What the inflation contrarians get right and how to fix it. By Matthew Yglesias.

What the inflation contrarians get right and how to fix it. By Matthew Yglesias. 

Slow boring.com

January 18, 2021. 

Hey folks, hope everyone enjoyed the long weekend and is getting excited about Inauguration tomorrow.

Today I want to talk about two things that seem far afield but that I believe to be related. The idea of a universal child allowance, which I call for in One Billion Americans and disagreements about monetary policy.

So monetary policy first. This is the Personal Consumption Expenditure Deflator — the price index that the Fed says it is targeting. Officially, the Fed is supposed to have a symmetrical two percent inflation target. In other words, the PCE deflator should grow at about a 2 percent rate, equally likely to be above or below 2 percent. And as you can see, that’s not the case. The Fed has been close-ish since the end of the Great Recession but definitely erring on the side of too low.

There are a bunch of reasons for that, but one reason is that the world is always producing new rounds of theories which purport to say that the real inflation rate is higher than that. The latest big one to make the rounds on Bitcoin Twitter and elsewhere is the Chapwood Index:

It exposes why middle-class Americans — salaried workers who are given routine pay hikes and retirees who depend on annual increases in their corporate pension and Social Security payments — can’t maintain their standard of living. Plainly and simply, the Index shows that their income can’t keep up with their expenses, and it explains why they increasingly have to turn to the government for entitlements to bail them out.

It’s because salary and benefit increases are pegged to the Consumer Price Index (CPI), which for more than a century has purported to reflect the fluctuation in prices for a typical “basket of goods” in American cities — but which actually hasn’t done that for more than 30 years.

The middle class has seen its purchasing power decline dramatically in the last three decades, forcing more and more people to seek entitlements when their savings are gone. And as long as pay raises and benefit increases are tied to a false CPI, this trend will continue.

This has gotten some coverage in the Financial Times and you can see Brian Romanchuk for a detailed methodological debunking.

But to make a broader observation here, the thing that virtually every inflation contrarian take I’ve ever read has in common is that it takes the following form: Sure, the government says prices are only rising by 1-2 percent per year but if you look at the price of a bunch of stuff that’s risen faster than average you can see that prices have risen much faster than that.

This is true! If you ignore the items experiencing below-average rates of price increase, you are left with a very rapid pace of price increase. But that’s not a flaw in the inflation calculation, it’s a mechanical consequence of averaging a bunch of price changes together.

The price of computers, for example, has fallen considerably. And so has the price of closely related things like TVs and smartphones and mobile phone service. The price of cars has fallen, too, albeit less so and to see the difference, you need to consider that a lightly used car purchased in 2020 has a much better feature set than a brand new car purchased in 2010. All the outsourcing of manufacturing to Asia that people complain about has made clothing and furniture cheaper.

Since some stuff is actually getting cheaper, other stuff needs to be rising in price by much more than 2 percent in order to get the average inflation level that the Fed is aiming for. That’s how it’s supposed to work. Low inflation doesn’t mean there are no relative price shifts. And I think we could have a much healthier conversation if we talked about relative price shifts rather than inflation.

Relative price shifts are a big deal

If the price of fruit and vegetables started rising by double digits per year, offset by falling prices for sugar, wheat, and other staple commodities, that would have serious implications for people’s diet and health.

To just shrug and say “well the price of food is stable” would be pretty unresponsive to the actual situation, which is that a normal person is either going to see the quality of their diet erode or else the share of their income going to food rise.

Critically, this is not inflation.

I am a stickler here just like I’m a stickler about immigration and wages, because it’s really important for policymakers not to lose the plot on the need for aggressive monetary policy to generate full employment.

That being said, these relative price shifts are also bad.

And in this case it’s a fake example. But here are some real facts about how relative prices have changed:

This chart is telling you the plain truth, which is that if you took a healthy, childless person from 2000 and teleported them to 2020 and showed them Spotify and Netflix on an iPad Pro their mind would be totally blown. And an iPad Pro plus a magic keyboard costs less in nominal terms than an iBook did in 1999. Your guy would be extremely impressed with the IT revolution and the information superhighway.

But then if you bring forward another guy who’s got three kids — ages 4, 2, and six months — and tell him what his new child care costs are going to be, he’s gonna be really sad.

