They Wouldn’t Know Inflation if It Bit Them in the Ballot

Biden-Harris defenders try to ‘decompose’ the rise in prices, forgetting what inflation actually is

By Joseph C. Sternberg. Excerpts:

"Not so, say the revisionists. Representative of the genre is a recent Washington Post op-ed by Peter Orszag, CEO of Lazard and a director of the Office of Management and Budget in the Obama administration. He argues, based on research he conducted with economists from Lazard and the Brookings Institution, that supply-side problems such as supply-chain disruptions accounted for 79% (not 78% or 80%) of the inflation in 2021."

"The Bidenomics rear guard is talking about something different: changes in relative prices, such as the jolt to prices for toys that might arise due to a Chinese pandemic lockdown, or the energy price shock after Russia’s 2022 invasion of Ukraine. In the process they beg the most important questions, in the true sense of that phrase—taking as a given the phenomenon one ought to be examining.

The obvious follow-up questions after an observation that snarling supply chains pushed up some prices would be: Why and how were consumers able to absorb those higher prices without offsetting declines in service prices? Why did temporary changes in relative prices for some things morph into a large and durable increase in the prices for everything? Mr. Orszag and his co-authors only mention cryptically in the last paragraph of their research note that the supply pressures they describe “inevitably have a demand component.”

There’s a lot of interesting economics to be done to understand the recent bout of inflation. For instance, what role did monetary policy play in all this? And how and why did a fiscal blowout like the American Rescue Plan stimulate rising consumption specifically? Why not, say, higher household saving or investment via 401(k)s and the like?

On the latter point, the revisionists note there’s no clear relationship between inflation and stimulus spending measured as a proportion of gross domestic product. But an alternative “fiscal theory of the price level,” championed by John Cochrane at the Hoover Institution among others, posits that the important link is between new government spending and the existing government debt level. When measured in this way, a robust relationship emerges between faster inflation on one hand and higher government spending relative to existing debt on the other hand.

The intuition is that as households and businesses collectively start to doubt the government’s long-term ability to repay a debt-fueled spending binge, incentives develop to consume rather than save and invest. Agree or disagree (I’ll profess agnosticism for now), this theory at least tackles the demand half of the inflation equation that the revisionists would rather ignore."