CreatePDF_96942492_1.txt

A History of Economic Whac-A-Mole :: Project Syndicate: Alan S. Blindera€™ s new book, A Monetary 
and Fiscal History of the United States, 1961-2021a€l. There has been neither linear development 
nor much a€oeprogressa€D in figuring out how to manage modern economies in the interest of 
macroeconomic stability. Instead, Blinder describes:
wheels within wheels, spinning endlessly in time and space a€! [with] certain themes a€l waxing and 
waning a€l monetary versus fiscal a€! the intellectual realm a€l the world of practical policy 
making a€l the repeated ascendance and descendance of Keynesianisma€l

Problems appear and are either solved or not solveda€!. The response sets the stage for a new and 
different problem to emergea€l. Actions taken in the recent past left the economy more vulnerable 
in some waya€!. Can inflation be expected to ebb, or does it tend to be highly persistent, with 
each shift in the rate becoming permanently embedded in the likely future? When Blinder a€oeentered 
graduate school in the fall of 1967 a€l empirical evidence virtually
screamed out that [it could be expected to ebb]  Theory and empirics clashed sharply. As Groucho 
Marx memorably asked, a€~Who are ya gonna believe, me or your own eyes?a€™ a€D Going with your own 
eyes was not the right thing to do. As economist Thomas J. Sargent soon showed in a a€cebeautiful 
five-page papera€D that was a€oeunderappreciated at the time,a€D much of the theoretical debate 
a€oewas beside the pointa€Da€l. Now, the same

problem is back. Do inflation expectations remain well-anchored or not? Is the answer the same as 
it was in the 1970s? It might well be, or it might not bea€!.

Blindera€! lets us ride shotgun along the extremely rocky road that US policymakers have traveled 
in their quest for price stability, full employment, financial resilience, and robust investment. 
Each episode produced by the Wheel of Fortuna is strikingly and a€“ I believe a€“ almost completely 
accurately described. Read and absorb Blindera€™ s account, and you will be qualified to present 
yourself as a respected elder statesmen who has seen much
macroeconomic policymaking up close, and whose advice warrants attentiona€!.

While history (correctly handled) can be very useful in helping us understand current situations, 
theory (at least currently fashionable theory) is nota€l. Monetary policymakers who make their 
decisions on political grounds should count on their reputations being permanently tarnisheda€!. 
Using fiscal policy properly to manage demand and support growth is incredibly complexa€! in ways 
that are impossible for the political system to comprehend in real
timea€!

Two years ago, when the Biden administration-to-be was planning how to try to manage the 
macroeconomy, it sought to avoid three mistakes.

The first mistake was the trap into which the Obama administration had fallen: failing to 
prioritize properly and to set up the game board for the rapid return the economy to full 
employment. The Obama administration had a plan for a first round of recovery measures. It had no 
plan for what it would do if Republicans and blue-dog Democrats proved obstreperous, and its first 
round failed to do the entire job. The cost was a lost half-decade of growth, and a
further widening of income inequalities. The Biden administration was not going to make that 
mistake, but would, rather, prefer to make its own different mistakes.

As to the counterfactual, one possibility would be one in which inflation was still below 2%, and 
in which the labor-market recovery from the Plague Recession of 2020 was as slow as the 
labor-market recovery from the Great Recession of 2008:

FRED - Employment-Population Ratio • 25-54 Yrs./80.5*100


I A. J

’.5-54 Yrs./8O*1OO

201 6                        2018


Recovery of prime-age employment from recession, start of recession = 100, Great Recession of 2008 
and Plague Recession of 2020
Would that be a better world? Should the Fed have done that? I really do not think soa€!

It is at this point that I do have to admit that the economists I most respect are not doing much 
better:

Emi Nakamura: Noah Smith: Interview. a€~The recent increase in inflation is much more than 
historical experience would have predicted (which is about an increase in inflation of 1/3% for 
every 1% decrease in unemployment)a€!. Supply shocks are back!a€! There has been a historic shift 
in demand from services to goods: <https://fred.stlouisfed.org/graph/?g=LnYU>a€! [and] secular 
shifts in demand can lead to the same
inflationary pressures as supply shocksa€L ThirdaCI a very rapid recovery and a lot of government 
supporta€!. Households have a huge buildup in savings chttps:Z/fred.stlouisfed.org/graph/?g=Lo 1 
j>, and spending this down is no doubt contributing to demand. Conceptually, one might expect these 
demand pressures to be captured by the unemployment ratea€!. One thing that hasna€™ t contributed 
much to inflation so far is an
unhinging                                                                                           
                                                                                                    
          of longer run inflation expectationsa€!. Market expectations are predicated on what the 
market expects the Fed to do. There is a self-fulfilling prophecy element in this, as in many 
things in macroeconomics. So long as the market expects the Fed will do what it takes to contain 
inflation, we wona€™ t see much movement in longer run inflation expectations. The Fed is working 
very hard to preserve this. But we cana€™ t take
this for granteda€l

LINK:

Noahpinion

Interview: Emi Nakamura, macroeconomist

If you ask any macroeconomist to tell you who the stars of their profession are right now, Emi 
Nakamuraa€™ s name will surely be at or near the top of the list. In 2019, Nakamura won the John 
Bates Clark medal, one of econa€™ s two most prestigious awards a€” and one thata€!

Read more

a year ago A- 59 likes A- 23 comments A- Noah Smith

One way to put it is this: There has been much discussion of the NAIRU or the a€oenatural rate of 
unemploymenta€da€”the unemployment rate below which you should not try to push the economya€”but 
there has been little discussion of any a€oenatural rate of inflationa€na€”the rate of inflation 
below which you should not try to push the economy. All competent macroeconomists agree that there 
is a positive natural rate of inflation: we have high costs of
nominal wage cuts in terms of the destruction of worker-boss trust, very high costs of bankruptcy 
workouts, and very very sticky nominal debts. Given those institutional-structural features of the 
economy, a positive natural rate of inflation to grease the gears of the labor market and of the 
debt market is an inescapable necessity. But how high is the natural rate of inflation in normal 
times? And how does it alter in times of supply shocks and of sectoral­
rebalancing demand shocks? Not enough economists have spent not enough time on these issues.

My view is that there is noa€”nonea€”zeroa€”case for not accommodating supply and 
sectoral-rebalancing shocks until they threaten to destabilize long-run inflation expectations. 
After they threaten to do so, there is a trade-off to be dealt with. Before they threaten to do so, 
there is not.

The second mistake was falling into the trap of giving too large boost to spending. Rapid and 
complete recovery would require the acceptance of some inflation: wages, needed to rise in 
expanding industries to pull workers into them, because the post-plague configuration of the 
economy would be different than the pre-plague configuration ; bottlenecks would emerge during 
reopening, and the prices of bottlenecked commodities needed to rise in order to signal
the economy that here was a problem of finding substitutes and increasing supply that needed to be 
crowd, sourced and sold quickly. How much inflation? Nobody could say. But if the re-opening 
inflation shock was too large, it could easily trigger a Federal Reserve overreaction, which would 
put us once again back into the semi-depressed or depressed state of secular-stagnatio,n with 
interest rates at their zero lower, bound and little policy traction to promoe
recovery.

The third mistake was that too big a boost to spending would be followed by an insufficient 
reaction by the Federal Reserve, in which case the economy would fall into a configuration in which 
inflationary expectations were elevated, which would lead to a stagflation reminiscent of the 
1970s.

The metaphor of steering, like Odysseus, between Scylla and Charybdis seems apposite. The first 
mistake is simply not steering through the strait at all, the second is sailing too close to the 
hydra monster, Scylla, of seclar stagnation. The third is being dragged into the stagflation 
whirlpool of Charybdis.

Even a year ago, however, it still seemed that the task was not that difficult. There had been 
policy and political will to set the oars to work to drive the boat forward at speed. There seemed 
to be a wide middle path between secular stagnation and staglation. You could arguea€”we 
dida€”about whether staglation was the bigger danger to be avoided, or secular stagnation was. But 
both risks seemed relatively low, and manageable with a Federal Reserve that


Then, this last February, came Vladimir Putin's invasion of the Ukraine. The safe path 
narroweda€’’indeed, the safe path may have disappeared. Then, in June, the Federal Reserve 
abandoned its forward guidance with a 75 basis-point interest-rate hike, pointing to an unreliable 
Michigan survey number as justification. It, at least, no longer believed that it understood the 
situation.

Thus today what worries me even more than that there might be no safe path is that whether or not 
there is, the Federal Reserve appears to have given up on trying to find it. I no longer hear 
Federal Reserve officials note that last winter and spring's tightening of monetary and financial 
conditions has not yet had a chance to materially affect the economy. Janet Yellen once said to me 
that the FOMC had a strong tendency to overreact to the immediate news flow
unless it based its thinking around and had something like the Taylor Rule to serve as a 
navigational Pole Star. But the world has changed. The Great Moderation economy in which the Taylor 
Rule made sense is gone. And the Federal Reserve has no replacement to guide its thinking away from 
immediate news-driven groupthink.

Financial markets, at least, right now appear to be betting that the Federal Reserve is about to 
make mistake number two: pursuing policies that have too great a chance of returning us to the 
world of secular stagnation, once again at the zero interest rate lower bound on monetary policy, 
with the prospect of then triggering another lost half-decade of economic growth, and another 
upward leap in inequality.

As of the start of February 2022, the five-year five-year forward CPI inflation breakeven rate in 
the bond market was hanging at 2% per yeara€”a number corresponding to a PC each chain inflation 
forecast from 5 to 10 years hence of some 1.6% per year, materially below the Federal Reservea€™ s 
2% target. Thus as of the start of February, I was feeling very good about being on Team Transitory 
as far as inflation was concerneda€”or at least on Team The-
Fed-Has-Got-This, and Team The-Inflation-Expectations-Anchor-Is-Solid.

The policy discussion surrounding appropriate monetary policy has been greatly hobbled by a lack of 
attention on the natural rate of inflationa€”a€Dthe level that would be ground out by the Walrasian 
system of general equilib- rium equationsa€! [accounting for] structural characteristics^! 
including market imperfections, stochastic variability a€! cost of gathering informational [and] of 
mobility, and so ona€!a€D <https://www.aeaweb.org/aer/top20/58.1.1-

17.pdf>. Chief, among these structural characteristics is downward nominal wage stickiness: the 
extreme inadvisability for worker-morale and hence effort-elicitation reasons of a business 
attempting to continue to employee a worker at a lower nominal wage.

The first-order implication of this is that the natural rate of inflation will almost always be 
positivea€”that, contrary to Milton, Friedman, the long-run Phillips curve is NOT vertical, but, 
rather that downward nominal wage stickiness requires that the economy have a positive average rate 
of inflation, in order to grease the wheels of commerce and achieve anything close to an efficient 
allocation <https://www.brookings.edu/wp-
content/uploads/2000/01/2000a_bpea_ akerlof.pdf>.

The second-order implication of this is that the natural rate of inflation will be higher in times 
when there is a good deal of reallocation to be donea€”at times when the economy is not in a stable 
configuration with respect to sectors and industries, but is instead hunting for a new and 
different cross-sector and cross-industry relative allocation of effort.
At times like now.

So I ran through the qualitative considerations that impact what the natural rate of inflation is 
likely to be right now for Tristan Bove of Fortune.

a€oeThe reopening inflation wea€™ ve had has so far been a very good thing ,a€D Brad DeLong, a 
professor at UC Berkeley, told Fortune. His comments contradict the more hawkish stance on 
inflation famously championed by Harvard economist Larry Summers, who worked alongside DeLong in 
the Department of the Treasury during the Clinton administration.
DeLong argues that there is a major economic shift taking place that people should welcome. It all 
has to do with our strange but kind of wonderful post-pandemic economy.