And, yeah, the oldest is going to be in public kindergarten soon. But school only runs until 3:30 PM; it takes months off in the summer; and there are lots of random days off. The skyrocketing cost of “child care” is not limited to the formal child care sector — it largely extends to aftercare and after-school programming, to summer camp, and even to babysitters. There are various specific things at work in all of these subsectors, but the basic story is the same — watching kids and taking care of sick people are labor- intensive so Baumol’s Cost Disease ensures that as technology and productivity improve in other sectors of the economy, the costs rise in the less-productive sectors.

In a more banal example, it’s gotten more expensive to hire a live band to play at your party but it’s also become incredibly cheap to gain access to almost any song in the world via the streaming music service of your choice. In the music example it’s just entertainment. But the relative shift toward cheaper stuff but more expensive childcare and health care is a big change for society.

Everyone sitting home alone watching Netflix isn’t great

What I think people ought to say isn’t that the “real” cost of living has risen, but that the implications of these relative price shifts are bad and depressing to contemplate.

If relative price shifts cause people to go to the theater less but to the movies more, then that seems fine. Or if we all bought more clothing but less furniture; or if the shifts went the other direction and we got less clothing but more furniture. Changes in consumer behavior due to changing tastes and shifting prices are fine and normal.

But food, housing, child care, education, and health care are all expenses that scale pretty linearly with family size. And the price of all of them has risen faster than inflation, offset by the falling price of a lot of other stuff.

This is bad stuff, and in my view captures what’s correct when people say that they feel like the cost of living is rising. They mean that having and raising children is an integral aspect of the good life in a way that buying a really big television is not, and that a relative price shift that’s left us with fewer kids and larger televisions hooked up to four streaming video services is change for the worse. And I absolutely agree that it is change for the worse. But if we insist on calling it “inflation” rather than what it is, we aren’t going to fix it.

Less inflation won’t help

The key is to remember the difference between relative price trends and overall inflation. Whether we had 4 percent inflation or 0 percent inflation, we’d still have had the same relative shift where the basic elements of the traditional good life got more expensive relative to playing casual games on your iPad.

If the Federal Reserve were to react to these kind of concerns with tighter money, people will lose jobs and incomes and inflation will slow down, but the relative price shifts won’t be improved at all.

The problems here are on the “real” side of the economy.

Some of them are kind of complicated. People write whole long books about higher education costs, and I’m not going to try to touch that one here. Let’s just say again that while soaring tuition is a genuine problem, it’s a problem that needs to be actually addressed in a specific way — not with monetary policy.

I hope everyone knows by now what I think about housing.

But I think the big thing is that we should take seriously the point that having and raising children is an important thing, and not just a consumer choice to be weighed against the falling price of wireless telephone services.

Improving the Child Tax Credit

The solution here, I think, is to treat parenting sort of like how we treat retirement.

We’ve decided, as a society, that it’s important for people to have a stable, secure, and dignified retirement. So there is a program that sends you money every month if you are elderly. We ought to have a similar program that sends a monthly check to every parent of a kid under 18. Two kids, you get two checks. Three kids, you get three checks. I think you can probably make a case that the checks should be bigger when the kids are littlest and smaller when they’re teens, but I don’t have a dogmatic view about that.

A critical thing is that I think this should be a truly universal program.

Right now there’s a Child Tax Credit, but it’s only partially refundable which means that the poorest families (with the smallest tax liabilities) don’t get the full value. It also phases out so that more affluent families don’t get it. Also because it’s a tax credit, it comes but once a year when monthly checks are more helpful to low-income families that may be living month-to-month in a very precarious way.

House Democrats — building on senate legislation from Michael Bennet and Sherrod Brown — have a plan to improve the CTC:

They want to make it bigger — $3,600 per year for kids under six and $3,000 a year for older kids.

They want to make it fully refundable.

They want to pay it out mostly as an “advance” on the year-end credit.

Joe Biden’s American Rescue Act adopts the first two of those ideas but drops the third. But also in Biden’s plan it’s just a one year program. So from Biden’s point of view this is essentially an extra fiscal stimulus that will be paid out in 2022 (when people file their taxes) to supplement everything else he’s doing in 2021.

As Biden’s team is keen to point out, this would cut child poverty in half.

Of course by that token it would be better to do the Brown/Bennet idea and make it a permanent reduction.

These are excellent ideas and they would make America a better place. But I do think we can do better than that.

The trouble with tax credits

A member asked me why this is structured as a tax credit and all, and the answer is that while there are reasons, they aren’t good reasons. Instead, they are reasons of history and path dependency.

