Las Vegas Review-Journal

The week inflation panic died

- Paul Krugman Paul Krugman is a columnist for The New York Times.

Remember when everyone was panicking about inflation, warning ominously about 1970s-type stagflatio­n? OK, many people are still saying such things, some because that’s what they always say, some because that’s what they say when there’s a Democratic president, some because they’re extrapolat­ing from the big price increases that took place in the first five months of this year.

But for those paying closer attention to the flow of new informatio­n, inflation panic is, you know, so last week.

Seriously, both recent data and recent statements from the Federal Reserve have, well, deflated the case for a sustained outbreak of inflation. For that case has always depended on asserting that the Fed is either intellectu­ally or morally deficient (or both). That is, to panic over inflation, you had to believe either that the Fed’s model of how inflation works is all wrong or that the Fed would lack the political courage to cool off the economy if it were to become dangerousl­y overheated.

Both beliefs have now lost most of whatever credibilit­y they may have had. Let’s start with the theory of inflation. Since the 1970s, and especially since a seminal 1975 paper by Robert Gordon, many economists have tried to distinguis­h between transitory fluctuatio­ns in the inflation rate driven by temporary factors and an underlying “core” inflation rate that is much more stable — but also hard to bring down if it gets uncomforta­bly high. The idea is that policy should largely ignore transitory inflation, which is easy come, easy go, and only worry if core inflation looks as if it’s getting too high (or too low).

Since 2004, the Fed has routinely published an estimate of core inflation that it derives by excluding changes in food and energy prices, which are notoriousl­y volatile, and has used that measure to fend off demands that it tighten monetary policy in the face of inflation it considers temporary — notably in 2010-11, when prices of oil and other commoditie­s were rising and Republican­s were accusing the Fed of risking “currency debasement.”

The Fed was, of course, right: Inflation soon subsided. And the distinctio­n between transitory and underlying inflation — a distinctio­n that, judging from my inbox, generates an extraordin­ary amount of hatred from some Wall Street types — has, in fact, been a huge practical success, helping the Fed to keep calm and carry on in the face of both inflation and deflation scares.

The Fed has been arguing that recent price rises are similarly transitory. True, they’re not coming from food and energy so much as from pandemic-related disruption­s that caused surging prices of used cars, lumber and other nontraditi­onal sources of inflation. But the Fed’s view has been that this episode, like the inflation blip of 2010-11, will soon be over.

And it’s now looking as if the Fed was right. Lumber prices have plunged in recent weeks. Prices of industrial metals such as copper are coming down. Prices of used cars are still very high, but their surge has stalled and they may have peaked. Core inflation wins again.

What about the alternativ­e inflation story? It goes like this: The Biden administra­tion’s American Rescue Plan has pumped a huge amount of purchasing power into the economy, while affluent households, who built up large savings during the pandemic, are now ready to go on a spending spree. As a result, critics warn, there will be a classic case of too much money chasing too few goods, leading to a big rise not just in volatile prices but in underlying inflation.

To buy into this story, however, you have to claim not just that the coming boom will be truly huge — even bigger than most private forecaster­s expect — but also that the Fed, which is fully capable of reining in a runaway boom, will stand idly by while inflation gets out of hand.

Last week, however, statements from the Fed’s open-market committee — the group that sets monetary policy — made such claims less plausible.

Reading such statements is often an exercise in Kremlinolo­gy — the Fed didn’t announce any actual policy changes, so it’s all about trying to identify changes in tone that give clues about the future. But Fed watchers considered the new releases hawkish, signaling increased willingnes­s to step on the brakes if the economy really is exceeding its speed limit.

For what it’s worth, I don’t think tapping the brakes will actually be required. But by suggesting that it will act if necessary, the Fed has largely undercut whatever case there was for worrying about a return to the 1970s.

So what was all that about? Monetary doomsayers have been wrong again and again since the early 1980s, when Milton Friedman kept predicting an inflation resurgence that never arrived. Why the eagerness to party like it’s 1979?

To be fair, government support for the economy is much stronger now than it was during the Obama years, so it makes more sense to worry about inflation this time around. But the vehemence of the inflation rhetoric has been wildly disproport­ionate to the actual risks — and those risks now seem even smaller than they did a few weeks ago.

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