Moody's Talks - Inside Economics - Once and Future Inflation

Episode Date: November 23, 2021

Mark, Ryan, and Cris discuss inflation throughout the history of the United States and whether we're in the midst of an era.Full episode transcript here. Questions or Comments, please email us at [e-mail]. We would love to hear from you.  To stay informed and follow the insights of Moody's Analytics economists, visit Economic View. Hosted by Simplecast, an AdsWizz company. See pcm.adswizz.com for information about our collection and use of personal data for advertising.

Welcome to Inside Economics. I'm Mark Sandy, the chief economist of Moody's Analytics, and I'm joined as per usual by Ryan Sweet, Director of Real Time Economics. Hey, Ryan, all as well? Everything's well. Busy weekend, but everything's good. Good. We just chatted on Friday, and I'll come back to this in a second. This is a little bit of an unusual podcast, so we talked a couple days ago. So you had a good weekend. I did until I had to fill up at the pump. It's getting expensive. It's your indicator. We'll come back to that.

That's your indicator. What'd you pay? $3.40, $3.50 for a gallon? Oh, no, you get premium, don't you? You got to get the premium in these SUVs now, so it's, I'm over four. I didn't know that. Really? You have to get premium?

I didn't know that. Well, maybe not in your SUVs, but you should be. Oh, really? Huh. Okay. Chris, do you get premium? Oh, yeah, you're the front. Oh, I do not.

You get, you get, you get, uh, Super Octane Plus. Chris plugs his cars in. Oh, does he? No. Or you don't? I get the cheap stuff. Oh, and that's Chris DeReedy's Deputy Chief Economist.

Hey, Chris. Hey, Mark. And you had a good weekend also? I did. I did. I was a little on the cool side. I know. Jeez, it's already winter here.

I wrote a piece on inflation. So, apropos to the conversation today, because we're going to be talking about the history of inflation. This podcast is going to be different. This is going to air the week of Thanksgiving, so it's a little over a week from now. So this is more of a kind of an evergreen. We're not going to do the statistics today like we normally do. We're just going to dive right into the topic at hand in inflation.

And this is really, we're going to take a step back first here and talk about the history of inflation, inflation since the nation's founding, hopefully learn some lessons. from our experiences of inflation past, and then talk about inflation now, because obviously that hair on fire, you know, kind of moment, everyone's really upset about the 6% plus CPI inflation report we got last week, and so I want to talk about that. So this is a little bit different. I will say, you know, if you really do miss us a week of Thanksgiving, you can always follow me on Twitter at Mark Zandi. So just an advertisement. I'll be tweeting for sure,

you know, during this period. So please feel free. I just want to know who wins the Wallyball. Exactly. That's what I'll be twinning in. Yeah. We're all getting up for that. You know, the volleyball. For folks who weren't listening a couple of podcasts ago, Wallyball is what the Zandis do on Thanksgiving. We go into a racquetball court set up as a volleyball, you know, volleyball, in a racquetball, I think it's racquetball court. Yeah. So it allows the old guys to play with the young guys, the women to play with the men. We can all kind of be equalized, so it's a lot of fun. Someone always gets injured. Hopefully it's not me, but, you know, someone always gets injured, but I'll let you know. Okay, let's dive in. So the way I was thinking about framing this

conversation, or at least around the history, was I've identified half a dozen inflation eras, let's call them. And I'm hoping that we could, and talk a little bit about the era and then, you know, what we learned about inflation, inflation dynamics from that experience. And very quickly, maybe I should just name the eras, see if you guys agree or disagree with this kind of breaking up of history. So era number one, pre-federal reserve. The Federal Reserve was put on the planet back in 1913. So anything from the beginning of the nation's founding, let's say, you know, 1770. through early 1900s.

That's the pre-Federal Reserve era. That's an inflation era. Second, the Depression of the 30s, that we saw deflation during that period. So that's a period unto itself. That's the second era, third era. World War II, Korean War, so that was the 40s through most of the 50s,

at least the mid-50s, alteration and shortages and talk a little bit about that. Then the fourth era, Whereas the period, what I call great inflation, that was really actually began in the mid-60s, and then inflation steadily accelerated through the 70s, kind of peaked in the 80s, and it didn't really kind of normalized until, you know, late 80s, early 1990s. So that's the fourth period. The fifth period I call the Great Moderation.

That's the 1990s through 2010. That was a positive supply shock, you know, the tech boom and the impact that. on inflation. And then, of course, the low inflation period after the financial crisis, that's the most recent period. And then now here, so that's six different areas. And then now here today, we're talking, we're in the middle of the pandemic and we're starting to see inflation again. And we'll talk about that as well. So what, do you think that's a generally pretty good way of thinking about the history of inflation in the context of the United States? Does that make sense to you guys?

It does. It's a lot, right? Yeah. But I think that's the right. Those certainly are all the major errors. So we may spend more time on some versus others. Yeah. Yeah. You know, there's one period I could not kind of fit into the frame. That was between 1955 and 1965.

It's like not influenced by wars. The Korean War kind of ended by then. But there was, you know, inflation was kind of moderate during that period. So that's the 10-year period that I didn't put anywhere. So I'm not sure what to do with that one. So this is like a walk-down memory. lane of your professional career as an economist. Yeah.

It's so funny because just per chance I picked up a book on Andrew Jackson. I was reading a little bit about the second Bank of the United States. And this gets to the first period pre-Federal Reserve. And do you guys want to take a crack at characterizing that period? I mean, I got a sense of things, but do you want to characterize that period in terms of the inflation performance and what was going on? Anybody want to take a crack at that? I feel like a lot of inflation, except around the war of 1812 and then the Civil War

when we had to finance the award. But overall, inflation wasn't it moderate? It was all over the map. Yeah, it was chaos. Volatility. Yeah. Maybe average. Lots of inflation, lots of deflation, lots of inflation, lots of deflation.