The Zoom worldThe new economy, DeLong says, is one with more time spent online, fewer jobs 
requiring in-person interactions, and a substantially higher rate of goods production .Ita€™ s like 
we have zoomed decades into the future in just a few years.a€oeA couple of decades,a€D DeLong said 
when asked about how many years of economic change have been crunched into just over two: a€oeA 
couple of decades of structural change and social and
economic learning about how to be online as a permanent thing ,a€da€ceFew er in-person workers in 
retail establishments, a lot more delivery orders, substantially more goods production, and also 
substantially more information entertainment and production as well,a€D is how DeLong described his 
vision for the new economy during a separate interview with Fortune last week covering his new 
book, Slouching towards Utopia. The meeting took place over
Zoom, DeLong noted, proving his point .Inflation in the U.S. is currently serving two functions 
that could help the economy in the long run, according to DeLong: helping expand new economic 
sectors poised for big growth, and uncovering and optimizing supply chain snags that have been with 
us since the beginning of the 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 the one we left behind in 2020, DeLong said. a€oeWe want to get back to a full employment 
economy quickly. But ita€™ s a very different full employment economy when we get back there,a€D 
DeLong saidMoving workers away from industries like retail and hospitality and into expanding 
sectors needs to come with incentives in the form of higher wages, according to DeLong, which means 
inflation.a€oelf you want to create economic incentives for
people to move into the expanding sectors where we actually need more workers, their wages have to 
go up,a€D he said. a€oeWhen youa€™re coming out of a big recession, the natural rate of inflation 
has got to be above the normal 2%,a€D he added. a€oeThe rate of inflation that the market really 
wants to see in order to get production and distribution and transportation into an efficient 
allocation has to be more than 2%.a€DIn addition to helping bring the
economy into the new era, DeLong sees another benefit of inflation today: it could help resolve 
crippling supply chain bottlenecks, 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, it could be the impetus behind a revitalization and ultimately a strengthening 
of industry, according to DeLong, who says inflation is involving more people
with figuring out either how to produce more of what we need, or less of what we dona€™t.a€oeThat's 
the absolutely glorious thing about the market,a€D he said. a€oeThat when prices are aligned with 
social values, it means that you don't just have one brain or a few brains working on the problem. 
Everyone's brain is working on the problem. And everybody does what they can to solve it in their 
immediate circumstance .a€DBut as always, therea€™ s a

catch.

Stagflation risksThe positive outlook for inflation does come with a caveat, DeLong and other 
economists admit. Expectations that inflation will become entrenched in the economy and stick 
around might become a self-fulfilling prophecy, which would lead 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 is still very possible.a€oeWorst of
all is you get stuck in the stagflation of the 1970s,a€D he said. a€oelf inflation gets entrenched 
in expectations, it will be a very bad thing.a€DThe ideal situation, DeLong says, would be a repeat 
of the recessions that hit the U.S. in the late 1940s and early 1950s, both of which were 
relatively short before inflation subsided.But a worst-case scenario of stagflation also remains 
possible, DeLong warned, especially if expectations of inflation become entrenched in
the economy.a€oeEntrencheda€D has been a bogey word for the Fed this year, and a situation it 
desperately wants to avoid. Entrenched inflation refers to people expecting prices to keep going 
up, which can lead to inflation staying around much longer than it would otherwise.Should inflation 
become entrenched during a recession, it would be a a€oevery bad thinga€D for the economy, DeLong 
said. Whether this will happen will likely depend on the direction
gasoline and energy prices take, which have been highly unpredictable so far this year.a€oeWhether 
or not expectations get entrenched and we get a 1970s problem really depends on the trajectory of 
energy prices,a€D he said. a€celnflation expectations are always driven by what people see at the 
pump.a€DTop economists and bankersa€’’including Allianz and Gramercya€™ s chief economic adviser 
Mohamed El-Erian and Goldman Sachs CEO David
Solomona€”have warned that inflation is already becoming entrenched and persistent around the 
world. And the World Bank has issued multiple warnings this year that persistent inflation combined 
with slow economic growth is leading to a very real risk of stagflation in multiple countries 
around the world.Also, not every economist shares DeLonga€™ s view that there is much good at all 
about the current inflation, with many saying it is a much more pressing
issue     that the government is failing to adequately control. Steve Hanke, an economist at Johns 
Hopkins University, recently criticized the Fed for a€oeincompetence and mismanagementa€D that has 
led to inflation, and predicted that the Fed letting the U.S. money supply run short could lead to 
a a€oewhoppera€D of a recession next year.DeLonga€™ s old boss Larry Summers has been singing a 
dire tune on inflation for over a year, warning last year that the
Federal Reserve was being too passive about rising prices. At the release of this weeka€™ s CPI 
report, Summers wrote that the Fed was faced with a a€oeserious inflation problem ,a€D and 
cautioned that unemployment will likely have to start ticking upward before inflation recedes 
significantly .Many economists fear that todaya€™ s high levels of inflation, and the Feda€™ s 
commitment to containing it, could trigger a recession as early as next year, although
the jury is still out on whether this would constitute a deep or shallow downturn. In a blog post 
last year, when inflation was already becoming a source of concern, DeLong compared the recovering 
U.S. economy to a driver suddenly accelerating away. The skid marks left on the asphalt represented 
inflationa€”a blemish and a nuisance to be surea€”but worth it to get the economy back on track. A 
year later, inflation can still just represent a temporary skidmark
on the road to recovery, he says.

1. Macro Policy Guiding Principle: prioritize full employments’’make Saya€™ s Law true in practice 
even though it is false in theoryS!

2. Macro Policy Guiding Principle: move the economy as fast as possible to what its long-term 
optimal structural configuration should be

3. Macro Policy Guiding Principle: Guiding principles (1) and (2) overrides desirability of 
immediate price stabilitya€!

4. We still have lots of room to run before we can say that the post-Volcker Fed has failed to meet 
its inflation target in an average-outcomes sensea€!

5. Time to panic about inflation will be when the bond market gets worried about ita€”but right now 
the bond market is very much a€oeFed has got thisa€Da€!

6. Yet the political economy of the thing is overwhelmingly relevant: inflation that gets Biden 
booted from office would be very bada€!

7. Even prolonged inflation may helpa€”in that there is a lot of structural reform we need to do, 
and this may help us get it donea€!

8. Hexapodia!

And my immediate first response is to ask the question: In what sense is the Fed supposed to have 
been "way too slow" in tightening monetary policy? We still are way short of full employment. Some 
of that is due to childcare and virus-fear bottlenecks. But some of it isna€™ t. And to the extent 
that there are important jobs not being done because people cana€™ t afford to make alternative 
childcare arrangements or fear the virusa€”well, the inflation that
comes from paying people more to see if they will take those jobs is to be welcomed, not fought:

FRED — Employment-Population Ratio


Plus the economy has undergone a great wheel: 6% less relative to trend in personal consumption 
expenditures on services, and 20% more relative to trend in personal consumption expenditures on 
goods. Not all of that is going to stick into the post-plague economy, but a good deal of it will. 
We have an economy in which nominal wages and some nominal prices are really sticky downward. That 
means that if market prices are to do their job signals of where the
value is, prices and wages in industries that need to expand must rise relative to prices and wages 
in industries that need the contract. With prices and wages in industries that need to contract 
sticky downward, that means: inflation:

130

120                                           Personal Consumption Expenditures: Goods


110

100

90

80

70

60

50

40

2002       2004       2006       2008       2010       2012       2014       2016       2018       
2020

Now it is certainly true that we do not want the inflation now, which we want, and which is an 
essential part of a rapid restoration of general prosperity, to stick around once we arrive at 
whatever our new normal is going to be. But I look outside my window now, and I see no new normal.

Thus my immediate second response is to ask the question: Why is it not obvious to nearly everybody 
questions of inflation control should be postponed until their proper datea€’’which will be when 
the plague has fallen to an endemic flu-like illness, and when the economy is back to full 
employment?

Perhaps I should not be surprised at our world of public discourse about finance and economics that 
does not seem to have thought much, if at all, about the relationship between macroeconomics and 
rapid structural change. This is, after all, the same world of public discourse about finance and 
economics that never managed to absorb Paul Krugman's very important 1998 point call if you find 
yourself at the zero lower bound on interest rates, that means that your
inflation target is too low: <https://www.brookings.edu/wp-content/uploads/2016/07/1998b bpea 
krugman dominquez_rogoff.pdf>


Brad DeLong: By Invitation: What Can America Learn From Its Past Bouts of Inflation?: a€~In 1947 
and 1951 the problem went away by itself. In 1920 the Fed tightened too much, says the economist:

The first and most important thing to recognise about the macroeconomic situation in America is 
that Jerome Powell and his Federal Open Market Committee (fomc) should be taking victory laps. Two 
and a half years after the start of the financial crisis in 2007, Americaa€™ s unemployment rate 
was kissing 10%, the Federal Reserve realised that it was out of firepower and the Obama 
administration had just thrown away its ability to help by promising to veto
spending and tax bills that were insufficiently austere. After that moment it would take six years 
for Americaa€™ s economy to approach full employment. The impact of deficient employment meant that 
output was $7trn lower in 2013 than it would have been otherwise. Additional losses stemmed from 
the investments not made, business models not experimented with and workers not trained during the 
decade of anaemic recovery.

We have avoided all that this time around. Relative to the Fed presided over by Ben Bernanke 
between 2006 and 2014, Mr Powella€™ s team are public benefactors to the residents of America to 
the tune of $20trn, if you consider that there are more jobs and fewer idle factories now and in 
the future because of their actions. We have an uptick in inflation partly because the 
Feda€’’alongside Congress and the presidencya€’’responded far more aggressively to the
pandemic-induced recession than to the global financial crisis. A world in which the economy 
recovers so quickly that inflation emerges is better than one in which recovery drags on painfully 
for years.

America has faced five bouts of inflation in the past century or soa€”or six, depending on whether 
you count the 1970s as one or two episodes. The inflation during the second world war, which was 
tamed by price controls, is not relevant to our situation. That leaves four (or perhaps five) 
historical parallels which provide lessons in how to deal with the current inflation problem.
First: Six Episodes of U.S. Inflation Above 5%/Year in the 1900s

The top graph is the CPI inflation rate; the bottom graphs are overlapping graphs of the Federal 
Reservea€™ s discount ratea€”the rate at which it lends to banks on reasonable collateral.

FRED   — -Consumer Price Index for All Urban Consumers: Purchasing Power of the Consumer Dollar in 
U.S. City
Average

1920        1930        1940        1950        1960        1970        1980        1990        
2000        2010        2020

FRED    — Interest Rates. Discount Rate for United States                                           
            VIEW MAP a?

15.0

12.5


10.0

Counting 1974 and 1979 as two episodes, there were six times in the twentieth century during which 
the annual inflation rate got above 5%. One was the World War II inflationa€”cut off by price 
controls. Then came the post-WWII structural-rebalancing-and-pent up demand inflation, and then the 
Korean War structural-rebalancing inflation as the U.S. government wheeled its economy to fight the 
Cold War. During both the Fed sat bya€”it was then still
focused on keeping the prices of Treasury bonds high. The inflations soon passed away.

Before those came the World War I episode. That episode of inflation was cut off by an increase in 
the discount rate from 3.75%/year to 7%/year, which not only ended the inflation but enforced 
deflation: a 20% decline in the price level from its peak. (This decline, I should ask, made the 
task of restoring the gold standard at anything like pre-World War I nominal parities much more 
difficult, hence much more pointless.) Milton Friedman and Anna J. Schwartz
judged that the rise was a€oenot only too late but also too mucha€D 
<https://archive.org/details/monetarvhistorvo0000frie/page/230/>: the Fed should have moved earlier 
to prevent excessive bank discounts from inappropriately boosting high-powered money, and at the 
moment the Fed did move the structure of credit was sufficiently based on a continuation of Fed 
policy that the Feda€™ s move generated a€oeone of the most rapid declines [in economic
activity]                                                                                           
                                                                                                    
                  on recorda€D.

If the Federal Reserve had not moved to raise discount rates after World War I, what would have 
happened? Friedman and Schwartza€™ s judgment is that an earlier increase of, say, 125 basis points 
to remove the incentive for banks to engage in excessive discounts would have brought the excessive 
growth of the high-powered money stock to an end, and stopped the inflation.

