Not only are you paying more for things than you were a year ago, but consistently higher than expected Consumer Price Index readings continue to devastate the stock market, sending the S&P 500 down more than 1,000. points on Tuesday, his worst day since June. 2020.
One of America’s top financial historians says this moment calls for a lesson in economics.
“The reopening of inflation we’ve had so far has been a very good thing,” said UC Berkeley professor Brad DeLong. Fortune. His comments contradict the more hawkish stance on inflation championed by Harvard economist Larry Summers, who worked alongside DeLong at the Treasury Department during the Clinton administration.
DeLong argues that there is a major economic shift underway that people should embrace. It all has to do with our weird but wonderful post-pandemic economy.
The new economy, DeLong says, is one with more time spent online, fewer jobs requiring in-person interactions, and a significantly higher rate of goods production.
It’s like we’ve zoomed decades into the future in just a few years.
“A few decades,” DeLong said when asked how many years of economic change had been squeezed into just over two: “A few decades of structural change and social and economic learning about how to be permanently online.
“Fewer in-person workers in retail establishments, a lot more delivery orders, a lot more production of goods, and also a lot more entertainment and information production,” is how DeLong described his vision of the new economy during a separate interview with Fortune last week covering his new book, Advance to Utopia. The meeting took place over Zoom, DeLong noted, proving his point.
Inflation in the United States currently serves two functions that could help the economy in the long term, according to DeLong: helping to develop new economic sectors ready for strong growth, and uncovering and optimizing supply chain problems. who have accompanied us since the beginning of the 2000s. pandemic.
Unemployment is now at its lowest point since before the pandemic, but the full employment we are returning to is not the same as we left off in 2020, DeLong said.
“We want to quickly return to a full employment economy. But it’s a very different full-employment economy when we go back,” DeLong said.
According to DeLong, moving workers from industries like retail and hospitality to expanding sectors must come with incentives in the form of higher wages, which means inflation.
“If you want to create economic incentives for people to move to the growing sectors where we really need more workers, their wages have to go up,” he said.
“When you come out of a big recession, the natural rate of inflation has to be above the normal 2%,” he added. “The rate of inflation that the market really wants to see in order to achieve an efficient allocation of generation, distribution and transmission must be above 2%.”
In addition to helping usher the economy into the new era, DeLong sees another benefit of inflation today: it could help solve crippling bottlenecks in the supply chain, by resorting to the economic adage that high prices are often the best cure for high prices.
With supply chain issues contributing to high prices and making people less likely to buy, this could be the impetus behind a revitalization and ultimately strengthening of the industry, according to DeLong, who says inflation implies more people figuring out either how to produce more of what we need, or less of what we don’t need.
“It’s the absolutely glorious thing in the market,” he said. “That when prices are aligned with social values, it means you don’t just have one brain or a few brains working on the problem. Everyone’s brain is working on the problem. And everyone does what they can to solve it in their immediate situation.
But as always, there is a catch.
Risks of stagflation
The positive outlook for inflation comes with a caveat, admit DeLong and other economists. Expectations that inflation will take root in the economy and persist could become a self-fulfilling prophecy, leading to something even worse for the economy.
The word for that is stagflation: the worst-case scenario of slow economic growth combined with high inflation. DeLong says it’s still very possible.
“Worst of all is that you’re stuck in the stagflation of the 1970s,” he said. “If inflation is rooted in expectations, that will be a very bad thing.”
The ideal situation, DeLong says, would be a repeat of the recessions that hit the United States in the late 1940s and early 1950s, both of which were relatively short before inflation abated.
But a worst-case scenario of stagflation also remains possible, DeLong warned, especially if inflation expectations take root in the economy.
“Entrenched” has been a false word for the Fed this year, and a situation it desperately wants to avoid. Entrenched inflation refers to people expecting prices to continue to rise, which can cause inflation to persist for much longer than it otherwise would.
If inflation took root during a recession, it would be a “really bad thing” for the economy, DeLong said. Whether or not that happens will likely depend on the direction of gasoline and energy prices, which have been highly unpredictable so far this year.
“Whether or not expectations are anchored and we have a 1970s problem really depends on the trajectory of energy prices,” he said. “Inflation expectations are always determined by what people see at the pump.”
Top economists and bankers, including Allianz and Gramercy chief economic adviser Mohamed El-Erian and Goldman Sachs CEO David Solomon, have warned that inflation is already taking root and persist in the world. And the World Bank has issued several warnings this year that persistent inflation combined with slow economic growth is creating a very real risk of stagflation in several countries around the world.
Moreover, not all economists share DeLong’s view that current inflation has much good, with many arguing that it is a much more pressing problem that the government is failing to get its hands on. adequately.
Steve Hanke, an economist at Johns Hopkins University, recently criticized the Fed for “incompetence and mismanagementwhich led to inflation, and predicted that the Fed would let the US money supply run out could lead to a “whopper” of a recession next year.
Former DeLong boss Larry Summers has been singing a terrible tune about inflation for more than a year, warning last year that the Federal Reserve was being too passive on rising prices. When releasing this week’s CPI report, Summers wrote that the Fed was facing a “severe inflation problemand warned that unemployment will likely have to start rising before inflation recedes significantly.
Many economists fear that the current high levels of inflation and the Fed’s commitment to containing it could trigger a recession as early as next year, although the jury is still out on whether that would constitute a deep or shallow downturn.
In a blog post last year, when inflation was already becoming a concern, DeLong compared the recovery of the US economy to an engine suddenly revving up. The skid marks left on the asphalt represented inflation – a stain and a nuisance for sure – but it was worth it to get the economy back on track.
A year later, inflation may still represent only a temporary slippage on the road to recovery, he says. But between war in Ukraine and uncertain energy markets for the foreseeable future, DeLong admits the outlook is much bleaker now.
“We have energy price inflation and food price inflation from Russia and its attack on Ukraine. This considerably complicates the picture and makes the situation much more difficult,” he said.
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