I mean, it was the cycle, the business cycle, lots of business cycles. It was economic chaos. Yeah. The wildcat banking era, right? Yeah. just up down all around, right? Yeah. Well, I, you know, so it was, there was really no anchor to inflation at that time.

It was really all over the place. And I think that goes to the lack of a central bank. I think that's the lesson of that period. And the U.S. government set up the first bank of the U.S., you know, soon after the Revolutionary War. That had a very short charter. And then there was a brief period before they set up the second bank. of the United States. I think that was early 1800s to like 1840, something like that. And,

you know, it was kind of loosely managing monetary policy. I mean, it was issuing banknotes that were backed by gold, so they were relatively stable. But, of course, this is where Andrew Jackson came in. He did not like the second bank because he, I think, I think it's probably true. There's a bit of corruption there. The second bank would give credit and loans to Curry favor, to politicians and finance Jackson's opponents. And I think he took, as you would expect, umbrage to that. And when the charter for the second bank came up again,

I think in, you know, the 1830s, he said that he vetoed it. He didn't vote for it. And I think, actually, I think he won the, I think this actually helped him win the election of 1832 because, you know, he railed against, this is age old, right, rail against the New York banks.

In this case, it was a Philly Bank, the Philadelphia Bank, the second bank was in Philadelphia. And the building's still there. Yeah, it's still there, right? I think it's a museum, right? It is. I've never been. Have you been to that museum? I don't think so.

No, that, you know, that sounds bad, though. Sounds awful as economists. We didn't go and visit there. Yeah, we should really do that. All right, field trip. Maybe a field trip for the whole. Road trip for the podcast. I'm sure people will appreciate that, that pill trip.

We'll set up the podcast booths. was right there. Exactly. Exactly. But then I think we were completely rudderless without any kind of anything that approached to central bank throughout the, through the Civil War, the late 1800s into the early 1900s. And then we had the panic of 1907, and that was a doozy of a panic.

And I think that has spooked people. And they said, we need some stability here. We need central bank. And so by 1913, they had seven. up the Federal Reserve. So I think the lesson from that period would be central banks play a key role in terms of inflation.

Agreed? Greed? Yeah, well, I think you could take both approaches. Central banks play, from some economist's perspective, a key role in keeping inflation low. Other economies have argued central banks are the root cause of inflation because they're just printing money. If inflation's too high,

they do, yeah. Yeah. I mean, I I suppose. I mean, I guess this goes to crypto somehow, doesn't it? This goes to the, we're talking about the Federal Reserve in the U.S. inflation, but certainly central banks overseas aren't, have shown less disciplined and as a result have not had stable inflation. And that instability has created demands for alternatives like now crypto. So if you're like in El Salvador, or the Central Bank of El Salvador is not, well, they dollarized, I guess, but, you know, but I guess you're right.

Central banks are good and bad depending on where you sit, I suppose. Well, you would say, Ryan, though, the Federal Reserve has done a good job, right? I mean, if you look at a chart of inflation or growth since the beginning of the country, you can clearly see when the Federal Reserve was put in place, right? Before that, it was, as Chris said again, chaos, And after that, it's been a relatively period of relative stability.

Yeah, I would agree with that. Yeah. Okay. All right. Any other lessons from that period? No, the other lesson, I'm not sure if it's related to inflation, is that pay your debts. You know, Alexander Hamilton decided early on that he was going to pay off the Revolutionary War debt, even though it was trading at pennies on the dollar at the time because no one thought that the U.S. government would ever pay.

back the funds that they borrowed to finance the Revolutionary War. And the fact that he did that established the credit of the United States, the government, the central government. And we've been reaping benefits from that ever since. So another good lesson from that period, I think. Okay, let's move on. Second era, the Great Depression of the 1930s. How would you characterize that period?

Anyone who want to take a crack at that? Chaos. Chaos. Okay. All right. Deflation. Different type of chaos, yeah. Yes. And why, when you say deflation, that means falling prices. Persistently.

Consistently falling prices. And I think they fell from the 1929 crash through the mid-1933, I believe. They were deflating. Roosevelt came in early 1933 and he took the U.S. off the gold standard and the economy reflated pretty quickly. So what's the lesson? Well, first let me ask you this. What's the problem with deflation? Why are people, why such the fear of deflation? What's the economic rationale for why we don't want falling prices? I mean, if I'm a, if I'm a consumer, I kind of like falling prices, don't I? I mean, I can buy the same amount of stuff with less. So why, what's the problem with

deflation? Yeah. Yeah, so yeah, sure. Falling prices are good, but the problem is that they keep falling, right? And there's a negative spiral that occurs, right? So if I think that price is going to fall further, I'll keep delaying my spending, keep delaying my investment because, oh, tomorrow I could get a better deal. And so the issue is how do you break that psychology? It's really difficult. We don't actually have tools or certainly not well understood how to get out of that spiral without letting it come to its own natural fruition. And so it's dangerous from that perspective. On the other end, inflation, we actually have some tools.

We know what to do. Been through some cycles. It might be painful. I'm not saying it's a good thing to go through an inflationary cycle. But on deflation, it's really unknown. it's hard to break that psychology because it gets ingrained that tomorrow will be, you know, everything will be cheaper tomorrow. So just to keep delaying.

Yeah, it's just economically debilitating. Because. Because Chris is talking about the deflationary psychology. I mean, we can fast forward and talk about the housing bust after 2008. Deflationary psychology gripped the housing market and it took a long time to break that. Right. So people were delaying buying a home because they thought it was going to be. cheaper next quarter next year, two years from now.