Then came the 1970s: The Fed raised interest rates after the Yom Kippur War oil shock to control 
inflation; then, after inflation peaked, it lowered them to try to restore full employment; then 
came the year when, as the late Charlie Schultze said, a€oeour forecasts of nominal income growth 
were dead on, but inflation came in 2%-points high and real growth 2%-points lowa€D; and then came 
the Volcker disinflation, reversed in September 1982 when they
realized that they had bankrupted Mexico, and not resumed as the Fed decided to declare a fall in 
inflation to the 4-5%/year range as complete victory. That 4-5% target lasted for a decade, 
followed by the opportunistic disinflation down to and Alan Greenspana€™ s declaration of the 
2%/year inflation targeta€”a declaration that it is very hard today to argue was appropriate, given 
the extraordinary amount of time global north economies have spent with interest
rates at their zero lower bound since.

What does macroeconomic theory tell us that the Federal Reserve should do now, in the spring of 
2022?
Olivier Blanchard writes:

In early 1975, core inflation was running at 12 percent and the real policy rate was equal to about 
a"’6 percent, a gap of about 17 percent. Today, core inflation is running at 6 percent and the real 
policy rate is equal to a"’6 percent, a gap of 12 percenta€”smaller than in 1975, but still 
strikingly largea€!. It then took 8 years, from 1975 to 1983, to reduce inflation to 4 percent, 
with an increase in the real rate from bottom to peak of close to
1,300 basis points, and a peak increase in the unemployment rate of 600 basis points from the early 
1970s. Today is obviously different in many waysa€!. [But even so,] it reasonable to think that a 
200-basis-point increase in the policy rate, so only 1/6 of the rate increase from 1975 to 1981, 
will do the job this time when the gap between core inflation and the policy rate is 2/3 of what it 
was in 1975? And that unemployment will barely
budge? I wish I could believe ita€! 
<https://www.piie.com/blogs/realtime-economic-issues-watch/whv-i-worrv-about-inflation-interest-rate
s-and-unemplovment>

The suggestion seems to be that we have today 2/3 of the problem we had in 1975, and so the 
solution would be to do 2/3 as mucha€”to raise interest rates by 800 basis points, 8% pointsa€”but 
then to apply some haircut to that 800 basis-point interest-rate rise because a€oetoday is 
obviously different in many waysa€D.
But why does he pick 1975-1983, rather than 1951 or 1948 or 1920? Does economic theory tell him to 
do so?

Truth be told, there is no economic theory. There is only history, and its events, and analogies we 
make based on judgments concerning complicated emergent processes we do not understand very well 
that come out of the millions of interactions that are the economy. Sometimes, it is true, we 
distill and crystallize the history into something we call theory where little squiggles that look 
like E£, r, I2, If, and so on; we then mainline the crystallized product. After
mainlining it we can think we know something. But after mainlining crystal meth we experience 
increased energy, elevated mood, extraordinary confidence, racing thoughts, muscle twitches, and 
rapid breathing, among other things.

Move cautiously. Be data-dependent. Wait for it to become clearer which, if any, historical 
analogies are relevant to our situation. And always, always, always remember that in an economy 
that is near and that we have a good reason to fear will long remain in danger of hitting the zero 
lower bound on nominal interest rates, premature and excessively aggressive moves that raise 
interest rates cannot easily be corrected.

The first is the inflation of the first world war, which was brought under control when the newly 
established Fed raised its discount rate from 3.75% to 4.5% between November 1917 and April 1918, 
and then again to 7% between October 1919 and June 2020. This triggered a short but very deep 
recession accompanied by substantial deflation. Milton Friedman later judged that the Fed moved too 
latea€”it should have started raising interest rates a year or more
before it dida€”but that it moved too far when it did move.

The second is the inflation which emerged after the second world war. It peaked at 19.7% in the 
year to March 1947 as Americaa€™ s economy reoriented itself from its wartime to its post-war 
structural configuration. Tank factories turned back into car factories. Resources that had been 
devoted to building factories and equipping them with tools were released to make all the consumer 
goods that had been rationed during the war. The second world wara€™ s
military-industrial complex was dismantled. Prices and wages went up in sectors where demand was 
high but supply constrained in order to pull resources to where they were wanted. The Fed did 
nothing. It was focused instead on propping up the value of all the Treasury bonds that had been 
issued to fight the war. Inflation averaged 8% over the following year and then went negative in 
1949, when a minor recession came. Once supply had shifted to match the
sectoral pattern of demand, the bottlenecks and the upward price pressure disappeared. Because few 
expected the inflationary trend to continue, nobody was able to demand a high wage increase or get 
away with a price increase, as those who paid them shrugged and said a€oeita€™ s just inflationa€D.

The third bout came in 1951. Inflation peaked at 9.4% in the year to February that year as America 
geared up to fight the Korean war and, perhaps more important, as it built up its global military 
capabilities in the early years of the cold war. The military-industrial complex was rebuilt, and 
rebuilt for a nuclear and aerospaceage. Again, the Fed didnothing. And the inflation wave passed. 
By March1952it was below 2%. And recession was avoided until a minor
one in late 1953. Again, once supply had shifted to match the sectoral pattern of demand, the 
bottlenecks and the upward price pressure disappeared. Once again, because few expected the 
inflationary trend to continue, no one was able to ask for a high wage increase or get away with a 
price increase.

The fourth, or the fourth and fifth, came between 1966 and 1984. Inflation rose from 2% at the 
start of 1966 to 4.4% on Richard Nixona€™ s inauguration in January 1969. It then rose and fell 
throughout the 1970s before soaring to a peak of 12.8% in March 1980. The Fed dithered. Arthur 
Burns, its chairman from 1970 to1978, was too interested in maintainingastrong economy while his 
friend andpatron Nixon ran for re-election in  1972. He did not believe
that Congress would let him keep interest rates high enough for long enough to cure inflation 
through monetary policy. It was only when Paul Volcker became chairman that interest rates were 
raised to a peak of 16.9% in December 1980, and were not lowered below 10% until August 1982.

Which of these is our current situation most like? In my view, the second and third bouts of 
inflation, in 1947 and 1951, are the right models. That is because the long-term inflation 
expectations implicit in the bond market are still trading at their normal 
a€oein-the-long-run-inflation-will-be-abouta€“2.5%a€D range. Bond traders appear to expect a little 
extra inflation over the next couple of years, but after that a return to what has become 
considered normal.
Unless workers and managers see more inflation in the future than bond tradersa€”something that 
seems unlikely to mea€”they have no warrant for pushing for high wage increases or thinking that 
they can get away with price increases ahead of a continuing inflation wave. So there is 
considerable hope (though hope is not confidence) for a soft landing.

But there are two risks of a hard landing. One thing to fear is that the inflation episode today is 
like that of 1920. Back then the problem would have passed on its own, but the Fed tightened too 
much in response. There are no indications of overtightening yet, but then there wouldna€™ t be: 
the effects of the roughly two-percentage-point rise in both nominal and inflation-indexed ten-year 
Treasury rates since December 2021 will not begin to show in the real
economic data until 2023.

But between the war in Ukraine and uncertain energy markets for the foreseeable future, DeLong 
admits the outlook is much cloudier now.a€oeWe have energy price inflation and food price inflation 
springing from Russia and its attack on Ukraine. That is greatly complicating the picture and 
making the situation much more fraught,a€D he said.

Then, on February 24, the grand prince of Muscovy sent his army to invade and try to conquer 
Ukraine in a lightning strike. Things did not go as he planned. Energy and grain prices went 
through the roof, as we contemplated the possibility of a world in which much of Western Europe 
froze and much of Nigeria and Egypt starved in the winter we are now going through. And the 
five-year five-year forward CPI inflation breakeven rate rocketed up: from 2% per
year to its peak of 2.67% per year on April 21,2022.

FRED   — 5-Year, 5-Year Forward Inflation Expectation Rate

2.8

2.6


2.4

2.2

2.0

(D

1.8

CD

1.6

1.4

1.2

1.0

0.8

2018-01       2018-07       2019-01       2019-07       2020-01       2020-07        2021-01       
2021-07       2022-01        2022-07

Expectations of annual PCE-chain inflation from five to ten years hence of 2.27% were not a major 
breaking of bond-trader confidence in the Federal Reservea€™ s commitment to its target. But if you 
think the target-zone width is 0.6%-points annualized and thus that the bond market thinks that Fed 
is or will get on target whenever the five-year five-year forward CPI inflation breakeven rate is 
between 2% and 2.6% per year, there was reason to worry. As I
asked my more hair-on-fire friends back then: Are we now only one more big supply shock away from 
losing the inflation-expectations anchor?

Perhaps we were.

FRED   • Personal Consumption Expenditures Excluding Food and Energy (Chain-Type Price Index)

0.8

0.6


Jan 2018 Jul 2018 Jan 2019 Jul 2019                        Jan 2020 Jul 2020 Jan 2021               
   Jul 2021       Jan 2022 Jul 2022

But we did not get that additional large adverse supply shock. And the monthly PCE-chain inflation 
number for November released on December 23 was 0.16%, which when multiplied by 12 is less than 2% 
per year.

One swallow does not make a summer. One data point does not make a trend. Even the rundown from 
0.62%a€”7% per yeara€”in June is not necessarily bankable: after all, we saw rundowns from December 
2021 to April 2022 and before that from Auguty 2021 to December 2021.

As I have said, this plague-ridden business cycle is one of the rare times that I do not envy the 
members of the FOMC. What they decide to do over the next six months will start to affect the real 
economy of demand, employment, and production starting one year from now, and start to affect the 
inflation news starting a year and a half from now. Many things good and bad will happen in the 
next eighteen months. And whatever the Federal Reserve decides to do,
it is sure to regret it afterwards.

Will it overdo interest rate increasesa€”has it already overdone interest rate increasesa€”and will 
two years from now see the economy mired once again in secular stagnation, with interest rates at 
their zero lower bound, and no visible path for a rapid return to full employment? Will the economy 
attain the soft landing of immaculate disinflation? Will additional supply shocks or political 
pressures wind us in stagflation, or even in enough of a fear of stagflation
that recession comes and is painful and prolonged?

If I were on the FOMC right now, I would hold very tight to two considerations:

1. The Federal Reserve does not have to move slowly. The past six months have demonstrated that 
there are very few downsides to the swift movement in monetary policy that 75 basis-points 
increases in interest rates every month and a half deliver. And a 75 basis-point increase at an 
FOMC meeting is not a speed limit. This suggests: Take advantage of optionality. When the situation 
is unclear, pausea€”and then move fast when the situation becomes
clear.

2. In retrospect, Alan Greenspan's decision to set the Federal ReserveaC™ s target inflation rate 
at 2% per year was very ill-advised. There is an argument that there are substantial benefits from 
maintaining and strengthening credibility by getting the economy back to the 2% per year target, 
even if that target is going to be raised in the medium term. But is that really the kind of 
credibility the Federal Reserve wants to have? It is not clear to me that the
Federal Reserve is better off with it. Is it good for markets to think that you will persist in 
policies when it is clear that circumstances have revealed that they are stupid, and do so just 
because?

Once again: I do not envy the members of the FOMC this winter.

I disagree pretty strongly with the extremely smart Vince Reinhart here. He says that the past few 
years have revealed a€cecracksa€D in how the Federal Reserve makes monetary policy.
But I cannot see any cracks: to date, to me, monetary policy since the plague began has been 
well-nigh perfect.

Vince Reinhart thinks that the Fed moved a€celatea€D and moved a€cefasta€C, as if those are bad 
things. But in the situation it was optimal to be late, and good to then move fast. Indeed, if I 
had my druthers and had been running things, I would have moved later and then faster. The optimal 
monetary policy strategy coming out of the plague was to:

1. delay raising interest rates until inflation was high enough to grease a rapid reopening 
recovery of and shift in economic activity into its new post-plague full-employment 
sectoral-balance configuration.

2. delay raising interest rates until there was full confidence that raising interest rates would 
not send the economy back to the secular-stagnation zero-lower-bound interest rate configuration.

3. then move rapidly to raise interest rates so that expectations of inflation did not become 
established and entrenched.

4. taking care not to overdue interest rate increases and so generate not a sfot landing but 
stagflation, quite possibly ending in a return to the secular-stagnation zero-lower-bound interest 
rate configuration.
It looks to me like the Fed has succeeded 100% at (l)-(3). (4) still hangs in teh balance, but so 
far so good.

