Inflation, Jay Powell and the problems facing the economy

The below article does a nice job of summarizing the dynamics surrounding the increase in prices that have been going on for much of this year. How big of a worry should it be? Who knows? We are going through an unprecedented time and there will be unprecedented things going on. If there is anything to remember when thinking about the dynamics of the economy right now, that is it.

For those who were around in the 1970s and came of age during that time, inflation is the most terrifying economic word there is. To be fair, inflation back then was a serious problem. At the same time, thinking that is where things are headed really strikes me as fighting the last, last, last battle, similar to people who lived through the Great Depression hiding cash under their mattresses for the rest of their lives. Having lived through a pandemic, I am sure I will always be paranoid about the next one for the rest of my life, no matter how unfounded that concern is. If many decades from now, I am warning ludicrously about the next pandemic and advocating for some bad ideas to prevent it, I hope younger people will tell me to shut up.

To be sure, nobody really knows where things will go. Maybe we are headed for something awful or maybe everything will be wonderful and great. Just remember that every recession and its aftermath has its own cause(s) and things going on that make it different from the ones before.

Whether the inflation we have seen as “transitory” or longer lasting is far beyond my expertise and I am not going to be a prognosticator on that. My concern with the focus on inflation is not that I think it isn’t real or never a problem, but that it is not the biggest problem we have right now. As the article notes, there are still close to 7 million people unemployed. Some of them may have retired early, but most probably would like to be working again. To me, fixing that really should be where the focus is.

True, inflation can become a serious problem if it spirals out of control although that tends to take years to materialize. At the same time, as the article notes, there is a downside to trying to bring it down. Raising interest rates can cause a recession, which is what happened during the early 1980s. That was probably necessary then, but should only be done as a last resort. Most of the price increases we have seen are because of supply-related issues, which have been affected by things such as the pandemic and natural disasters, along with miscalculations by manufacturers about the impact the pandemic would have on demand. I think raising interest rates because of that would be a horrible idea.

It is important to remember that inflation is not per se bad. Moderate amounts almost always happen and that tends to mean incomes are growing, which is good. For those who are debtors, inflation is a good thing. The increases in home prices are good for homeowners who will see their equity values increase. The article mentions that both Europe and Japan have been trying for years now to get inflation higher. While excessive inflation is bad, deflation is even worse and tends to be a sign of really bad things happening. When the economy fell off a cliff in 2008, for example, gas prices plummeted, providing relief at the pump, but not exactly a price worth paying on the whole.

Jay Powell has been great

Jay Powell has been a great Fed Chair and I really hope Biden reappoints him. He has more credibility on both sides of the aisle then probably anyone in the monetary policy world. Markets and businesses like him and so do plenty of economists and others on the left. He kept interest rates low even when times were much better and in doing so discredited one of the most pernicious ideas among economists. That is the idea that the economy in 2015 was a good as it gets and that unemployment going below 4% is bad and means inflation, which means let’s raise interest rates. Under Powell, unemployment went below 4% and inflation did not surge. The economy really was running hot and people saw incomes increase like they had not in decades.

The CARES Act was a great piece of legislation. Almost as big was Powell committing the Fed to focus on unemployment and do everything it could to get it down. The Fed has a dual mandate, which is to focus on both inflation and unemployment. Since the 1970s, the former has gotten almost all of the attention while the latter was given short shrift. Powell changed that focus and has continued to do so.

While acknowledging that prices have gone up by more than expected, he has still stayed the course and encouraged everyone to take a breather and not panic. He has emphasized that it will be several months at least before anyone has any clear idea where things are headed. He could not be more right. Almost nobody alive today has lived through a pandemic. There is no playbook about what to do to recover from a pandemic-caused downturn. We are in uncharted waters and the only rational thing to do at this time is wait and see where things go.