So you can see how that psychology feeds on itself and just becomes economically debilitating. Right. So what you're saying is deflation and kind of depression go hand in hand. They're kind of intertwined and feed on each other. And therefore, if you're experiencing deflation, pretty good shot, your economy's going to hell at the same time. I always think of the three Ds of depression. You have the depth, the duration, the duration. and deflation. All three of those are characteristic of a depression.

Yeah. I guess the other sort of reason to be, and this is kind of a corollary what you said, is that if you're a debtor, that's a problem, right? Because the amount you owe, that doesn't tend to go down. You've got to be that no creditor is going to let you off the hook. You owe that money. But if you're in deflation, that means the prices for everything, including probably your wages or whatever your source of income is, that's falling too. So you have, you know, falling source of income to pay off your debt, and that's the prescription for default, right? I can't pay my debt, so I default. And that just exacerbates the economic problems. So the creditors who'd let you that money, they have a problem. Those are obviously

the banks and other creditors. They can't extend credit to anybody else, and everyone's going down into this deep, dark cycle, vicious cycle. I'd be, I guess, another way. Yeah, that's precisely. what happened with the housing market during the Great Depression, right? Yeah, exactly. People had these balloon payments, and there was no way they could pay them off. I think the other lesson from that period, at least one of my takeaways is curious to what you think is, you know, pegging your economy to gold is probably a bad idea. You know, so, you know, it takes kind of monetary policy out of your hands and hard to react.

And in fact, going back to the Depression, I think the British, they went off the gold standard first, and their economy reflated first. And then I think that's what Roosevelt saw. And then pretty soon after he got elected, I think almost immediate. I think he got into office early 1933 and he got off the gold standard. He had the bank holiday, like immediately when he took office. And then I think in the summer of 1933, he took us off the gold standard. And that was the end of the deflation, or beginning of the end of the deflation.

There was another bout of deflation later in the decade. We kind of had a second, you know, round of problems in the late 30, not as brutish, not as, a little bit more brief, but I think, you know, gold is certainly a fetter that, so that to me is a cautionary tale for anyone who wants to go back to anything consistent with the gold standard. And the gold bugs haven't gone away. There's still some lawmakers, some lawmakers still want to put us back on the gold standard. Yeah, they need to read this history. listen to this podcast. There you go. Yeah, there you.

Okay. They keep coming back. I don't get it. Yeah, I don't, yeah. It's every time the national debt keeps rising, so they're going to come back out of the woodwork soon. Yeah, because they just don't trust that we won't see inflation. Yeah. Well, then the next period up at World War II Korean War, we had pretty high inflation.

Kind of a, you know, negative supply shock, I guess. or I don't know how to, this is a supply shock, right? Your economy, all the resources of your economy even being diverted to building military equipment and financing the wars. So that means shortages for everything else. And demand generally is pretty strong because people are working, the economy's fully employed.

That's obviously one of the key reasons why we got out of the 1930s depression deflation because we had this huge massive influx of government spending to fight the war. But that was a period of rationing, supply shortages, generally higher prices. Not consistently, but generally. So I'm not sure what lessons to take from that other than, well, the good thing is it got us out of the Depression. The bad thing is, you know, obviously people had to live with rationing and everything else.

So that wasn't a great time. A lot of people drawing parallels of what's going on today to after the Korean War and World War. to because of the supply shock. And they're kind of pointing to that to show that it is transitory. It's temporary. Oh, interesting. Really? Mm-hmm.

Well, you know, I don't know that history very well. In the Korean War, did we have shortages? Were there a lot of shortages? I suppose there was, but I don't remember. I don't know that history very well. Yeah. Interesting. But I know we had shortages around World War II.

Yeah, then I, for sure. For sure. Yeah. So that's the event you're pointing to, I guess. Yeah. And also people point to after the Korean War, so I assume there were some shortages. I just don't know for, I haven't looked at it. Yeah, I don't know that history as well.

Yeah. Well, it's interesting, the Korean War, I mean, there was a lot of American troops overseas for that fighting that war. It's shocking. You know, if you look at, you know, the percent of the labor force that was overseas, it was very high. You know, people for kind of not focus on Korean War, but that was a pretty all-encompassing war for us. We were pretty, much of our economic economy was wrapped up in that war. So very important. Okay, here's the fourth era of inflation.

So we're now up to the mid-60s. I called the Great Inflation. And I don't think people recognize, but inflation started to really take off in the second half of the 1960s and then went stratospheric in the 70s and peaked in the early 80s. I believe CPI, consumer price inflation, peaked at close to 15 percent, I believe, in the early 1980s before the worker kind of stuff then. So I've got a few

takeaways from that period that I think are good lessons. What are yours? Anything you would point to that are lessons that are helpful in thinking about inflation? Certainly a lot of lessons for macroeconomics, right? All the models broke down

and contemplate these types of oil price shocks, reliance on the Phillips curve and whatnot. So certainly there were a lot of lessons learned, or hopefully they were learned. It seems like Maybe this is a good time to explain to the listener of the Phillips curve

because we'll come back to that. We're getting into the Phillips curve already. Well, just because Chris brought it up so people are asking Phillips curve. If you're not an economist you may not know what that is.

What is the Phillips curve? So it's a relationship between unemployment and inflation. So there is a tradeoff between the two. I guess there's a presumed tradeoff or prior to 19, or mid-60s,

there was a quite strong trade-off. But then over time, things have broken down a bit, and the theory has been revived in various fashions, you know, got to tinker around short-term versus long-term Phillips curve. So there's a lot of debate whether this relationship actually exists anymore between the two or if it takes so many heroic assumptions to maintain. I think it still exists. I just think the relationship is much weak. than it was in the 60s and 70s. Yeah, okay.