So what re the cracks? What is there to complain about?:

Vince Reinhart: Why Inflation Took Off in 2022a€”and What Happens Next: The year was a stress test 
of the Feda€™ s new framework, and the cracks were apparent'. a€~The Fed only garners such 
attention making or correcting a major mistakea€”and there was a bit of both this year. Inflation 
was allowed to hit a 40-year high. Monetary policy had to pivot forcefully to raise the target 
range for the overnight rate to 4.25% to 4.5% in
2022, including four 0.75-percentage-point installments. True, there were two outside, generational 
shocksa€”a global pandemic and a large-scale land war in Europe. However, those shocks were also a 
stress test of the Feda€™ s new monetary framework. This test revealed some significant cracksa€!. 
With inflationa€! at a 40-year high this spring, Mr. Powell and his Fed colleagues retired the word 
a€oetransitorya€na€!. The Feda€!
[brought] the overnight rate to a target range of 4.25% to 4.5% at Wednesdaya€™ s meetinga€L The 
target range still implies a negative interest rate in real terms, even with an optimistic take on 
inflation expectations. A negative real interest rate wona€™ t slow demand growtha€!. The challenge 
here is whether the Fed will be able to defeat inflation completely and regain the confidence of 
the markets. The jury is out...

Vince is very smart, and very knowledgeable, buta€!

(1) The Fed has the confidence of the markets. As of Fridaya€™ s close, the markets are betting 
that from five to ten years in the future the CPI annual inflation rate will be 2.12%a€”and that is 
a PCE chain inflation rate of 1.6%-l .7%, below the Federal Reservea€™ s target:

FRED^   5-Year, 5-Year Forward Inflation Expectation Rate


2.0

<D
V

u.

<V

1.5

1.0

0.5

nnaay, Dec it>, zuzz

2013            2014            2015            2016            2017            2018            
2019            2020            2021            2022

The jury is not out. The Federal Reserve does not have to regain the confidence of the markets. It 
has the confidence of the markets. I cannot see how anyone can say otherwise without a theory 
explaining why the people trading on the markets are not a€oethe marketsa€D. And I do not know what 
such a theory might be.

(2) The target annualized rate of 4.25%-4.5% for overnight money does not a€oeimply a negative 
interest rate in real termsa€D. The 5-year, 10-year, and 20-year inflation-indexed U.S. Treasury 
securities are all hanging up there at positive annual real interest rates of 1.1%-1.5%:

FRED  —  Market  Yield  on  U.S.  Treasury  Securities  at  10-Year  Constant  Maturity,  Quoted  
on  an  Investment  Basis,  Inflation-Indexed

—  Market  Yield  on  U.S.  Treasury  Securities  at  5-Year  Constant  Maturity,  Quoted  on  an  
Investment  Basis,  Inflation-Indexed

— Market Yield on U.S. Treasury Securities at 20-Year Constant Maturity, Quoted on an Investment 
Basis, Inflation-Indexed

2.0

1.5

1.0


0.5

<u

L_   0.0

o

-0.5

-1.0

-1.5

-2.0

I

J,    . /

2013            2014            2015            2016            2017            2018            
2019            2020            2021            2022


Yes, the current overnight rate is less than the current inflation rate. But those sectors of the 
economy in which demand is sensitive to real interest ratesa€’’construction and, via the exchange 
rate, exports and import-competing productsa€”are governed not by any real overnight rate but by 
the real longterm interest rate. The claim that a€oea negative real interest rate wona€™ t slow 
demand growtha€D does not apply, because the relevant interest rate is not
negative.

(3) In fact, the claim that a€oea negative real interest rate wona€™ t slow demand growtha€D does 
not make any sense: a shift from a more negative to a less negative real interest rate would slow 
demand growth. (But, as I said, we dona€™ t have a negative real interest rate in any relevant 
sense.)
Well, that was a surprise!

Given that Jay Powell let himself get panicked out of his forward guidance into a much bigger 
stomping-on-the-brakes because of a preliminary consumer confidence number that vanished as more 
data came in, will he now allow himself to be guided back to what he was planning to do before he 
freaked? Or would that be too humiliating?
What he should, of course, be watchinga€”and what he says he is watchinga€”is core PCE:

FRED   — Personal Consumption Expenditures Excluding Food and Energy (Chain-Type Price Index)

0 --

1985              1990              1995              2000              2005              2010      
        2015              2020

which now stands 2%-points below where it would be had the Federal Reserve actually hit its 2%/year 
inflation target since the Great Recession began. And he should also be watching the 5/5 forward 
inflation breakeven

FRED^ — 5-Year, 5-Year Forward Inflation Expectation Rate

3.5


1.0

0.5

0.0

2004            2006            2008            2010            2012            2014            
2016            2018            2020            2022

which shows no signs of inflationary psychology.

Add in a remarkable tightening of financial conditions from January-May, which will put substantial 
drag on the economy next year as its effects hit exports and construction:

FRED — Market Yield on U.S. Treasury Securities at 10-Year Constant Maturity, Quoted on an 
Investment Basis

4.5

2011         2012         2013         2014         2015         2016         2017         2018     
    2019         2020         2021         2022

And the reliable recession indicator that is yield-curve inversion.


FRED — 1 O-Year Treasury Constant Maturity Minus 2-Year

Constant Maturity


-3

1985              1990              1995

2000              2005              2010              2015

2020

So tell me: What is the argument for the Federal Reserve not standing pat, and seeing what the 
policies it has already undertaken will do to the economy?

FRED^ — Employment-Population Ratio

65.0

62.5


50.0

1992      1994      1996      1998      2000      2002      2004      2006      2008      2010      
2012      2014      2016      2018      2020      2022

Greenspan made his reputation by cutting-shorta€”over the objections of other Fed governorsa€”his 
interest rate increases in the mid-1990s, and so triggering the high productivity-growth late 1990s 
of the dot-com boom. Bernanke thought he had done all that he ought to in the early 2010s and 
presided over a flatlining depression-condition employment level half-decade, followed by continued 
anAlmic recovery. Powell ought to be thinking about how to
manage the situation so that he will be able to take a rapid-return-to-full-employment victory lap.

Key Insights:

1. Yes, it is possible to talk about everything in an houra€!

2. We are not very far apart on what the Fed is doing and should be doinga€’’there is only a 100 
basis-point disagreement^!

3. Miles would be 100% right about the proper stance of monetary policy if he were in control of 
the Feda€!

4. Miles is not in control of the Feda€!

5. Thus Brad thinks that asymmetric risks strongly militate for pausing for six months, and then 
moving rapidlya€!

6. Smart people need to think much more about how to increase lovea€!

7. Remember Robot Tarktil!

8. Noah Smitha€™ s mother is a good friend of a€ceMurderbota€D author Martha Wellsa€!

9. Hexapodia!

Ia€™ m going to have GPT3 make this into an oil painting, what youa€™re describing here about 
marriage. Let me pull out one piece of that because I think ita€™ s important, both for that 
period, for the inflation that comes, and also for eventually, in this conversation, thinking about 
where we might be going. I think when people hear about social democracy, theya€™re very familiar 
with the social-insurance side of it. It has health care and maybe pre-K and
education and so on.

But you mentioned the way the government is involved in decision making. And therea€™ s often, in 
this period, this sort of tripartite bargaining structure by which decisions are made a€”

Brad Delong

in business, in labor a€”

Ezra Klein

a€” with government and labor a€”

Brad Delong

a€” big government a€”
Ezra Klein

And business. Tell me a bit about that, both what that was and then how maybe it set the stage for 
some of the inflation of the a€~70s.
Brad Delong

Well, consider that the federal government, in the 1960s, was spending something like 7 percent of 
national income on its own account in investment. And a lot of that was military a€”
Ezra Klein

What does that mean?

Brad Delong

a€” a lot of that was outer space. A bunch was civilian, things that are not providing direct 
services to people and things that are not buying goods that then provide direct, immediate 
services to people, things that are very much aimed at building capacity for the future. And 
thata€™ s 7 percent not counting government expenditures on education.
Well, now, maybe ita€™ s a quarter of that as a share of national income a€” that the idea of the 
government was looking toward the future and was spending an awful lot of money trying to build 
infrastructure, science, technology, capabilities to produce things.

We saw the apex of this during World War II when the government built a huge number of factories 
that it then gave away to the private sector afterwards on the grounds that the government didna€™ 
t think it was terribly competent to run them. That was a major commitment the government made 
during the social-democratic era that it has not made in the neoliberal era, where the view has 
been that the private sector is much better positioned to figure out what
we should be investing in.

And in the United States, other countries did significantly more, France and Japan most especially, 
in terms of combining business with government and focusing where the investments of the society 
would be going, and boosting their magnitude.
Ezra Klein

So tell me a bit about labor in that period because I think people, even in this period, are 
familiar with the idea that government and business might collaborate quite closely. But labor is 
much weaker today. But what was it then?
Brad Delong

It was a mass production. It was a mass-production economy, rather than today our global 
value-chain economy, which means an awful lot of people on assembly lines and elsewhere, doing 
fairly-routine and very similar jobs, which made it extremely easy to organize them and for them to 
believe they have one common voice, which means theya€™re highly likely to vote for a union to 
represent them because theya€™re confident the union leaders will think
like they do.

And theya€™ re very much aware of their numerical strength in the country, so much so that say, 
periodically, GM. and Ford executives would come to the president of the United Auto Workers, 
Walter Reuther, and saying, why dona€™ t you come on over here and run the company since as much 
about the auto business and more about the work force than we do?

And that extremely strong labor-side voice is something that is almost entirely absent at least 
from our elite discussions. The New York Times used to have several dedicated labor reporters. Then 
they had only one, I think, Steven Greenhouse, the idea that ita€™ s simply not there as an 
interest group, as an estate in society, to hark back to earlier forms of political organization.

And in large part, ita€™ s not there. Laws did a great deal of it. Greater business confidence did 
a great deal of it, both aspects of the neoliberal turn. But it also reflects the changing 
underlying technologies, the fact that if I were Friedrich Engels, I would say, hey, wow, this 
global value-chain economy really is a different mode of production than the mass-production 
assembly-line economy that we saw in the 1960s.
Ezra Klein

Before we get too deep into the way inflation rose in the a€~60s and a€~70s. I just want to talk 
about what it is. What is inflation? What do you tell your students?
Brad Delong

The standard view is inflation is too much money chasing too few goods. I dona€™t think thata€™ s 
really right. Ita€™ s too much spending chasing too few goods. Ita€™ s that people have 
expectations about what prices are going to be. And they assume that, on average, prices are going 
to be pretty stable in normal times.

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And when the flow of spending is less than the flow of production, you get huge amounts of 
inventory accumulation followed by businesses pressing the big, red button and firing people, you 
get a depression. When therea€™ s higher demand than there is, that can be produced, you get empty 
shelves. You get long lines. You get T.S.M.C. and GlobalFoundries saying youa€™re going to have to 
wait an extra six months to get this particular chip.
And then you also get substantial price rises as people say, well, this thinga€™ s in really short 
supply. Why dona€™ 11 cut the line and offer to pay more for it? Or people say, I dona€™ t have 
very many of these. If I keep my prices the same, Ia€™ 11 sell out of them by noon. Ia€™ m going to 
raise my prices today.

So inflation is when people show up wanting to buy things, expecting to buy things, and find that 
the economy has tricked them, that it disappoints their expectations because youa€™ re unable to 
buy what you wanted to buy at the prices you expected to buy. And so at the end of the week, you 
find that $50 that you were planning to have just isna€™ t there because you spent it on gas 
because the gas price reached $6 a gallon.
Ezra Klein

When I ask an economist what inflation is, I tend to get that more-or-less mechanical-sounding 
answer a€” too much money, too few goods, too much spending, too few goods. And then I scratch and 
I start to get very hazy ideas about psychology and beliefs and expectations about the future. So 
if ita€™ s just too much money and too few goods or too much spending and too few goods, where does 
the idea of peoplea€™ s ideas come in? How does inflation
become an almost cognitive dimension of the economy?

Brad Delong

Well, there are two ways. The first is John Maynard Keynesa€™ s observation back in 1919, that 
inflation is a betrayal of social trust at an extraordinary level. When you have a depression, 
maybe one in 20 people loses their job and they have a really lousy time.
Maybe other people are scared that they dona€™ t dare quit. But for the people who those people are 
working for, the fact that someone isna€™ t quitting and is more eager to please you is a plus. And 
a depression affects only a few people.