I don’t know how much this has to do with his performance as Fed Chair, but it is notable that Powell is not an economist. He is a lawyer. That brings a whole different perspective to a role that has traditionally been dominated by economists. While economists have things to offer, like any profession they have their limits and blind spots. Any profession can fall victim to groupthink. Powell not coming from that sector may have helped him chart a new course in how the Fed approaches inflation and unemployment. I doubt, for example, that many, if any, economists would have continued to not touch interest rates after unemployment went below 4%.

Comparing what we are facing now with respect to inflation to the 1970s is not apples-to-apples at all. One challenge though that whoever is Fed Chair in 2022 and beyond may face is pressure to reverse course and cut back support for the economy, including by raising interest rates. In the 1980s, then-Fed Chair Paul Volcker faced immense pressure to reverse course, only in the opposite direction with respect to interest rates (he did not reverse course). In the coming months and beyond, I am sure many of the loudest voices screaming about inflation will become even louder and demand the Fed reverse course. They should not be listened to. Powell has the credibility and track record to avoid doing that. In the end, Volcker was vindicated. I believe Powell will be as well if he stays the course, as he has promised to do. Between his steadfastness in fighting to get unemployment down, his successfully shifting the Fed’s focus towards unemployment and away from inflation and his broad credibility with so many important players, he should be reappointed as Fed Chair next year.

The problems our economy has are comparatively good problems to have

All things considered, having to worry about supply issues seems like a much better problem to have than issues on the demand side. Virtually every economic downturn is because of a fall in demand. The recession we had, which officially “lasted” only 2 months, was virtually unheard of. Incomes were expected to collapse along with employment. Neither happened. Unemployment shot up briefly but then came back down. Yes, it is still elevated, but it has recovered much faster than the recession in 2008.

As for the supply issues, a lot of that seems to be because the US is a victim of its own success. Manufacturers cut back on production (most notably chips) early on when the pandemic hit. They were expecting demand to fall and so they cut back on production to avoid losses. Because of the CARES Act and actions by Powell, demand in the US did not collapse but surged. Ramping up production takes time, but will happen soon enough. The result right now is higher prices. This is one instance where market forces really should be left alone to do their work. They will sort things out even if it takes some time. Again, the idea that we should raise interest rates to bring down prices because of this is insane.

Households right now are flush with savings. The stock market has surged. People have been stuck at home and many decided they wanted or needed to remodel their homes, hence the big increase in housing-related item prices. Natural disasters seem to be taking a toll on production all over the world, along with the pandemic. The latter, of course, is still very much a problem in most of the world even if vaccines are widely available in the US. That is one more reason why the US needs to vaccinate the world.

With respect to unemployment, it will hopefully begin to come down at a quicker pace in the coming months. It may take a while for some people to sort things out. We are all going through an unprecedented time. Many people, especially in restaurants, are rethinking what they want to do with their lives. Restaurant work is often rough with low pay, no benefits and poor treatment by management and customers. If people are looking for other lines of work that are better, that is a good thing even if it means the unemployment rate stays higher for a while.

It may be that restaurants wind up automating a lot of their work. That is fine. It would be good for the people who remain there because they would be getting paid better. I really hope the pandemic has brought about a change in how employer-employee relationships are seen. So many workers have put up with a lot of crap for years and are now fed up. Who can blame them?

I have never been a fan of the cult-like worshipping of small businesses. No, I am not saying small businesses are bad, they are absolutely vital for the economy. What I am saying is that there is nothing inherently better about small business compared to big business. I know politicians cannot say that, but I am not a politician, so I can say it. I especially dislike the notion that small businesses are entitled to an endless supply of cheap labor, as is often the implication of listening to business owners rant about unemployment benefits and accusing workers of being lazy. I really think someone whose business model depends on squeezing every last penny out of employees really needs to give it a rethink. Hopefully, they will not have a choice in that going forward.

While the pandemic has been a disaster on so many levels, maybe one silver lining of it is that it shifts the balance of power towards employees. If workers now have more leverage to demand better pay and treatment, that would be great outcome. Businesses have not had to seriously compete for workers in some time. When workers gain leverage, that means their lives improve on and off the job. Just as the Great Depression had a silver lining of shifting things towards workers, maybe the pandemic will do the same.