Fair enough. More dynamic, I guess. Exactly. Or the measurement is also questionable. Like, how should you be measuring Slack? Is it truly unemployment? Is it employment population ratio? What's the right?

Primary risk. Yeah. We'll come back to this in the context of current, our discussion about what's going on now. But my sense is the Phillips curve, that relationship between unemployment is, Inflation is what I would call very non-linear. You know, there isn't much of a relationship until unemployment gets to a certain point. And at that point, things change very quickly.

You know, wage and price pressures, you know, develop very rapidly. So, you know, nothing yet you're at 6% unemployment, obviously, no problem. 5% unemployment, no problem. 4% on a problem, no problem. 3.5% unemployment, nothing really. 3% boom, you got a problem. You know, so it kind of hit some kind of tipping point in labor markets and psychology and you're often running.

So it feels very, very nonlinear to me. The other two lessons from that period is with regards to the Fed is don't let inflation get out of control or it's really, really painful to tame inflation. And then- Well, what does that mean to get out of control? Like consistently above their target. I mean, I think- Why? Because it dislodges inflation expectations.

There you go. inflation expectations, right? That's the key. That's the key. That's the lesson from the 60s and 70s. Okay. So what is inflation expectation? So it's people, I mean, you can, there's all different measures of inflation expectations, but it's basically what people or businesses anticipate inflation to be one year from now, five years from now, 10 years from now. Right. Right. So in that period, inflation expectations rose. And that's what you meant when the, you said the Federal Reserve lost control. Correct. And at that point, it's very difficult to get those expectations and thus overall actual inflation back down. Yeah, to get them back down, Volker, who was chairman of the Federal

Reserve, had to jack up interest rates very, very quickly, get them very high to bring realized inflation and inflation expectations back down. Yeah. Okay, here's my historical narrative of that period. So you go back into the mid-60s, late 60s, that was the period of Vietnam and of the great society. So Lyndon Johnson, the president, ran a highly expansionary, what they call highly expansionary fiscal policy. That is, I'm going to spend a lot of government money, you know, kind of sort of the debate we're having now around inflation. Deficit finance, I borrow money to do it. And at that point, the economy coming into that period was pretty close to full employment. Unemployment was very low.

The Phillips curve was working fine, but he really pushed on the accelerator, and the economy started overheat. Then you get into the early 70s and all of a sudden you have oil price shocks. That's the oil embargoes. There was one in 73, I believe, and of course another one in 1980. And that was a very significant supply shock. It hurt growth, but it really jacked up inflation. At that time, you know, the economy is very dependent on energy. We consumed a lot, much more energy than we produced.

so that really, you know, jacked up inflation. And then this when inflation expectations come in, the Fed decided, oh, I'm going to focus on the weaker growth created by the higher oil prices, that's, you know, the negatives of that, and not focus on inflation, and therefore they kept interest rates very low for a long period of time, let those higher inflation expectations become entrenched. And then you're in this vicious weight price spiral where, you know, workers think, everyone thinks inflation is going to be high. So workers demand a higher pay increase.

Businesses say, fine, no problem. I'll give you that pay increase because they know they can pass that through to their customer in the form of higher price. Workers see that. They say, okay, you got to pay me more. You've got to raise my wages even faster. You can see how you get into this kind of very dark wage price spiral. This sounds, this dynamic I just described, sounds kind of familiar, doesn't it? Sort of, right?

around the pandemic. Same kind of dynamics. People are arguing the same kind of dynamic. I don't believe it to be the case, and we'll come back to that in a few minutes. But when people worry about inflation today, many of them are hearkening back to that period of great inflation in the late 60s all the way going up into the 1980s. I mean, that's why people are talking about stagflation, because that's the last time we had a period of stagflation, which is very high inflation and low growth or high unemployment. And that's a central bank's worst nightmare. Like you were discussing, like, do you focus on inflation?

Or do you try to stimulate the economy? You can't win both. Yeah, of course, now the nice thing about that we learn from that period that we're using now, and the Fed is using now, is that inflation expectations matter. So back then, inflation expectations rose. Well, back then, no one who was even talking about inflation expectations. That wasn't even on the nomenclature. They weren't even thinking about it.

And so they had no way of measuring it and they had no way of thinking. thinking about it and they didn't respond to it. But today, we know inflation expectations matter a lot. And so because they're stable and low, the Fed's saying, hey, I still feel comfortable that inflation's going to come back in. I should be focused on the negative shock created by the pandemic. You know, the ill effects on the labor market, the fact that unemployment and underemployment is relatively high. So the difference between now and then, big difference between now and then, there's many, but the big, big one is inflation expectations. You know, this is, you know, this. even focusing on them is a big difference, but measuring them and then, you know, basing policy

on them are also a big difference. Okay. Then we, of course, as you pointed out, Paul Volcker, who became chair of the Federal Reserve in the late 70s, figured out that the only way that they're going to ring out these inflation expectations bring inflation down was just to kill the economy. And so we had jacked up interest rates. They went into double digits. You know, mortgage rates were 15, 20 percent.

back in the early 80s, did a number on the economy. That kind of wrung out inflation, inflation expectations. Not completely. You know, Alan Greenspan, the chair of the Fed who took over from Volker in the 80s, had to do more work and keep interest rates relatively high to ring out, further ring out inflation and inflation expectations. But Paul Volker did all the heavy lifting during that period. And that got us into the early 90s and mid-90s,

And this is a period of relatively low and stable inflation. I call this the period of the great moderation from 1990 through 2010. And here we benefited from a positive supply shock, right? Right? That was a period of the technology booming. That's when we had IT, right? So we had a positive supply shock. It was, you know, the Internet came on, generated a lot of economic activity, increased the

productive capability and the size of the economy, which took the pressure off inflation. So this is a period of very strong growth and relatively low and stable inflation. So it was a kind of a nirvana period that took us into the early 2000s. Was there any lessons from that period that you would take away from that period? I don't know about a lesson, but I would throw trade in there as well. This was a period of trade negotiations, right? We had NAFTA. We had lots of trade deals around the globe.