Inflation, pretty much everyone feels, wait a minute, this is not how the system is supposed to 
work. I had my budget. I had my expectations. All of a sudden, everyone is cheating me. Everyone is 
charging for things more than they are worth.
I dona€™ t know about you, but I have given up going to countries with overvalued exchange rates 
because I get there and everything is incredibly expensive. And I really feel cheated.

By contrast, when my now wife and I went to Britain a€” I think it was the summer of 1984 or the 
previous time, when the pound sterling was at its lowest value, was in fact, close to kissing a 
dollar to a pound, it seemed like everything in Britain was one third off, that everyone was 
offering me extraordinary bargains.
And the effect on my psychology was immense. It was such a happy time, in large part because I did 
not have this underlying feeling that people were kind of cheating me. So thata€™ s what inflation 
means on a psychological level.

There also is the question about what determines the rate of inflation. And there, the willingness 
of people to raise their prices or to demand higher wages very much depends on what they expect 
other people to be doing at the same time.

And so that means that if there is a general expectation that inflation is going to be 7 percent 
next year, lots of people are going to go into things thinking, my wages should go up by or I 
should be able to raise my prices by about 7 percent per year and that fact will do an awful lot to 
determine what the rate of inflation is because this is one of these economic equilibria in which 
there is a little bit of the fundamentals but therea€™ s a lot of just things are what
people expect things to be.

Ezra Klein

I want to hold on that first insight, the John Maynard Keynes insight, that inflation is a 
destroyer of social trust. I want to read you another John Maynard Keynes quote about inflation. He 
says, a€oeThere is no subtler, no surer means of overturning the existing basis of society than to 
debauch the currency. The process engages all the hidden forces of economic law on the side of 
destruction and does it in a manner which not one man in a million is able to
diagnose .a€D

Tell me about that last piece, that therea€™ s something uniquely destructive about an economic 
affliction that seems to have very little logic and very little diagnosability.
Brad Delong

On the one hand, this is Keynes as establishment upper-class twit with an underlying belief that 
society holds together only if people think it is just and fair and rational, even though that it 
isna€™ t.

And to all of a sudden have an inflation, to all of a sudden have people who have substantial 
amounts of immediate market power because what theya€™re selling is in short supply able to extract 
huge amounts of wealth from everybody else, that makes it very clear that the race is not to the 
swift, that instead, luck, time, and chance rule everything and that the distribution of income and 
wealth, the order of society, is just some random arrangement based on how
lucky you are and how unscrupulous you are and that is not the kind of thing on which you can build 
a society with enough trust to actually run a productive, modern economy.

[MUSIC PLAYING]

Ezra Klein

So then I want to talk about how the inflation of the a€~60s and a€~70s actually happens. In the 
story you tell, what we think of as the inflation of the a€~70s really begins in the late a€~60s 
with President Lyndon Johnson. Tell me a bit of that narrative. What are the economic forces here 
that are at play?
Brad Delong

All right. The Democratic administrations of the 1960s are very interested in running a 
high-pressure economy and hope that they can get full employment. And maybe the price will be that 
inflation, on average, will be 3 percent rather than 1 percent or 2 percent or maybe 4 percent at 
most, but that ita€™ s worth doing because you get more people at work, businesses are willing to 
invest a lot more in training people, the African American unemployment rate
goes down by 2 percentage points for every one percentage point the overall unemployment rate goes 
down and so forth.

And so therea€™ s some liking by the administration for a high-pressure economy collides with 
Lyndon Johnsona€™ s belief that he must wage the Vietnam War or be subject to political attacks by 
soft on communism from the Republicans, but also that he does not dare raise taxes in order to cool 
off the economy as the Vietnam War rolls forward.

And so when Richard Nixon enters office in 1969, he has an inflation problem. Inflation is around 4 
percent or 5 percent or so. His economic advisers tell him that well, what you really need to do is 
you need to let the Federal Reserve raise interest rates a lot and to significantly cut back on the 
federal deficit. And so let unemployment go up by 1 percent, 2 percent, 3 percent.

Nixon says, OK. But as time passes and as he looks forward to 1972 and his re-election and he 
remembers 1960, when he and his friend, Arthur Burns, had gone to Dwight Eisenhower and said, hey, 
it looks like there might be a recession at the end of 1960. Ita€™ s very important that the 
economy be strong on Election Day. And here I am, your vice president. I have carried your water 
for eight years. Ia€™ ve done loyal service. You owe this to me to help me
out and to push policy.

And Eisenhower blows him off. Nixon loses extremely narrowly. Nixon remembers when, by 1972, Arthur 
Burns is not only Nixona€™ s friend but is also installed as the chairman of the Federal Reserve 
Board. And so Nixona€™ s ideas about how you need to cool off the economy a bit go out the window 
as the important thing is to have a strong economy in November 1972, and in fact, to reduce 
inflation as you try to get a strong economy, to impose wage
and price controls with the idea that these will be temporary and that they wona€™t distort the 
market economy too much and you can take them off once the thing has passed a€” which does not work 
all that well.

Ezra Klein

Let me hold you on that because why? I think wage and price controls seem very intuitive to people 
when you hear about inflation. Look, if the problem is that we are rising prices too fast and in 
turn, wea€™re rising wages too fast and wea€™re getting into a feedback loop between the two, just 
tell everybody to stop. But economists really dona€™t like these. Why?
Brad Delong

Well you set yourself a huge administrative problem if you try to say, we are going to construct a 
bureaucracy to tell you not to raise wages and prices. And if you actually want to, you have to go 
to some board and make an argument for it. Then you have to say that we cana€™ t get this 
particular product. We cana€™ t find anyone to work unless we raise their wages.

You start degrading the ability of the market economy to actually do its job, like right now. Right 
now we have two kinds of inflation going on. One is an underlying 5 percent inflation jump up of 
inflation from 2 percent to 5 percent, as a result of reopening the economy after the plague. And 
the other is the Vladimir Putin oil-and-grain Europe is likely to freeze this winter and Nigeria 
and Egypt may starve.

The first of these, wea€™ re coming out of a plague. We need to get people back to work. And we 
also need to get people back to work in a very different configuration than we had back in 2019. 
Lots of technological learning about things you can do remotely and things you cana€™ t since then. 
Wea€™ re reopening with an economy with much more goods production, with many fewer in-person 
sales, and with more deliverators and more website designers
and data-center operators.

And if you want to get people back not just into jobs, but into the right jobs for the future, you 
really have to offer the people moving into those sectors higher wages so they find it advantageous 
to go. And you really cana€™ t cut anyonea€™ s wages. If you tell someone wea€™ re going to pay you 
less than we paid you last year, ita€™ s such a major psychological insult that theya€™ re unlikely 
to work hard for you or indeed to work at all if you do that.

Wages in expanding sectors have to rise. Wages in contracting sectors stay the same. Youa€™ ve got 
to get some inflation in order to make this reopening happen rapidly and smoothly. Plus the 
bottlenecks. You have a bottleneck. You have something in short supply. As Friedrich von Hayek 
would say and did say, the whole point of a market system is that it means that decisions are not 
made by some clueless central planner or by someone mindlessly following
a bureaucratic rule book that only covers a third of the cases. But instead, decisions are made by 
people on the spot who have the information.

We need to crowdsource solutions to all the bottlenecks and supply-chain difficulties that have 
emerged as wea€™ ve reopened. And the way to do that is to offer people money if they figure out, 
had a way to provide more of, say, this particular type of lumber right now and to provide people 
with incentives to economize if we dona€™ t really need this but can use something else.
So Friedrich von Hayek would say that yes, coming out of a plague, if you want to come out of it 
rapidly, get back to full employment rapidly, not repeat the lost decade of the 2010s, youa€™re 
going to have some inflation.

Ezra Klein

So back to the a€~70s.
Brad Delong

Yes?

Ezra Klein


So Mixon has relatively-high inflation.

Brad Delong
Yep.

Ezra Klein

He has a Fed chair. We understand Fed chairs to be relatively independent.

Brad Delong

Not then.

Ezra Klein

Why does Arthur Burns not just do what we think should be done now and hike interest rates up until 
inflation goes away?
Brad Delong

Well, Arthur Burns is a Republican. And Arthur Burns is one of Nixona€™ s best friends. And 
Republican Fed chairs, therea€™ s a tradition of them hewing a little closer to the Republican 
Party line that in fact, they should.
Do you remember the days when Alan Greenspan was saying, no, no, if you look carefully I did not 
actually endorse a€”

Ezra Klein

I do remember those days.

Brad Delong

a€” George W. Busha€™ s 2001 and 2003 tax cuts. I did not endorse them.
Ezra Klein

You had to look very carefully.
Brad Delong

I simply fuzzed my testimony before Congress so that every Republican could claim I had endorsed 
them. And then I stayed silent. And Alan thought hea€™ d preserved his technocratic purity by doing 
so. Those on the other side begged to differ and think he acted relatively badly.

To some degree, Burns acted badly in 1972. To some degree, Burns went as far as he could in terms 
of pressuring the Nixon administration to do something in order to fight inflation. Paul Volcker 
reports conversations with Burns on funding flights to Europe and so forth in meetings and Burns 
would rant about how more had to be done.
To some degree, Burns thought he would not be allowed to, that if he were to raise interest rates, 
then Congress would come and would take the Feda€™ s powers away, that he could only preserve his 
independence by not using it.

Ezra Klein

This is interesting to me. And you spent some time on this in the book because I think we look back 
and see Arthur Burns is primarily, simply a politicized actor. But the Fed chair who comes after 
him, whose name I and everybody else forget, also does not hike interest rates very high and for 
the same reason a€” therea€™ s a few a€” that the people will not stand for, the politicians will 
not stand for some random person, running the Fed, crashing the economy
because thata€™ s how they think inflation should come down.

Brad Delong
Yes.

Ezra Klein

And in a way, that seems actually quite logical, that therea€™ s been quite a shift post Volcker in 
what we think it is a€” what we will morally expect the Feds are doing.
Brad Delong

Especially because the Feda€™ s interest-rate weapon is one with a€” its extremely narrowly 
targeted. ita€™ s targeted at home builders. Ita€™ s targeted at exporters.
Ezra Klein

Your friend, Larry Summers, gets so mad at me when I say the interest-rate weapon is weird. He 
really does not like it when I criticize the interest-rate weapon.
Brad Delong

It is weird. It may be the only weapon we have and is powerful. But it hits exporters, it hits 
import-competing businesses, and it hits construction. With overwhelming force, it also hits anyone 
whoa€™ s bankrupted or who relies on someone who goes bankrupt because they were over leveraged, 
when the interest rates go up.

But ita€™ s not a broad-based tool to cool off the economy in general. Ita€™ s a tool to put a 
bulla€™ s-eye on a few sectors, whomp them with a brick, and then hope that whomping then spreads 
more-or-less smoothly and rapidly to the rest of the economy. Ita€™ s something you really would 
rather get out of some other way if you could figure out how to.
Ezra Klein

So inflation in this period is not that high, though, under Johnson, under Nixon a€”
Brad Delong

Ita€™ s 5 percent.
Ezra Klein

Ita€™ s 5 percent, 6 percent a€”
Brad Delong

No a€”
Ezra Klein

Somewhere in that range?
Brad Delong

5 percent to 7 percent, yes.
Ezra Klein

So what happens that shifts from 5 percent to the really big spikes we begin to see, to the 
stagflation era?


Brad Delong

The 1973 Yom Kippur War. The U.S. provides a lot of emergency resupply to Israel during this war. 
And the Saudis get pissed and say, we are going to impose an oil embargo on the United States and 
the Netherlands. And oil prices immediately spike a€” and spike by a lot.

And so the Organization of Arab Petroleum Exporting Countries a€” I got this wrong in the book and 
Ia€™ ve been swamped by energy economists on it. I said OPEC. Ita€™ s actually OAPEC, is the 
organization a€” says, hey, wait a minute. We now have a lot of pricing power over the global oil 
market. We dona€™ t have to accept $3 a barrel asthe oil price, which was what it had been set at 
before. Wea€™ re going to raise it to $10    and wea€™ regoi
keep it there.