If you scroll history back to the much more libertarian conservative political climate of the 1980s and 1990s, then big new spending programs were just a non-starter. Tax cuts were the order of the day. But cuts in tax rates are sharply regressive. So a liberal could say “instead of a big government program to buy everyone a can opener, I’m going to create a $20 Can Opener Tax Credit usable once every 10 years” and you could maybe get Republicans to go along with it.

That was fine as far as it went. But the political appeal of tax credits meant that they multiplied fairly rapidly. And the see-saw between Democrats and Republicans since Reagan has been to leave us with lower taxes but a more progressive structure — i.e., rich people are paying a larger share of the smaller overall pie of income taxes. The result is that there are now huge swathes of the population that don’t benefit from tax credits because they have no net income tax liability. So many tax credits are “refundable” (i.e., you end up paying less than zero income tax), but then there are still concerns that for it to be a tax credit you ought to be working (i.e., paying payroll taxes) so lots of these things are only partly refundable.

Over its life span, the Child Tax Credit has been getting larger and better, which is good. And the Democratic proposal is to essentially expand it into the best form of itself.

But this still leaves you with the following problems:

Like most tax credits, it phases out for people at higher incomes rather than operating as a general support for parents the way public schools do.

There’s a huge group of people who will qualify for the expanded CTC but won’t qualify for the monthly “advance” because they’re not expected to get a tax refund. Those people likely won’t realize they are benefitting from a general support for parents.

Because it’s administered through the tax code with various means-testing criteria, you only get the money if you file your taxes correctly to claim it, which it turns out lots of poor people don’t do.

And critically, while tax credits as a political response to Reaganism had a kind of narrow logic, the expanded fully refundable CTC does not have any of that logic. This is a program that, working as intended, will just send monthly checks to very poor families with little or no labor market earnings. That’s the welfare state (which is good!) and not a tax cut. The only reason to do it this way is path-dependency. The CTC has been around a long time; it’s accepted by the political process; Republicans have proposed expanding it before; and so members of Congress are comfortable talking about it.

That’s a reason, but it’s not a good reason.

Do a real child allowance

Matt Bruenig has been spending a lot of time the past few days being churlish and petulant on Twitter about CTC expansion advocates, which I do not endorse.

But he is correct that it would be better to accomplish these goals by sunsetting the entire tax credit concept and starting from scratch with a cash allowance for kids that would replace the CTC and a couple of other tax credits. I would make this completely universal. You have a kid, you get a check. Mark Zuckerberg’s got two kids, so he’s getting two checks. Does he need the money? No. But he’s entitled to send his kids to free public school where he lives, he’s entitled to check books out from the library, he’s entitled to go use the park, and he should be entitled to the child allowance. By the same token, a single-mom with no income is entitled to send her kids to free public school, to use the library, and to go visit the park and she should be entitled to the child allowance.

It’s for everyone.

For low-income families: The big benefit of this approach is the simplified administration. No complicated forms; you just need to show that the kid exists.

For middle-income families: The big benefit is political — you’re taking the program out of the Submerged State and clarifying that this program exists.

For high-income families: The big benefit is a statement of purpose — the allowance subsidizes all families with children, because it’s a statement that society considers this important. It drastically curtails child poverty, but it’s not just an anti-poverty program.

Bruenig’s proposal is for $374 a month which I can just hear every political staffer in the world saying should be a round number. My Niskanen colleagues Robert Orr and Samuel Hammond propose slightly tweaking the way his proposal works to fix a technical issue with the way he would treat one-child households with modest but non-zero income.

These are interesting details.

But to me what’s important about this is the 50,000-foot view. The child allowance is important not just as a way to improve anti-poverty policy, but as a way to address the confusion around inflation and living standards. The United States is not suffering from an eroding value of the dollar, but it is suffering from an erosion in normal people’s ability to enjoy the good life. That’s because the relative price of parenting-related expenses has risen compared to everything else. We ought to redress that.

I also think cash on the table ought to play a larger role in progressives thinking about child care costs. Waving a wand to create high-quality publicly run child care centers all across the country would be a great idea. But as far as I can tell, nobody actually knows how to do this at massive scale. Rather than being paralyzed and doing nothing (the current approach) or writing PDFs that are full of hand-waving about the key point of how to create these institutions at massive scale, it would be better to give families money. Money can be used to purchase child care services or to meet other expenses in other ways. And that would let you invest in building-out quality child care centers at a reasonable pace, while also paying attention to quality and to the reality that not everyone wants center-based care for their kids.