Presumably that helped to contain the costs as well. You know, of course, China entered into the WTO in 2001, and that really changed a lot, right? That really brought down goods prices because a lot of goods manufacturing globally got pushed into China where the costs were lower, and that brought down goods price inflation. That's a good point. That's a very good point. So you had a technology boom and you had this increase in globalization. I guess deregulation might have also played a bit of a role, right?

Wouldn't you think? In terms of, I mean, you know, you go back to, I guess the seminal event was, when I guess this is kind of anti-union. When Reagan broke the air traffic controllers union back in, I think it was 1980, or the early 80s, and he had a period of deregulation in lots of different industry. that also, I think, affected, you know, labor's negotiating power, helped to reduce inflation expectations, and also cause prices in different sectors to at least the rate of growth slow or even decline in some sectors. So I might have played a bit of a role then. I think a lot of reasons

for that, but for that slowing in moderation and inflation, but regulation might make a role on the list, towards the bottom of the list. I'm just throwing this out there. Do you think, income inequality or wealth inequality over that period played a role in keeping inflation loan? How so? We just get the distribution of income skewed away from people that have a high marginal penalty to consume towards those

of a high marginal penalty to save. I'm just throwing out there because that's another thing that occurred in the 1990s and early 2000s. I think it was certainly a result of all the globalization, the deregulation, the technology. The decline in the unions. declining unions all play a role in the skewing of the income and wealth distribution.

But it's, I don't know. Can you connect the dots back to inflation, at least directly connected on? Not directly, but maybe through like income, income wage drove, things like that. Yeah. I don't know, Chris, what do you think? Yeah, I think the causality, naturally I would think the cause that goes the other way. But, right, those other factors caused inequality, but inequality leading to lower inflation. I don't know.

I don't know. It's a stretch. I will say one other key takeaway. Oh, go ahead. Just looking through the whole list here, as we're talking through this, psychology is such a large component of this, right? Really, if you want to be a student of inflation, it sounds like you have to be an armchair psychologist to really understand what's going on. I think the great moderation, right, you also had a period of fiscal discipline. I think people felt pretty comfortable during that period that inflation was not going to

take off or deflation was not going to creep in. So I wonder if that also played a role here. It's just that consumer psychology was pretty stable during that period. Yeah. Yeah. Yeah. Yeah. I think, yeah, you're right.

Sentiment, psychology, which I wrap up into expectations. Yeah, I think they're very, very critical. I guess the other, going back to the technology, boom, that was a period of pretty rapidly declining prices. Remember, there was outright deflation for. or chips and other technology, internet technology. And that, I'm sure, had a role in bringing down inflation in a very significant way. Yeah.

Well, on that note, another issue here is measurement throughout this whole period as well when we are measuring inflation as well. So that's another issue just in terms of the whole discussion here is how can you measure prices over time and how do you do that consistent, how you account for those quality changes. So just a little grain of, I think we've got all the errors, right, but a little grain of salt that, you know, what we, how we're measuring inflation. So what are you referring to when you're saying, when you talk about the technology boom in measurement, what are you referring to? Just the, so inflation overall is a measurement of general price levels over time. How do you control for changes in the quality of the goods over time is a really challenging technical issue, right? We're not just talking about apples in one period versus Apple's another period. We're talking about Apple computers in one period versus Apple computers another period,

which have a very different set of capabilities. So if you just look at the list price of those two goods or those two computers, let's say, right? They might be the same, but one is substantially more powerful. So how do you control for those changes in quality over time? And that's something that the BLS has struggled with. I think any economist struggles with. to make those types of quality measurements.

So when we're looking at some of those inflation figures during a period of rapid technological change, it could be difficult to really grasp the true underlying price changes. On a similar note, oh, sorry. In that period, the Fed shifted their focus from the Consumer Price Index to the personal consumption expenditure deflator. So they're essentially measuring the same thing, consumer prices, but they have different methodologies. They have different weightings. You know, one uses fixed weights, which is the CPI. And Greenspan argued, I think it was in the mid-1990s that the CPI was overstating inflation. So that change, you know, going away from the CPI to the PC deflator doesn't seem to make a big difference, but it does today.

And next year, it's going to be really important. We can talk about that down the road. Yeah, yeah, good point. Just to strike the point home, though, for the listener, the Bureau of Labor Statistics, which is the keeper of the CPI data, the consumer price and inflation data, and I guess it's the Bureau of Economic Analysis who uses the CPI and the producer price indices from the BLS to construct the core PCE. They do make quality adjustments. You're just saying that's pretty tough to do at any time, but particularly a period of rapid technological change because things are improving, quote unquote, and measuring that's pretty tough to do. That's right. That's right. Yeah, yeah. I have a lot of respect for the work they do, certainly. It's just very difficult to disentangle. Okay, this brings us up to the last historical era, inflation era, and that's the period of low inflation concern to disinvolition decelerating price growth. You know, there was some balance of depletion concerns. This was after the financial crisis in the last decade before the pandemic.

And it's weird to think about it now, but disqualification. before the pandemic hit, the Federal Reserve and every central bank in the developed world was struggling with how low inflation was. It was just consistently below their targets, and they were trying to get it up. And so what's the lesson learned from that period of what's called low inflation period? I mean, what caused that? And, you know, what's the lesson from that period? Any views on that? we had a very, very slow recovery after the financial crisis, which, you know, the catalyst of a recession can also factor into the strength of the recovery. And when you have a financial crisis, usually the recoveries are much slower.