And so you have the entry of the House of Saud on the geopolitical scale as a mighty and fearsome 
thing that has to be dealt with. And then you have U.S. and European economies that immediately 
must start to cope with the fact that all of a sudden, this one, key, industrial input into the 
civilization is all of the sudden three times expensive as it used tobe, which means a huge amount 
of energy-intensive     manufactures and other things are     no lon
And a lot of businesses have to turn and immediately change their plans to figure out how can we 
reconfigure ourselves to be more energy efficient. And also, everyone faces gasoline prices that 
have suddenly gone up by a lot. This works its way through the system as inflation as all of a 
sudden, the price of one key input is $10 rather than $3.

And it also brings on a recession because a whole bunch of money that was flowing through the 
spending system is now being diverted overseas and is being put into the Saudi coffers. And 
theya€™re not immediately spending it on U.S. exports in order to rebalance the economy 
immediately.

So 1973 to 1975 sees both the deepest recession since World War II and an explosion of inflation to 
10 percent, followed by a reduction of inflation down to maybe 5 percent of 6 percent come 1976, at 
which point Jimmy Carter gets into office by saying Gerald Ford has mismanaged the economy. Look at 
sum of the inflation and the unemployment rate. Look at this, quote, a€oemisery indexa€D as his 
economic adviser Art Okun had constructed.
The Carter administration then says, well, unemployment is high. Wea€™re just coming out of a 
recession. Wea€™re going to not step on the gas. But wea€™re going to let the economy grow because 
even though inflationa€™s 6 percent, unemployment is problem one.

And then there came the year whena€” as Cartera€™ s chief economist Charlie Schultze once told me, 
our forecasts of total nominal G.D.P., nominal national income, were accurate. But inflation came 
in 2 percent high and real growth came in 2 percent low because productivity growth had fallen off 
the cliff because people were no longer concentrating on making their businesses more efficient 
with respect to labor, but instead with more efficient with respect
to energy.

And then comes the Iranian Revolution and the cutoff of Irana€™ s oil supplies. And the Saudis take 
advantage again. And all of a sudden, the price of oil is $30 a gallon. Inflation is more than 10 
percent. Paul Volcker replaces G. William Miller as Fed Chair.

And Paul Volcker says, wea€™ ve gotten ourselves into a situation in which people dona€™ t just 
expect inflation next year to be what it was last year. People expect inflation next year to be 
what it was last year plus a bit more. Ia€™ ve got to fix this and I got to fix this by hitting the 
economy on the head with a brick and keep hitting until people understand that no, if they insist 
on raising their prices, theya€™ 11 have no demand for their products.
And it works. Worst recession of the post World War II era, with its peak in 1982 when the 
unemployment rate hit 11 percent. And I graduated from college, looked around at the job market, 
and decided, Ia€™ m not going to leave the university and hence, did not.

And then in the middle 1980s, inflation settles back to something like 4 percent, which would have 
been viewed as a horrible thing back in the late 1960s, as evidence that things were going badly. 
But by then, everyone says, yay, wea€™ ve had a victory over inflation. Wea€™re not going to talk 
about it anymore.
Ezra Klein

Paul Volcker is such a crucial figure here.
Brad Delong

Yes.

Ezra Klein

But you described him in the book as something of an accidental Fed chairman. So how do you get 
this guy, who is willing to go much further than the recent ventures are, thinks the political 
system will support that a€”
Brad Delong

Well, hea€™ s not a financier. Hea€™ s a financial civil servant. He rises up through the 
bureaucracy. He is Under Secretary of the Treasury for Monetary Affairs during the Nixon 
administration.

And so he goes from Under Secretary of Monetary Affairs to then being chosen as president of the 
Federal Reserve Bank of New York, which has this strange, semi-medieval position in the Federal 
Reserve System in that ita€™ s just one of 12 regional banks but then it isna€™ t. And it has a 
special role on the open-market desk and so forth.

Paul Volcker is sitting there. And Jimmy Carter has a snit and decides he has to fire his treasury 
secretary, Mike Blumenthal. Cartera€™ s political advisers say, well, you cana€™ t just fire the 
treasury secretary and say wea€™ 11 choose another one next week. That would show an administration 
that is bureaucratically inept and in chaos. You have to have a person to fill in.

So Carter says, well, how about G. William Miller. I like him a lot. Hea€™ s my Fed Chair. Leta€™ s 
bring G. William Miller over as Treasury Secretary. And they say yes. And so the press release is 
prepared. And then they come and they say, well, wait a minute. Cana€™t just move the Fed chair 
over and say wea€™re going to name a replacement next week. That would indicate an administration 
that was bureaucratically inept and in chaos. You have to
have a replacement for the Fed chair.

And well, whoa€™ s the obvious person? Well, either the number two or number three at the Fed, 
depending on how it is, is this guy, Paul Volcker, who is definitely nonpartisan and in fact, 
somewhat of a Democrat. OK, wea€™ 11 name Volcker.

Charlie Schultze again asked Cartera€™ s domestic policy adviser, Stu Eizenstat, if anyone had done 
any research into what Paul Volckera€™ s views about monetary policy should be and as I understand 
it, did not get an answer. And so Paul Volcker winds up as Cartera€™ s choice for Federal Reserve 
chair, at which he says that Arthur Burns was worried that we had to curb our actions in order to 
keep our independence. If there was ever a time when
independence needed to be used it was now. And so I am going to be independent.

Ezra Klein

Ita€™ s easy to see Paul Volcker as this guy history turned on. But something you point out in the 
book is that you have a bunch of other countries dealing with fairly high levels of inflation at 
the time, Germany, France, Japan, the U.K. But they keep it more under control than we do. Or they 
disinflate earlier than we do without the drastic shock therapy that Volcker applies in the U.S. 
Why is that? Why did we need to do more?
Brad Delong

It was easier to do earlier, when the problem was smaller. And when Japan and Germany get off the 
train, they got off the train significantly earlier when the problem is smaller. I think that 
people who ask a€” people who criticize Volcker have a problem in saying what else could have been 
done given the situation at that moment.

And the most they will say is that he hung on to the high interest rate policy too long. I mean, he 
bankrupted Mexico, among other things. But then therea€™ s the question of what happens if you 
relax the high interest-rate policy too early as in fact, G. William Miller had and then you find 
not just that the problem is back, but that all of the unemployment that youa€™ ve inflicted on the 
construction and export industries has been to no good at all a€” that
criticizing Volcker for holding on to the policy too long is, I think, unfair. And criticizing 
Volcker for undertaking the policy at all requires that you have an alternative.

And we left these social Democrats say, well, this is actually the time to have used wage and price 
controls, or this was the time to have imposed surtaxes on businesses that raise their prices, or 
this was the time to have actually gone to the unions and struck a bargain that is, you, unions, 
agree to freeze your wages for the next three years in order to say that you can cooperate with the 
general macroeconomic requirements of the country. And in return, we push
for, and we, in fact, get through pension reform, expanded welfare state, this and that, a lot of 
things that are good for Union members in general.

Whether that grand bargain could have been made or not, it was not tried. Whether the unions would 
have bought for it, we do not know. And Volcker could not have made that. Only Carter and the 
Unified Democratic Congressional Caucuses could have made that. And in the late 1970s, Democratic 
Congressional Caucuses did not like Carter very much. And he did not like them. And he, being a 
Georgia guy, did not like unions at all.
Ezra Klein

So tell me about the political consequences of the inflation crisis in the aftermath. How exactly 
does it get weaponized against social democracy and government in general?
Brad Delong

Well, first, that the social-democratic governments are clearly, clearly incompetent. They do not 
understand the situation and they cannot deliver, that what theya€™ ve delivered is stagflation, 
the worst of high inflation and high unemployment, that the [INAUDIBLE] the misery index was bad 
when Gerald Ford was running for re-election. Look at this thing now.

Second, and behind that, the idea that inflation is the result of a society that is permissive, 
that social democracy will inevitably hand out more tickets to things than there are actually seats 
on the roller coaster. And this is endemic in it because it simply cannot say no, especially not to 
the organized interest groups, big labor, those parts of big business that have gotten in bed with 
it, welfare-rights organizations, minorities and so forth that think they have a claim
on it.

And so in order to have stable prices, in order to have a functioning society, we need to get back 
to the unpermissive view that you get only what you pay for and that you pay for only what you can 
earn so that social democracy, that the New Deal order was in the end going to pretend that more 
could be produced than could be a€” as, in fact, right-wing economist Jacob Viner had written of 
the emerging New Deal order in John Maynard Keynes. Ita€™ s going
to work only as long as the printing press can stay ahead of the business agents of the labor 
unions, in terms of their wage demands. And it will work for a while but then it will fell apart.

Add to that all the other things, the reasons that people did not like social democracy very much. 
And Paul Krugman is, I think, pretty certain that it was the inflation that actually pushed the 
system off the cliff, that it would have hung on without it and you would not have had the 
neoliberal turn. Ia€™ m less sure.
Ezra Klein

I want to now read a quote of yours to you from the book because I think this puts a nice point on 
what begins to happen in the 1970s. You write that, a€oepeople do not just seek to have good things 
materially. They like to pretend that there is a logic to the distribution of the good things and 
especially its distribution to them in particular, that their prosperity has some rational and 
deserved basis. Inflation, even the moderate inflation of the 1970s, stripped the
mask away.a€D

Tell me how inflation changed the moral narrative of the economy as we turn from the 
social-democracy era to the neoliberal era. When you say it stripped the mask away, what did it 
strip away exactly?
Brad Delong

What it stripped away was precisely the idea that the social democratic, the New Deal order, had 
gotten it broadly right, that people were working hard and they were getting their incomes and that 
people who had been unlucky in the sense of not being in places where huge amounts of wealth was 
made honestly and honorably were getting substantial amounts of support and everyone had their 
right to their Social Security, to their Medicare, to their

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But that by and large, the system made considerable sense in that yes, there were some cases in 
which inheritance played a big role, but that by and large it was a meritocracy in which those who 
exerted themselves could rise and in which there was a fair amount of luck involved and chance and 
fortune and who your friends are, but that was secondary to the idea that people were by and large 
getting what they deserved.

And with inflation coming, with you having to wait for hours in line for gasoline, as Jimmy Carter 
and company bollocks up the adjustment to the oil-price increase, with unions that are strong, able 
to use their power to get substantial cost-of-living increases written into their contracts and to 
get a catch up from past inflation increases when it came by surprise, it becomes clearer or 
appears clearer that if you do not have big labor or big business or big
government looking after you personally, you are a person of relatively little account and the 
system is working against you.

Ezra Klein

It also seems to me a€” I want to try this as an idea on you a€” that therea€™ s something about 
inflation that also erodes confidence in those and really any institutions. I wouldna€™ t, I think, 
be able to prove this to you. But I have a theory that recessions and depressions are crises. And 
people often turn to experts and to authorities when there is a crisis.
But inflation is a kind of disorder. Ita€™ s a derangement of the system. And people tend to turn 
on experts and authorities when the system becomes deranged, when it isna€™t working the way the 
experts and the authorities told them it would.

Brad Delong

I would say that there are similar reactions to both, that when a crisis comes, you turn to 
somebody who has an answer or an explanation. But you also are extremely likely to vote the 
bastards out who mismanaged the system this way.

And so there are then desperate attempts by everyone to say someone else mismanaged the system, 
which I think, reached its apex in what we saw in 2007 to 2010, the American Enterprise Institute 
and Heritage Foundation and other guys who said, well, we have this Great Recession because the 
government forced banks to lend for mortgages to poor, black people, something with absolutely no 
empirical content whatsoever but that serves as a distraction that
hits a mental fault line in a great deal of the potential audience for that.

It goes both ways. But it definitely is the case that all you had to say in the late 1970s was that 
if the government was competent and understood the economy, we would not be having this inflation.
[MUSIC PLAYING]

Ezra Klein

I want to go back to the too many tickets for the roller coaster. You get part of that in terms of 
the critique, the government gives too much to too many undeserving people. Deservingness is a big 
part of this politics. Therea€™ s also the issue, though, of, to be blunt, worker power.

