What "transitory" means and why it matters
Slow Boring.com
By Matthew Yglesias
Oct. 28, 2021
Inflation is bad, but it is much more likely to go down than up.
Everyone’s got inflation on the brain these days, and I’m detecting a growing impatience with reassurances from authorities that rising prices are likely to be “transitory.” At the same time, analysts who earlier in the year proclaimed themselves Team Transitory have generally been taking victory laps as they feel data tends to support their view.
I think that kind of team thinking makes for unhealthy analysis, and at this point in time, it’s useful to draw a distinction between two claims.
Inflation in the back half of 2021 has been higher than the Fed forecasted it would be at the beginning of the year, and it’s now overwhelmingly likely that we’ll be experiencing some high inflation in the first half of 2022.
There is no sign as of yet of inflation accelerating or becoming embedded in expectations in a way that would suggest a possible loss of control over price rises.
The former is a legitimate beef that the public has with policymakers. A non-trivial number of analysts warned of this possibility, and they are correct to feel vindicated. In particular, the inflation that we have seen has not been limited to a handful of pandemic-specific sectors of the economy and instead now pretty clearly reflects a broad-based increase in cash induced by very generous fiscal policy.
But on the other hand, the “transitory” proposition never really hinged on this.
A huge global pandemic is a really big deal. It’s killed hundreds of thousands of Americans, many more people around the globe, and it’s also led to many cases of non-fatal illness that were nonetheless serious and involved hospitalizations or prolonged recuperation at home. The pandemic has also significantly altered almost everyone’s daily conduct — not commuting to offices, wearing masks on the job, conferences and conventions going global, schools getting stricter about attendance while sick. An economic cost alongside the humanitarian one is inevitable; there’s nothing fiscal or monetary policy can do about that. What policy can do is impact what kind of cost is ultimately borne.
In the beginning, it seemed like the pandemic would induce a really serious recession. But thanks to Jerome Powell and Steve Mnuchin and Nancy Pelosi and Joe Biden and Raphael Warnock and others, that hasn’t been the case — we pumped a ton of money into the system, flushed people’s pockets with cash, and largely averted severe economic deprivation despite a very scary and disruptive virus. Instead, we got a moderate amount of inflation, which while bad is clearly preferable to a prolonged spell of mass unemployment. So why don’t policymakers always opt for “moderate amount of inflation” over “prolonged spell of mass unemployment?”
A big reason is that they worry that even a moderate amount of inflation could unleash an inflationary spiral of 5% this year, 6% the next, and 8% the year after that. And in this sense, inflation still looks clearly transitory.
(Spencer Platt/Getty Images)
We do not see a frenzy of consumption
Something that I think is pretty obvious but not always explicitly discussed is that perceptions of future price trends impact consumer behavior.
For example, Apple just released a series of new MacBook Pro laptops with new M1 Pro chips that look really good but are also pricey. As the owner of a MacBook Air with a now-outdated M1 chip, I am kind of jealous of the owners of these new machines. And while they are expensive, I could afford to go buy a new one if I really wanted to. But I’m not going to do that, because one thing we all know about the computer industry is that improvement in quality is fairly rapid, and 18 months from now cheaper and/or better Mac laptops will likely be available. My current laptop is still very good, and it’s more prudent to wait.
But sometimes the market for a good isn’t like that. If you see a pair of sunglasses that you really like and you can afford to buy them, then you might as well buy them now. You could be thrifty and decide you actually don’t want to spend money on sunglasses, but there’s no particular reason to expect future sunglasses to be better or cheaper than current sunglasses. You just have to decide if your budget can accommodate them and how much you like them.
Rising prices, at least in theory, could have the effect of inducing current consumption.
If some kind of price wizard told me that Moore’s Law has been repealed and laptop prices will be higher in 2023 than in 2021 with no improvements in quality, then I might run out and buy a new MacBook Pro today. After all, why wait if the prices are going up? That’s the inflationary spiral, a dynamic in which nobody wants to hold onto cash because they perceive that its value is falling, so they spend, spend, spend right away. That furious pace of spending induces more inflation, which induces more spending. And the thing policymakers fear is that once that mentality has taken hold, it’s hard to break short of inducing an intense recession like we saw in 1981-82 when unemployment started at 7.4% on Ronald Reagan’s inauguration day and soared to 10.8% by November 1982.
The core claim of “transitory” is that this is not happening.
I’ll try to present some data in support of the transitory claim, but I also suggest everyone search their personal anecdata. What are you hearing? I am hearing a lot of people bummed out about gasoline prices being high, people annoyed by shipping delays, and a generalized sense of anxiety that the money we got from Uncle Sam arrived in the past but the price increases induced by the money arriving are happening now. You go from exhilaration (“I got $1,400!”) in February to annoyance (“Bacon costs what?”) in September. But what I do not hear is people with cars in perfectly good working order responding to the rising price of cars by rushing out to go buy a brand new car before prices go even higher. Tell me if I’m wrong, but I don’t think I am.
Signs inflation will go down
The clearest reason to believe inflation will go down in the future rather than up (i.e., be transitory) is that “core” inflation (where you ignore food and energy prices) is lower than headline inflation.