So I think that's one reason why central banks were struggling to get inflation higher. Yeah. We saw a lot of slack in the labor market. I mean, we didn't get a lot of improvement in the job market for years. This gets back to sort of the Phillips curve, right? I mean, what you're arguing is that you came out of the financial crisis. The economy grew very slowly, didn't absorb all the slack. Unemployment was high or other measures of slack in the labor market signal a lot of excess capacity there.

People weren't working. That kept wages down and prices down. That's one reason why I had low inflation. Of course, China and globalization were still playing a key role there, keeping inflation down. In inflation expectations, they were starting to migrate lower. They held in pretty well, though. And that's one, I guess, one reason why we never experienced, you know, outright deflation because people still believed at the end of the day, the Federal Reserve and other central banks

would get what they wanted. So they, inflation expectations held firm. But that was, that was a period when it was, and I think we came to the conclusion that one that you mentioned earlier, Chris, that, you know, we have pretty good tools for bringing down inflation. We don't have really great tools for bringing inflation up or sort of. for in a deflationary environment to ending a deflationary period. So that's another lesson, I think, from that period. And they're Europeans, I don't know. They're in Japanese. I'm not so

sure that I think we all kind of feel we're broken free of the low inflation period. I think we feel that way at the moment. I'm not sure if that's still, if that's how the Europeans and Japanese think. I'm very curious. Well, the other lesson is don't flinch when you see inflation for the first time for central banks. I mean, that's what the Fed did. They were very, very patient. waiting for inflation to accelerate at their central banks. As soon as they saw, you know, the white of inflation's eyes, they panicked. And they started raising interest rates, and then their economy is backtracked. Right. This is coming out of the financial crisis you're saying. The Fed waited, waited, waited, waited, and inflation, even though it was low here in the U.S., it was much stronger

than it was in Europe and Japan, where the, well, particularly Europe, where they kind of reacted immediately to the high inflation, kind of cut off the growth, and, you know, never got back to a place where they felt good about inflation. Yeah, and I think the other lesson during that period is that our economy is much less sensitive or reliant on energy prices. So in the past, go back to 70s and 80s, we talked about that led to a lot of higher inflation, persistently higher inflation. Now fluctuations in energy prices have a very temporary impact on consumer prices.

Right. Hey, one other quick thing before we get to inflation in the current context, why two percent? Why, why does the Federal Reserve Board have a 2% inflation target? I got my explanation. I'd be curious to hear what your explanation is. Why, too? Why not 1.56897, or 3.4582. Why 2%? Do you want to go first, Chris? Oh, go ahead. So I guess we're asserting, yeah, everyone agrees that it should be greater than zero should be some positive number, right? Right, right? Because zero, is too close to the bound deflation where we established that. But why two versus three?

Yeah, that's a, I don't have a strong opinion on that. I think if you choose something. Yeah, I don't think there's a lot of rationale. I mean, 2% is the golden rule, most central banks in developed economies, is that they aim for 2% inflation because it's far enough above zero where you don't worry about deflation. And also it's far enough above zero where if you get these measurement issues, that you're actually not targeting too low of inflation.

I'll give you two reasons. One, substantive reasons. One, if you're at two, that means some industry, some businesses are pretty close to zero. And it's not a great thing if any business or industry is experiencing outright deflation, right, for the reasons we articulated before. So you want inflation set high enough that no industry or business of consequences in a deflationary environment. I think that's part of it. Second is, you know, if you have 2%, it's high enough that, you know, you have the Fed Reserve

and other central banks have a little room to lower, you have low inflation of low interest rates. If it's too low, you have no room to maneuver. And this is, you know, if it was one person, if you said at 1%, then the Fed doesn't, interest rates are going to be very low through even the best at times. And the Fed doesn't have a lot of room to react when things are tough. And that's why there's a move of foot, or at least there's a move of foot, or at least there's been a lot of debate that maybe two is too low. Maybe it should be three, because if it's three, that means the growth in the economy is strong enough in the good times, that interest rates are high

enough in the good times that when the bad times come, when you have a recession, you have enough room to lower rates and don't hit the zero lower bound and have to engage in things like quantitative, easing, bond buying, and that kind of stuff. So I think there are some pretty good reasons why you'd want to keep, you know, inflation, you know, around 2%. I think there's also lots of discussion around whether the 2% target has been interpreted as a ceiling or as a medium so far or previously it had been really the market ceiling right so you go to you go to two and a half to get two right that's I think that's two now now I think correct me if I'm wrong Ryan because you follow the faith closely I think the front why they changed the monetary framework

back in last summer and they said okay it's not 2% it's not the ceiling 2% is kind of through the summer you know right we you some, if you're below two for some points of time, you have to be above two for some point of time so that on average, through the business cycle, you're two, which, you know, if you do the, if you think about inflation expectations for a second, if you don't do that, if two percent of your ceiling, inflation expectations will always be below two, which means you'll never get to two. So, you know, in that simple arithmetic, I think, you know, if you kind of think about it. Anyway, okay, all right, real time. We're talking about, you know, inflation today.

And obviously, inflation is up a lot. The consumer price index is up 6% plus year over year, the highest in over 30 years. And, you know, there's a lot of debate and discussion around this. We debated it on our last podcast a little bit. You know, maybe we should reprise that and, you know, see where people stand. So just to summarize kind of the broader theories around inflation and inflation dynamics, you know, we began with the pre-fed period. That goes to the theory of the monetary theory of inflation that, you know, what the Fed does ultimately determines inflation, which I think is the case.