In that period, ita€™ s the unions putting wage increases into contracts. You get wage-price 
spirals. And therea€™ s some truth to that, arguably, in terms of how inflation works. But the 
other thing that you hear today is something similar. Now we dona€™ t have a strong unions. You 
dona€™ t have the same kinds of contracts. But what you do have is, I think, this fake trend of 
quiet quitting, which is really a TikTok idea but with no real evidence behind it.

But you see a lot of managers writing op eds about it. There is this feeling that everybody got 
lazy during the pandemic. They wouldna€™ t work. They wouldna€™ t work for reasonable wages and 
that one part of the neoliberal turn is actually a turn against worker power, worker power as 
instantiated in unions, worker power as instantiated in the moral willingness of workers to work, 
their work ethic. And you see that today too. Could you talk a bit about that
side of it?

Brad Delong

Well, the idea is that taxes will be lower on the rich so that the job creators will be 
incentivized to do their proper entrepreneurial thing and create jobs, rather than spend money on 
lawyers in order to figure out how to evade taxes, that the social-democratic New Deal order had 
created a world in which the returns to working hard were too low.

And so as a result, the productivity trend that had been extremely nice up until 1973, had then 
fallen off a cliff after 1973. And this was that we have finally done too much to punish hard work 
and enterprise. And so we need to get back to, as Deng Xiaoping said, to get rich is glorious. And 
we need to massively lower taxes on the rich in order to make that so.

Conversely, ita€™ s that the non rich have it much too easy, that you can find a union job and then 
feather bed your way through and the Union will represent you if they try to fire you and the boss 
has virtually no control over anything and that if you do get fired, well, then unemployment 
insurance is there for a while. And therea€™ s all this social welfare stuff that supports you.
In its most racist versions, ita€™ s this is why all these Black people are having kids out of 
wedlock. Ita€™ s because that then they get the A.F.D.C. payments which allow them to live and 
party, never mind that they have a one-year-old.

Ezra Klein

Tough on the partying, I can tell you.
Brad Delong

Yes, lots and lots of partying with a one-year-old. And so that a much greater degree of income 
inequality than we had in the largely middle-class, at least for white guys, social-democratic and 
New Deal societies of the a€~60s and 1970s was, in fact, strongly desirable.

And maybe the desirableness of it was regrettable in that people really needed to be incentivized 
to work hard properly, which required the rich be richer and the poor be poorer. And this is, alas, 
just the way things are in this fallen, sublunary sphere, where we cannot say, from each according 
to his ability, to each according to his need, and still have a functioning society.
And on the other side, you get into, well, the income inequality is actually a feature rather than 
a bug, that ita€™ s very important that society recognize industry effort and achievement. And if 
everyonea€™ s income is more or less equal, the fact that you are then giving out some people 
prizes for being industrious and organized and achieving, that really isna€™t sufficient.
Thata€™ s a fake reward when actually, the productive and successful deserve very real rewards. And 
money, in the form a€” and the social power over other people that money brings is a very important 
part of that.

Ezra Klein

I think therea€™ s a tendency to look at the effect economics has on politics as somewhat 
mechanical, that if you deliver good macroeconomic outcomes, you get rewarded, if you deliver bad 
macroeconomic outcomes, you get punished. But therea€™ s also a dimension where I think economics 
is understood and economic outcomes are understood and they end up influencing politics morally. 
There has to be a story people tell about the economy that they
believe.

And so whether inflation is the reason for the neoliberal era, whether ita€™ s a reason for the 
neoliberal era, one thing that happens here is that it is a€” from what I hear in your story and it 
seems persuasive to me a€” is that ita€™ s a major cause of a desire for a new story.

It makes the old story look bad, that we were wrong about what would come of that kind of moral 
suasion. And it creates this context for a new one that Reagan tells, that Thatcher tells, that 
others tell. And how would you describe the moral story of the neoliberal era? Youa€™ re describing 
what they thought didna€™ t work about the last one. What is the moral story     of the neoliberal 
era?
Brad Delong

Well, at least the plan for the neoliberal era was that you do indeed make income inequality 
significantly greater and you thus re incentivize both the rich,job creators and also re 
incentivize the great mass of the workers. And you also properly punish the slackers and the 
moochers as well.

In addition to widening income inequality, you take aim at the social-insurance state which has 
been vastly and completely corrupted by rent seeking, interest groups that have figured out how to 
make their way to Capitol Hill and then get a large amount of benefits channeled to them via all 
the things that government does that theyhave no rightful claim to, andthatthewar on rentseeking is 
a very important thing that neoliberals can do but that nobody else is
willing to do, especially not social Democrats, which did not work out, I think, the way that 
neoliberals hoped.

There also is that the social-democratic world had become vastly over bureaucratized. You trust 
bureaucrats to write rules and regulations but then you turn everyone into a software bot, 
essentially, that is following a rule book that has only one third of the cases properly covered, 
that what you really need is entrepreneurship and enterprise. You need to push power out to the 
people informationally and also power to act.

You see, I think the apex of this in the 1984 Apple computer Macintosh launch commercial, which is 
very much about how a Macintosh will enable you to move into the neoliberal era with control over 
your information rather than being simply a mindless cog working for a large, bureaucratic 
organization who has to bow to its    every   dictate.Instead, you can use your Macintosh computer 
to be a knowledge worker, be an independent knowledge worke
And add to those, there also is a very strong sense that if people had to buckle down and work, if 
the social-insurance state was not there and was not so lavish, well, you wouldna€™ t have people 
in Australia claiming unemployment insurance and then going on monthlong surfing vacations.

You wouldna€™ t kind of get all this permissiveness. You wouldna€™ t get the decline of the nuclear 
family. Mothers wouldna€™ t think that they had an option to leave husbands and accept various 
forms of A.F.D.C. and other benefits and would actually return to their proper place in the 
patriarchal household.

A very, very, very large tangle of Gordian knot, of all kinds of ideas about how the right ordering 
of the world was to accept that the market economy was a very powerful thing and that the market 
economy did what it did for reasons and that the right attitude toward it was that the market 
giveth, the market taketh away, blessed    bethe   name of themarket.
Ezra Klein

I think you, like many, including me, think that the neoliberal era ends in the aftermath of the 
financial crisis.
Brad Delong

Well it ought to have ended in the aftermath, yes.
Ezra Klein

Maybe ita€™ s not clear what comes after it. But it is not, certainly, unquestioned. And I think 
people are trying to understand what will come next. But why? Within the context of these moral 
logics, what is the financial crisis do that breaks that story?
Brad Delong

As of 2006, you could say, well, Reagan had a rough decade. But economic growth is rapid. Income is 
more unequal. So if you see that as a feature rather than a bug, youa€™re kind of happy. And then 
come 2007, it becomes very plain that the neoliberal policymakers had forgotten everything the New 
Deal knew about financial regulation.


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Ezra Klein

So wea€™ ve had, then, in the past decade and change, two truly major economic financial shocks. So 
we have the financial crisis and all the follows from it. Then we have the pandemic, moving into 
the inflation rate that wea€™re in now.
Brad Delong

And we may also have China hitting the middle-income trap and the return of major, conventional war 
with its subconsequent oil shock and killer robots stalking the skies above Ukraine, yes.
Ezra Klein

Well, therea€™ s a lot going on, much of it bad. But I want to hold on those two economic shocks 
because I do think, to what youa€™re saying, the financial crisis discredits this idea and in 
particular, discredits the idea that the rich know what theya€™re doing. The rich caused the 
financial crisis to a very high degree. The bankers, the financiers, they are theya€™re the 
villains of that particular morality story.
And then inflation comes. Inflation comes in the context when it feels like a turn is moving a€” is 
going back to the social-democratic policy making, a much more active government, industrial 
policy, being very, very worried about repeating the 2009-2010 mistake of under stimulating in a 
crisis. But here comes inflation to pound, in America at least, the Democrats.

Somebody who has spent a lot of time thinking about the joints of economic history, these times 
when old regimes die and new ones are born, what are your intuitions about the stories that could 
survive or emerge from this moment? Or at least what stories do you see people trying to tell?
Brad Delong

Yeah, so I think that this is a moment of danger. And because of who has happened to be in power in 
the United States right now, ita€™ s a moment of danger for any attempt done to see Biden as any 
kind of social-democratic revival.

Conversely, in Britain, it looks to be the death knell of the Conservative Party as we know it 
because ita€™ s been in charge during this and has had not only these problems, but all of its 
other self-inflicted problems as well, which are mighty, that ita€™ s throw the bastards out as a 
reaction to the inflation that wea€™re currently having.
And I confess that if you want to say that wea€™re conceptualizing ourselves as having a choice 
between neoliberalism on the one hand and the return to social democracy on the other, and various 
third, fourth, fifth and sixth ways, this is a bad thing for social democracy.

The third, fourth, and fifth and sixth ways that appear to have political valence right now appear 
to be very unpleasant things for the most part, things much, much worse than neoliberalism, things 
even worse than right neoliberalism, I would say, in my left neoliberal hat and that thata€™ s 
quite disturbing.

But I would also say that look, you couldna€™t run a gunpowder empire in 1650 like you ran a feudal 
regime in 1000. And you couldna€™t run a steam-power society in 1870 like you ran a gunpowder 
empire in 1650. Similarly, the mass-production economy that supported the New Deal order was a very 
different animal than the semi-globalized economy or theglobal value-chain  economyof the 
neoliberal order.
And we are now moving into what Ia€™m thinking of as an info-biotech economy right now. And so the 
forces of production foundations are very different. And any kind of political or political-social 
bargain built on top of them, if you try to recreate one that was built in the past on an earlier 
set of forces-of-production foundations, ita€™ s highly unlikely to work. Ita€™ shighly unlikely to 
  work at all.

Ezra Klein

Well, now, let me ask you a reverse of that question because the reason I wanted to have this 
conversation this way is that the 1970s are operating as the principal historical analog for the 
time wea€™re in. Chairman Jay Powell talks often about Paul Volcker. Everybody debating monetary 
policy talks about the 1970s.
What are the wrong lessons to take from the inflation and the monetary policy of the a€~70s and 
a€~80s for today? And what are the right ones in your view?

Brad Delong

Well, the wrong lesson to take is that obviously, wea€™re in the position Paul Volcker found 
himself in 1979, with inflation expectations extremely strongly entrenched in the economy, both in 
terms of what people were expecting to happen and also in terms of things that had been built into 
the multiyear contracting structure of businesses and union workers, that Paul Volcker had to raise 
unemployment rates high enough that unions would go to companies and
say, I know we have a 6 percent wage increase for next year built into our contract but can we give 
that back to you in return for you doing fewer layoffs here in this recession?

We are not in that position at all. You look at the long-run bond-market inflation expectation 
gauges that I prefer to look at, and they are all blinking that the bond market expects inflation 
to be lower than the Feda€™ s target in five years rather than above.

And bond-market traders expectations a€” they arena€™ t what people are counting on happening and 
what people real people are counting on happening a€” is much more attuned to whata€™ s happening 
to the gasoline prices that they see at the pump, that being the principal thing that people see 
that impacts them that fluctuates widely and that people do indeed take as gauges of inflation.

But the analogies between the late 1970s are still, I think, weaker than analogies with the 1947 
demobilization after World War II when we had inflation as the civilian economy opened up and then 
the reverse of that, in 1951, when we mobilized for the Korean War and the permanent Cold War and 
once again, had an inflation wave as the bottlenecks emerged in the national security sector, that 
Ia€™ d say the odds are still 60 percent that wea€™re repeating
those and only 40 percent that ita€™ s something somewhat or more analogous to the 1970s.

Of course, Vladimir Putin and company and the House of Saud could change that.

WE HAVE a very nice reframing of the current mindset of the Federal Reserve by the extremely smart 
Robert Armstrong and Ethan Wu of the Financial Times:

The Federal Reserve currently anticipates that their medium-run inflation target can be restored 
with an increase in interest rates of only 250 basis points over the next three years.

The first thing to say is thata€”if the Federal Reserve is correcta€”that low a level of interest 
rates at their peak means that we will once again hit the zero lower bound on interest rates if and 
win another negative demand shock hits the economy. That means, above all, that the long-run 
inflation target is too low to maintain macroeconomic balance. The Federal Reserve should already 
have thought about this and take an action to raise the inflation target.

