somebody else. (See Benedict Evans, “There Is No Such Thing as ‘Data’,” Financial Times, May 27, 2022): This is mostly nonsense. There is no such thing as “data”, it isn’t worth anything, and it doesn’t belong to you anyway. … “Data” does not exist—there are merely many sets of data. … Most of the meaning in “your” data is not in you but in all of the interactions with other people. But this is not my topic, although it is related. My topic is the false idea that one can induct theory from data without first having a theory, formal or intuitive, explicit or implicit, to indicate which data are relevant. In economics, this idea has been lately associated with Harvard University economist Raj Chetty, who apparently aims to teach microeconomic principles by first looking at the data  (see Don Boudreaux, “How Should Econ 101 Be Thought,” Econlib, January 6, 2020). That this is not consistent with the scientific way of understanding the physical or social world has been well explained by Karl Popper, the famous philosopher of science, in a series of articles in Economica (“The Poverty of Historicism,” May 1944, August 1944, and May 1945): I believe that theories are prior to observations as well as to experiments, in the sense that these are significant only in relation to theoretical problems. … Therefore, I do not believe in the “method of generalization”, that is to say, in the view that science begins with observations from which it derives its theories by some process of generalization or induction. (Part 2, p. 134-135) I believe that the prejudice that we proceed in this way is a kind of optical illusion, and that at no stage of scientific development do we begin without something in the nature of a theory, such as a hypothesis, or a prejudice, or a problem … which in some way guides our observations, and helps us select from the innumerable objects of observation those which may be of interest. (Part 3, p. 79) The literary literature provides us with a fun example of another sort. In an 1841 letter to his sister, French novelist Gustave Flaubert wrote: Since you are now studying geometry and trigonometry, I will give you a problem. A ship sails the ocean. It left Boston with a cargo of wool. It grosses 200 tons. It is bound for Le Havre. The mainmast is broken, the cabin boy is on deck, there are 12 passengers aboard, the wind is blowing East-North-East, the clock points to a quarter past three in the afternoon. It is the month of May. How old is the captain? In the French original: Puisque tu fais de la géométrie et de la trigonométrie, je vais te donner un problème : Un navire est en mer, il est parti de Boston chargé de coton, il jauge 200 tonneaux. Il fait voile vers le Havre, le grand mât est cassé, il y a un mousse sur le gaillard d’avant, les passagers sont au nombre de douze, le vent souffle N.-E.-E., l’horloge marque 3 heures un quart d’après-midi, on est au mois de mai…. On demande l’âge du capitaine? If you are looking for what determines a captain’s age or what is determined by it, most data in the universe are irrelevant. Of course, the exercise proposed by Flaubert could have been a mere cryptographic enigma, but solving it would still have shown nothing about induction as a way to derive scientific laws. (0 COMMENTS)

Jesse Horwitz recently asked me whether there would be better distributional effects from using fiscal policy rather than monetary policy as a stabilization tool.  The intuition is that monetary policy involves the purchase of financial assets whereas fiscal policy can directly deliver money to the public. I don’t see any important distributional differences, and I believe my view is pretty widespread among economists.  But I notice that lots of non-economists see things differently, and it’s worth asking why. The first thing to note about fiscal policy is that it does not involve the creation of new money, rather it takes existing money and moves it around.  When the government sends you a check, the money comes from taxes or borrowing.  The public as a whole doesn’t have more money, rather the money is moved from Peter to Paul. The perception that fiscal policy is fairer may come from the fact that fiscal spending can redistribute money from the richer half of society to the poorer half of society.  But that sort of redistribution is essentially unrelated to the use of fiscal policy as a stabilization tool.  Even governments that do not use fiscal policy as a stabilization tool often have a welfare state—but they don’t vary the size of the welfare state as a tool for reducing the business cycle.  Instead, they often rely on monetary policy. I suspect that some people mistakenly view fiscal policy as being fairer because they conflate the existence of a fiscal stabilization regime with expansionary fiscal policy.  But stabilization policy necessarily uses both expansionary and contractionary policy.  An expansionary policy occurs when policy is more expansionary than average and a contractionary policy occurs when policy is less expansionary than average. It’s true that the national debt trends upward over time, which may lead to the impression that expansionary policy is more common than contractionary policy.  But the national debt will trend upward over time regardless of whether fiscal policy is actively being used to stabilize the economy.  In the late 2010s, the federal government expanded the national debt to take advantage of the trend toward lower interest rates, not because we were in a recession.  If the average (cyclically adjusted) budget deficit is $X, then an active fiscal stabilization policy expands the deficit above $X when stimulus is needed and runs a deficit below $X when stabilization policy calls for reduced spending.  In this framework, there is no such thing as permanently expansionary stabilization policy. Economists tend to think of fairness issues in terms of the long run distribution of income.  It’s not obvious why either fiscal or monetary stabilization policy would have any long run impact on income distribution.   Even if the government does not use fiscal or monetary policy to stabilize the economy, there will be a government budget and there will be a money supply. In most cases, both will trend upward over time.   It is certainly possible that the mere existence of a government budget has distributional effects, and perhaps even the existence of a money supply has distributional effects.  But it’s not obvious (at least to me) how varying the money supply or government spending in a countercyclical fashion would have any important distributional effects. The Fed’s balance sheet has greatly expanded in recent decades, even as a share of GDP.  (I wish we had stayed with the much smaller pre-2008 balance sheet.)  But this balance sheet expansion was not due to expansionary monetary policy, rather it reflects the Fed’s shift to a floor system with the payment of interest on bank reserves, and also the declining trend in NGDP growth (which reduces interest rates and raises the demand for base money.). Prior to 2008, the Fed ran a very active stabilization policy without buying lots of financial assets.  The two issues are essentially unrelated. PS.  I’m not arguing against so-called “automatic stabilizers”, which cause the budget deficit to move somewhat countercyclically even without an active fiscal stabilization policy.  But active stabilization policy is best done by the monetary authority. (0 COMMENTS)

    The people who organized the Demsetz celebration that took place on May 27 have moved quickly to put the whole video on line. The personal remembrances from Harold Demsetz’s daughter Rebecca start at about 2:11:00 and go to about 2:17:05. Kam-Ming Wan then presents a note from the Alchian family. The part that involves Harry DeAngelo asking questions of Joe Kalt, Bob Topel, and me about Demsetz goes from 2:22:00 to 3:11:30 of this video. Enjoy! (0 COMMENTS)