But the view here is that the Fed controls the money supply and the money supply and ultimately controls the rate of inflation. We talked about the Phillips curve, you know, the relationship between unemployment and inflation as another kind of way of thinking about inflation. We've talked about supply shocks. We've talked about negative supply shocks, oil price increases, positive supply shocks, a technology boom. Of course, the pandemic is a negative supply shock.

Of course, we talked about inflation expectations. These are all key elements about how people are thinking about inflation dynamics today. So, you know, you add it all up. And we're sitting here today. The key question is, and it's the question everyone's asking, is this 6% inflation temporary? So the first question I have for you is, well, what does temporary mean? you know, or the Fed in Fed nomenclature, transitory, another way of saying temporary. What does that mean to you, temporary transitory?

All right. I'll go. I mean, Chris is checking his notes. That's, I thought you were all over this one. Oh, no, I wanted to look, you know. Go ahead. There's no time element to transitory. So you don't want to say it's six months, eight months, 12 months.

It's whether or not the underlying fundamentals are going to be. going to support persistently high inflation, and that is just not going to happen. Chris, do you have a definition of temporary transitory? I think Dryance is a good one, but I would throw the acceleration element, kind of that second derivative in there, right? If you see that the inflation rate is still high, but is falling, right? I view that it's going towards that two, two and a quarter percent target, that, to my mind, indicate something that's transitory, if it's accelerating, if it's maintaining, right?

And that's more of a permanent effect. Well, in the current context, the first derivative is certainly positive. That's the rate of change is positive. And the second derivative, which is the rate of the rate of change, is also positive. It's accelerating. So that would not be consistent with the idea that it's transitory, temporary, by your definition. Well, it's so for the next quarter, right? Yeah, exactly.

Next year, that's second derivative. But I want a definition that is functional that helps me. I mean, so you're saying, what are you saying? It comes back down to psychology that, I guess. It's the belief that the rate of change is going to decline over time. Okay, that's the answer, in my view. Okay. It's inflation expectations.

If inflation expectations are low, people believe inflation is going to come back down, then it's transitory. It's going to be transitory. You know, they're going to come back down. It's just a matter of time. It may not be next month to the next quarter. expectations are rising, that's no longer transitory. That means we're not going back to where we were, right?

Make sense? Yeah, I think we're in the same spot. Same spot. Okay. And people believe it's transitory because of what we're going through. You have supply chain shocks. They know that that's going to get wrong out, and that that will be disinflationary next year. Right.

Okay. So there's a few theories of what's going on here that have important implications. In terms of inflation and whether, by the way, I'll say to unequivocally, I think this inflation is temporary transitory. That by this time next year, inflation will be, you know, it may not be all the way back to the Fed's target, but to your point, of course, second derivative, it will be decelerating. the point that I don't think we're going to be really talking about inflation, certainly not in the public discourse. Economists will be, but no one else will be. Are you guys on board with that? Anyone disagree with that perspective? You're both on board with that. Yeah, I'm on board. I think it could be even faster.

Okay. And maybe this is a good time to reprise our debate, which we had in a podcast. Early on, early on was, you know, like our third podcast, you know, back in the spring of this year. And we, I'm wrong, if I characterize this wrong, we were focused on consumer price inflation. And I said, in our forecast was it for it to settle back into around the mid-2%, you're a two-and-a-quarter, two-and-a-half percent, something like that. That's our baseline, and still is. And I was saying, and that's where you landed, Chris. You said that's where we're going to go back to two and a quarter or two and a half. I was saying no, it's probably going to end up being higher than that, probably north of two and a half.

You were closer to three. Three, but I didn't think it was going to land there forever at three. I mean, that, yeah, that was kind of sort of where we're headed, two and a half to three. And you were like, less than two and a quarter, you were like two, maybe one and three quarters to two and a quarter or something like that, right, right? I think so. Penn's got it real, yeah, I think that's what you. Well, no, no, wait. I was one point.

Two and a quarter. Was that course that said that we were on looking at the core consumer expenditure deflator then? Okay, fine. All right. So in terms of the core consumer expenditure failure, there was two to two and a quarter for Chris. I was two and a half and two and a, I don't think I was a three for the core CPU consumer expenditure flitter. I was north of that. You were south of that.

So I know we're getting bogged down on the numbers, but bottom line, is everyone still happy with where they're forecasting inflation to go? No. Okay, so where are you now, Ryan? By the way, I'm very happy with where I am. I'm assuming Chris is happy with where... Yeah. Yeah. Chris is happy.

Remember the bet was average over the next five years. Oh, I don't remember that. We got to check the tape. I thought we were talking about average. Okay. Well, anyway, Ben. All right, so what are you saying then? Are you happy?

You're not happy with your forecast? No. Because I think, getting back to the psychology and inflation expectations, they're going to get pinned where the Fed wants them to be. and that's a little bit above too. So I think that's where we're going to be closer to what Chris is saying. Oh, you know what?

This is very crafty on Ryan's part. It's very nuanced. What he's saying is, I wasn't wrong. What happened is that changed its framework of monetary policy. Therefore, I'm changing my forecast. When the facts change, you've got to change. Actually, that's very creative, very good of you. That's a great quote.

Wired. That's interesting. Good point, though. That's a really good point. Okay, so, okay. Wait, wait, wait. But you're, right, your argument, as I recall, was demographics. You were arguing.

It wasn't the Fed. He was right for the, he's changing view, but he was, you know. Well, that's okay. The Fed is certainly part of that argument, but I wonder if his demographic outlook has changed at all. Is that no? Nope. Okay.

I still think that's a big deal. And I think productivity is going to be a lot stronger than people think. And that, as we talked on the past podcast, that's the firewall between, you know, a strong economy and inflation. Right. Right. You've got to be positive, again, it's positive supply shock lifting. And what's that? Work from anywhere?