To normal people, food and energy prices are actually the most important prices. Everyone buys food and electricity, almost everyone buys gasoline, and most people buy home heat. These are also expenses that recur routinely, and demand for these commodities is relatively inelastic. People do cut back on gasoline consumption when prices rise. But for most people, doing this even in the short-term is sufficiently difficult and disruptive enough that they mostly suck it up and pay more for gas, cutting back on non-gasoline expenditures. So it seems perverse to hear economists saying “if you ignore the price increases in the stuff that’s key to your daily life, the situation actually looks much better.”
That’s why I always want to be clear about the reason for looking at core inflation, which is that current core inflation is a better predictor of future headline inflation. That is the one and only reason to care about it. Inflation has been running over 5% for months now, and you are entitled to feel as aggrieved about that as you want. But if you want to know how alarmed you should feel about the future, core inflation is telling you that prices are likely to moderate.
Now to be clear, core inflation is not a perfect predictor. But surveys of inflation expectations show the mass public expects price increases to moderate, as do market-based measures of expectations, as do the Cleveland Fed’s complicated models.
Everything is pointing to transitory.
Something to note from the standpoint of your right as a citizen to whine and be annoyed: transitory is actually a low bar. A year ago, a gallon of gasoline cost $2.15 on average while today, it’s $3.32. Suppose that a year from now, prices rise another $1.17 — that is not the kind of relief people are hoping to see at the pump. But it would represent a declining rate of price increase (roughly 35% rather than 54%) and thus would be a victory for “team transitory.”
More than anything else, I think this is why the people fretting about accelerating inflation are making a mistake. A market economy has powerful equilibrium forces. When stuff gets expensive, people buy less of it (even gasoline demand is not entirely inelastic), and they also invest in creating new supply. Capital expenditures are surging across the board, and nominal (i.e., not adjusted for inflation) spending on goods is already falling from its spring peak.
Rather than leaping toward ruinous inflation, we are seeing the operation of a reasonably well-functioning market economy recovering from a pandemic. For inflation to explode, you would need some additional policy to boost household spending, and that’s not what’s happening.
Policy is turning contractionary
It hasn’t been discussed much, but the 2021 budget deficit, though high, was lower than the 2020 deficit both because the American Rescue Plan was smaller than the CARES Act and because tax revenue was much stronger in 2021. There isn’t going to be a stimulus bill in 2022, and revenues will continue to rise thanks to economic growth.
One result of all the stimulus over the winter is that spending shot up. But even with spending up, incomes rose even more and household savings increased. As Mark Zandi’s handy table shows, in percentage terms, the rise in savings was especially pronounced among families of more modest means.
But as he observes, these savings are being drawn down relatively rapidly.
He anticipates that labor force participation will rise as people run out of money, and beyond that, spending will have to decelerate if people aren’t getting more cash from the government.
Note that this is not the 1960s and 1970s when a large share of the population had an automatic cost of living adjustment written into their contracts. Back then, higher prices boosted wages across large sectors of the economy, which ensured consumers could afford the new higher prices. Today, people don’t generally have that protection. If prices go up, the amount of stuff we buy has to go down to adjust.
The Federal Reserve itself is getting ready to reduce quantitative easing at its next meeting and will be raising interest rates next year. I was vocally critical of tapering and rate hikes back in 2015, but today I think it’s totally appropriate. Unlike back then, inflation really is above target, so it’s reasonable to start tightening policy at a judicious pace. I’m not some kind of mega-dove who thinks there’s nothing to worry about here. But there’s no reason to worry specifically about inflation somehow getting out of control.
We ended the recession. Fiscal stimulus is gone. Monetary stimulus is being withdrawn. Policymaking over the past 18 months has not been perfect, but in broad terms, it’s been appropriate.
The real question — jobs
Rather than worrying about hyperinflation, I would worry about jobs.
We are still well below the pre-pandemic peak of employment, and after a string of very rapid job growth months, things have slowed down considerably. That’s bad.
The relevance of inflation here, though, is that unlike in 2015, the answer pretty clearly is not “more stimulus.”
A few months ago, I was pretty bought-in on the theory that a poorly structured UI program that meant people would lose money if they accepted a job was holding back employment growth. Folks on the left who derided that theory have been vindicated so far. What they don’t seem to realize is that their vindication is basically bad news for America, for the Biden administration, and for progressive politics in general because — again — there’s no good case for stimulus now.
Zandi’s theory is that the savings cushion is holding back labor force participation, and it will leap back over the next two months as people run out of money.
Other people think the Delta wave made some folks unusually hesitant to take jobs — something that could certainly interact with and reinforce Zandi’s theory. With Delta fading, booster shots approved, and vaccines for kids available soon, maybe that will change. Some people point to labor force dropouts among people over 50 and say “well, these are early retirements and those folks are never coming back.” I’m pretty skeptical of that theory. I think if it feels safe and remunerative to work, people are going to be inclined to go work.
But if you want to see a stirring defense of Covid-era macro policy, just look at inflation-adjusted GDP — by the second quarter of this year, the economy had already fully recovered!
When something bad happens, “we get some inflation but real output quickly recovers” is a much better problem than the alternative of prolonged recession.
The inflation itself is annoying and undesirable, but there is no sign that it’s spiraling out of control. The lingering problem is labor force participation, where nobody seems entirely sure what the story is. But I think our interpretation of 2021 is going to end up hinging critically on how those October, November, and December jobs reports come in. If they’re strong and we add two million more workers in the last quarter of the year, then the slowdown will look like a blip and it’ll be an overall successful recovery. If they’re weak and growth has stalled out, that’s a big problem crying out for a solution.
