Our Weird Economy
Takes from Kevin Erdmann, Scott Sumner, Joseph Politano, and Noah Smith
Note: Monday at 6 PM NY time, we will try to sort out what’s going on.
Kevin Erdmann sees a soft landing ahead for the economy.
Given downward inflation trends, which at this point appear to be pretty broad among components that had been high - lumber, shipping, used cars, etc. - a 3.6% real growth with sub-2% inflation, seems likely. Given the backward looking bias of cyclical sentiments, this must sound radically optimistic, but this is simply the base case trend.
Scott Sumner thinks that inflation is still a problem.
A desirable policy of bringing inflation down through gradualism would balance the costs of inflation and unemployment. It would impose a modest amount of pain on the labor market, but not too much. But the Fed has not imposed any pain at all. Indeed it hasn’t even returned to labor market back down to the boom conditions of late 2019. There’s been no balancing of costs. And there’s been no significant reduction in inflation at all. Despite what you read in the press, there’s been no tight money policy in 2022.
Over the last year, we have seen financial conditions worsen significantly as the Fed raised rates to 3.75%—but conditions worsened more than when the Fed raised rates to 2.25% in 2019 and less than when the Fed merely started signaling tighter policy in 2015/2016. By the same token, today’s tighter financial conditions have not yet had the same effect on inflation or real economic variables as they had during the 2019 or 2015 tightening cycles. Interest rates must be evaluated against their impacts on real economic variables to determine the stance of monetary policy, and policy is arguably looser today than during the 2010s despite nominally higher interest rates.
People are used to seeing their real wages go up most of the time, and any dips are small and short-lived. The inflation of 2021-22, however, has seen huge and sustained decreases in real wages across the board.
…If both employers and employees think inflation is going to die down in a couple months, maybe they’ll keep getting surprised when inflation fails to die down, with the result that wages keep undershooting inflation.
Where is Robert Lucas when you need him?
Actually, real wages should track productivity, which seems to be falling. I keep thinking that firms are hoarding labor and trying to avoid raising wages.
I continue to believe two things:
1. Nobody really understands what is going on.
2. Our “financial forest fire prevention” of the last several decades brought us here.
Maybe we kick the can down the road one more time and again compound the size of the final reckoning. Maybe not. There’s a lot of smoke.
In trying to predict future inflation, which is related to the printing of money and debasement of the value of the currency, the concept of "Real Interest Rate" (nominal - inflation) is relevant. At the present time with the small increases by the FED, the "real interest rate" has become more negative because the inflation rate has increased faster than the Fed's rate.
A negative real interest rate means that financial intermediaries can still make fortunes by borrowing at Fed rate and buying anything which will maintain value over time. An "investment" doesn't have to actually be profitable, it just has to maintain value. To kill inflation, the real interest rate must become positive. That is what the Fed did in the early '80s by increasing interest to 20%, which did kill inflation. All during the '70s, like today, half measures were taken while unions and all government workers obtained COLA's (cost of living adjustments). Nice for them, but to the great disadvantage of non-government and non-union employees, the value of whose paychecks decreased monthly as the cost of living increased.
Energy and human creativity are fundamentally the only limited resources on our finite planet. Therefore, a savvy investor could just buy steel or aluminum and let it sit as an "investment", all the while making a profit on the borrowed money. Aluminum will maintain its energy value.
I worked on an economic development project in Brazil in 1962. At the time, Brazil's high rate of inflation resulted in people buying rebar and storing it in their yards, essentially bypassing their currency that was loosing its value.
Inflation drives unproductive choices to the benefit of the individual to protect their assets. But these choices are destructive to the well-being of the society as a whole, by diverting investment funds from alternatives that could generate real profits in the long term and be the salvation of society which is being unnecessarily handicapped by the well-intended, but short-sighted maintaining of interest rates below what they actually are in the real world. The "Real Interest Rate" is really the only one that matters.