Yeah, we have work from anywhere. Businesses, you know, during the pandemic, invested a ton in equipment and software. So I think productivity can be stronger than it was, much stronger than it was pre-pandemic. Yeah. So that's a supply shock argument that we're going to need a. we're getting a positive supply shock, which is kind of, first is the pandemic initially is a negative supply shock, but we are going to get some positives out of this on the other side of it. Yeah, interesting. Yeah, I think to your point, we're not going to be talking about

inflation, you know, this time next year. It's going to be heading back towards the Fet's target, and then we're going to under shoot. We're going to fall below 2% for a period of time, and then come back up. Okay. So our collective view, and I make just to characterize this, And this, you know, correct me from wrong. But what we're saying is the pandemic is a negative supply shock. You know, it obviously hurt growth and is causing inflation to rise. But it's not going to be permanent or persistent because inflation expectations remain well anchored.

And moreover, a lot of the inflation is related due to the effects of the pandemic. And as the pandemic fades, you know, supply chains, labor market issues will iron themselves out and inflation will moderate and come back in. And where it actually lands, give or take, you know, we're debating whether it's a little higher than the Fed's target or the Fed's target a little bit below, but we're all still saying basically that inflation is going to get back down

to something we all feel comfortable that we're not going to be talking about. Is that a fair characterization? Yep. Yeah, that's right. Let me try one other thing out on you because this is another kind of strain of thought in the current debate and discussion around inflation.

That is that fiscal policy is the cause of the higher inflation. That the American Rescue Plan, you know, we've had a lot of fiscal support during the pandemic, beginning with the Cares Act back in March of last year, extending through the American Rescue Plan March of this year, $5 trillion in total, 25% of GDP, that that is the cause of this higher inflation. What do you think of that argument? You know, you didn't bring it up, so I don't think it's on the top of your list, but do you think this is playing much of a role here or any of a role or having any impact whatsoever? I think it's talking a little bit of an impact. I think it helped exacerbate the supply chain issues because there's economic payments. I think they should have been spread out over a period of time.

There was just too much money going into people's pockets. Then good spending went through the roof, and that exacerbated the supply chain problems that we have to that. Chris? Yeah, I'd buy that. Some effect, but I would say actually pretty minor, pretty minor. I can't connect the dots, tell you the truth. I mean, the ARP, the American Rescue Plan, really juice things up when we needed it back in March this year, you know, into April, maybe into May, before the Delta variant of the pandemic hit.

By the time the Delta variant of the pandemic hit, which was, you know, beginning in June, really in July, August, into September, the American, the American, the American, the American, the American, the American, the American, the American, the American, the American, the American, the American. The American Rescue Plan had turned into, you know, it wasn't a supportive growth. It was actually turning contractionary. It really wasn't providing much support whatsoever. The bulk of the stimulus from that was back in the spring. By the summer, that stimulus was largely gone and fading pretty quickly. And right now, you know, it's turning into a bit of a headwind to economic growth. The other thing is that demand, you know, sort of the channel through which the ARP,

the American Rescue Plan, the fiscal support would influence inflation is through demand, right? You're saying fiscal support, government spending, tax breaks, demand, demand means inflation, but demand growth got hit hard in the summer. Demand growth came to a standstill because of the Delta variant. So it's hard for me in terms of the timing of all of this, and even kind of the intuition behind it, that you can connect those dots. I just don't see it playing a role of any consequence here. But what about this argument?

You got the economic stimulus, a lot of demand, reduced inventories. And then when the summer came, Delta variant hit, supply chains got worse. There's shortages of things that drove the prices of those things higher. Yeah, I think that's a real stretch. I think supply chains were getting back online. There were still problems. Labor markets were still a bit scrambled, but they were getting back to normal. and then the Delta hit and, you know, just exacerbated everything, re-scrambled everything.

So I don't know. I think that's a pretty weak, pretty weak thread, yeah, which actually is important because the Build Back Better agenda, which is being debated now in Congress, people say that's going to be inflationary, which I don't know. That's certainly not what's going on now. Is it anything related to what's going on with Build Back Better? Anyway, we're running out of time. I promise that we keep this to the time.

So I'm going to stop right there. there's anything else you wanted at. I thought that was a pretty good history lesson. What do you think? Should we do this again? Yeah. I mean, I think the final point here I'd make is we've got to be, and I've said this a few times on these podcasts about different things,

and maybe about inflation, but we've got to be humble about this. Because inflation is a very, everything economic is complex, but inflation is particularly complex phenomena. Because Chris keeps pointing out, it's also related on psychology and sentiment, which, you know, very difficult to measure, very difficult to gauge. And so we've got to be humble here in terms of our understanding. It's rather limited and it makes this particularly uncertain period going forward.

Well, I'd say we have to be humble, certainly, but we also have to learn lessons. Did I say humble? Did I say humble? Yeah, yeah. I'm agreeing with you. We have to be humble, but we also have to learn the lessons from the past, right? So like the gold standard, right? That really, we should be putting that, we shouldn't be spending any more energy. on that topic and focusing on the future. But agree.

There we are. Right. And also that the money supply causes inflation. That used to, but that's no longer the case. Yeah. So you've got to learn that these relationships, we talked about the Phil's Curve. You know, M2 money supply growth. Those relationships change over time.

So you don't want to get wedded to your models. A long run M2, right? You're on board with that, right? Yeah, longer, yeah. But not now. All right. Well, with that, Ryan, I'm looking forward to the field trip to the second bank of the United States. I like this field trip idea. We've got to get going. We're going to call us a podcast.

Hopefully, you have a wonderful Thanksgiving, and we'll see you on the other side. Take care now. Bye-bye.