The second thing to say is that the overwhelming bulk of the inflation we are right now seeing must 
be transitory if such a small increase in interest rates will be sufficient to return the economy 
to its 2 1/2% per year long-run inflation target. This is, as I say over and over again, not a 
1970s like inflationary spirala€”not melting the enginea€”but rather leaving rubber on the road as 
you rejoin the highway traffic at speed. Rejoining the highway traffic at speed is a
good thing to do. Leaving rubber on the road is a necessary consequence of doing that. Ita€™ s 
stupid to complain about it.

The third thing to say is that restoring an economy to full employment while undertaking a massive 
structural shift in an economy with sticky downward wages (and some prices) has always, in our 
experience, been accompanied by a transitory burst of inflation. You have to incentivize movement 
into the sectors that need to expand by creating price differentials vis-a-vis the contracting 
sectors. And with their wages (and some of their prices) downward-sticky,
that is a transitory burst of inflation. It is the post World War II demobilization and the Korean 
war era mobilization from the Cold War that should serve as are examples, if indeed there are any 
examples that are relevant. Those who look at the US post-Korean War experience and try to 
generalize from that are, I think, barking up the wrong tree:

Robert Armstrong & Ethan Wu: The Fed Still Thinks Inflation Is Transitory'. a€~The most surprising 
thing in the Feda€™ s sedate December meeting was the newsa€! that monetary policy committee 
members project three interest rate increases next year, rather than the two that consensus had 
called for. Even this spooked no onea€L The Fed is acknowledging short rates will need to rise 
somewhat to hedge against persistent
inflation. That is evident in the 2022 and 2023 dots. But the median forecast for rates in 2024 
nudged up only a bit, from 1.75 percent to just over 2 percent. The longer-run dots have stayed the 
samea€!. The committee thinks, with a high level of unanimity, that a short raising cycle, topping 
out at 2.5 percent, will ensure that inflation is transitorya€!. Above target inflation will last 
about a year. Everybody, say it together now: transitory!
The Fed retired the word, but it still thinks the same waya€!. The bond market wholeheartedly 
agrees with the Feda€™ s attitudea€!

LINK: <https://www.ft.com/content/024e4598-61cf-4871-89dc-0626d71a8c96>

Share

Dean Baker: a€~Pretty damn good PCE numbers. Health care services index rose just 0.16 percent. 
With rent coming down sharply (we know this from private indexes of marketed units) sure looks like 
the Fed's job is donea€!

FRED   • Personal Consumption Expenditures Excluding Food and Energy (Chain-Type Price Index)

0.8

0.6



-0.6

FRED — 5-Year, 5-Year Forward Inflation Expectation Rate

2.8

2.6

2.4

2.2

2.0

1.8

1.6

1.4

1.2

Jan 2018 Jul 2018 Jan 2019 Jul 2019 Jan 2020 Jul 2020 Jan 2021 Jul 2021 Jan 2022 Jul 2022


1.0

0.8

2018-01       2018-07       2019-01       2019-07       2020-01       2020-07        2021-01       
2021-07       2022-01        2022-07

Some respected economists are talking as if the US economy is in serious inflationary trouble. But 
the current uptick in price growth is highly likely to be a largely benign consequence of the 
post-pandemic recovery.

BERKELEY a€“ In the past three years, technological advances have provided about one percentage 
point of warranted US real wage growth each year a€“ admittedly, only half the rate of earlier 
times, but still something. Yet, real wages are currently 4% below their warranted value from 
adding on the underlying fundamental productivity trend to the pre-pandemic real wage Employment 
Cost Index (ECI) level. Does that sound like a a€oehigh-pressurea€D
labor market to you?

Those who believe that the US labor market is in some sense a€cetighta€D point out that the ECI 
increased by 3.7% in the year to September a€“ well above its 3% annual growth rate in the 
pre-pandemic years of former US President Donald Trumpa€™ s administration. But, because US 
consumer prices have increased by 5.4% over the past year, the ECI-basis real wage has fallen by 
1.7% in that period. In a high-pressure economy with a tight labor market,
workers would have enough bargaining power to obtain real wage increases.

Nowcasting is extremely difficult, and hazardous. But the a€cenowa€D that I see today is the one I 
forecasted two to three quarters ago. Yes, the recovering US economy, like a driver who suddenly 
accelerates, is leaving inflationary skid marks on the asphalt. But, as I argued in May, these 
should not concern us, because a€oeburning rubber to rejoin highway traffic is not thesame thing as 
overheating theengine.a€D
The US is not currently in a situation where too much money is chasing too few goods, which would 
result in a surfeit of demand for labor and likely trigger an inflationary spiral. This is despite 
the fact that the ongoing COVID-19 pandemic and its associated disruptions continue to cause a 
substantial undersupply of labor.

Today, the US economya€™ s overall employment-to-population ratio is three percentage points below 
what we used to regard as its full-employment level. The ratios for women, African-Americans, and 
workers without a college degree are, respectively, five, 4.5, and four percentage points below 
this level.

Yet, economists whom I respect talk as if the economy is in serious inflationary trouble. Jason 
Furman, a former chairman of President Barack ObamaaC™ s Council of Economic Advisers, thinks 
a€cethe original sin was an oversized American Rescue Plan,a€D the $1.9 trillion recovery package 
that President Joe Biden signed intolaw in March. In FurmanaC™ s view, it would have been better to 
have lessaggressive policy measures and thus a slower
employment and growth recovery this year, because Bidena€™ s plan a€ recontributed to higher output 
but also higher prices ,a€D And according to the same New York Times report, former US Treasury 
Secretary Larry Summers thinks that a€ reinflation now risks spiraling out of control.a€D

The inflation worriers then argue that the COVID-19 crisis has permanently damaged the supply side 
of the economy by causing a lot of early retirements, as well as lasting disruption to the 
lean-and-mean supply chains on which a good deal of productivity and prosperity had depended. 
Perhaps. But similar arguments in the early 2010s, in the aftermath of the 2008 global financial 
crisis, aimed to justify policies thatdid not put the pedal to the metal and attempt
rapidly to re-employ so-called a€oezero-marginal-producta€n workers. One consequence of this 
timidity was the election of Trump, whose rise was fueled by the rage of those who thought 
a€ceelitesa€D cared more about immigrants and minorities than they did about blue-collar workers 
whose economic opportunities had never recovered to pre-2008 levels.

Lastly, some claim that, regardless of whether or not the labor market is tight, inflation a€“ 
whether driven by supply-side or demand-side factors a€“ is high and salient enough that firms and 
households will swiftly incorporate it into their expectations. Thus, the inflationary snake has to 
be scotched now, while it is small, before it grows and devours everything of value.

But so far, rising inflation has not been incorporated into any of the a€restickya€O prices in the 
economy, according to the measure constructed by the Atlanta Federal Reserve. True, the financial 
marketa€™ s current 30-year breakeven inflation rate, at 2.35%, is more than half a percentage 
point above where it settled in the second half of the 2010s. But todaya€™ s rate issimilar to that 
in the first half of the decade, and slightlybelowthe level that would be
consistent with the US Federal Reservea€™ s inflation target of 2% per year.

The current uptick in US inflation is highly likely to be simply rubber on the road, resulting from 
the post-pandemic recovery. There is no sign that inflation expectations have become de-anchored. 
The labor market is still weak enough that workers are unable to demand substantial increases in 
real wages. Financial markets are bias A© about the possibility of rising inflation. And a 
substantial fiscal contraction is already in train.
Given these facts, why would anybody argue that the a€oeoriginal sina€D was the a€reoversized 
American Rescue Plan,a€D and that tightening monetary policy starting right now is the proper way 
to expiate it? I, for one, simply cannot follow their logic.

Brad DeLong: When the Fed Stops Trying: First, it was committed not to fall into the same trap as 
President Barack Obamaa€™ s administration in 2009, when it failed to set clear priorities and look 
more than one move ahead. While Obama and his advisers had a plan for the first round of recovery 
measures following the 2008 financial crisis, they did not have a strategy for what to do when 
congressional Republicans and a€reblue-doga€D (pro-austerity)
Democrats mobilized against them. When that first round proved insufficient for delivering a robust 
recovery, the stage was set for a lost half-decade of tepid growth and widening income 
inequalities.

Second, the Biden administration^™ s policy planners were wary of providing too large a boost to 
spending. But they also knew that achieving a rapid and complete recovery would mean accepting some 
level of inflation. Because the post-pandemic economy would be configured differently than the 
economy that had preceded it, wages would have to rise in the newly expanding industries to attract 
the necessary supply of workers. Without clear price signals,
workers would not have gone where they needed to go for the recovery to stay on track.

Similarly, it was inevitable that bottlenecks would emerge during an economic reopening, and prices 
of bottlenecked commodities duly rose. Again, such signals were necessary to show where the 
problems lay. Higher prices naturally create incentives for substitutions and other solutions.

Just how much inflation would there be? Nobody could say, but Bidena€™ s team knew that if the 
reopening inflation shock was too large, it could easily trigger an overreaction from the US 
Federal Reserve. That, eventually, would put America back in a semi-depressed or depressed state of 
secular stagnation, with little policy traction to respond to the next crisis or to promote a 
recovery.
The third hazard to be avoided was that spending would rise by too much and the Feda€™ s reaction 
would be too restrained. In this scenario, inflationary expectations would become elevated or 
unanchored, and the economy would end up in 1970s-style stagflation.

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The situation was thus analogous to Odysseus sailing between Scylla (a multi-headed monster) and 
Charybdis (a massive whirlpool). The Biden administration could either not try to navigate the 
strait at all (the first mistake), or it could try its luck with Scylla (secular stagnation) and 
Charybdis (stagflation).

Journeying safely to the other side seemed eminently achievable as recently as a year ago, when 
there was both the policy and the political will to set the oars to work to drive the boat forward 
at the right speed. There even seemed to be a wide middle path between secular stagnation and 
stagflation. While many argued over which danger was worse, both risks seemed relatively low, and 
thus manageable with a Fed that understood the situation and was not prone
to panic.

Then came February 24,2022, when Russian President Vladimir Putin ordered his invasion of Ukraine. 
The safe path appeared to narrow. By June, the Fed had abandoned its forward guidance and replaced 
an anticipated 50-basis-point interest-rate hike with a 75-point hike, citing an unreliable figure 
from the University of Michigan inflation-expectations survey to justify the move. At this point, 
the Fed no longer believed that it understood the situation.

Today, it is unclear whether there is still a safe path between Scylla and Charybdis. But following 
two more 75-bps hikes in July and September, I worry that the Fed has given up on even trying to 
find it. Instead, like Odysseus, it has intentionally started to hew toward Scylla (secular 
stagnation), viewing it as the lesser of two evils. One no longer hears Fed officials cautioning 
that last winter and springa€™ s tightening has yet to ramify fully throughout the
economy. Instead, the Fed has signaled another 1.25-bpsa€™ worth of hikes to come before the end of 
this year.

US Secretary of the Treasury and former Fed Chair Janet Yellen once told me that the Feda€™ s 
rate-setting Federal Open Market Committee will tend to overreact to the immediate news cycle 
unless it bases its thinking on some transparent formula like the Taylor Rule. But while the Taylor 
Rule made sense during the Great Moderation, the days of persistently low and stable inflation are 
gone, and the Fed has no replacement framework to elevate its thinking
above the news-driven groupthink.

Not without reason, financial markets seem to be betting that the Fed is about to make mistake 
number two: pursuing policies that will likely drag the US back toward secular stagnation. If past 
is prologue, we eventually will return to a scenario in which monetary policy is stuck at the zero 
lower bound. The economy may suffer another lost half-decade of growth, and socially and 
politically destabilizing inequalities will become even more pronounced.

Optimal control. You have an objective: to get inflation back into its target range over the medium 
terma€”five to ten years from nowa€”and to do so while doing the least damage to other objectives 
like employment and growth. If your best forecast is that your current policy path gets you there, 
you maintain your currency policy path. If your best forecast is that your current policy path does 
not get you there, you take the cheapest and most effective step to
move the future needle. If the bond-market 5-year 5-year forward inflation breakeven is not the 
best forecast, what is the best forecast? Indeed, given that inflation is an expectational 
phenomenon in all our standard modelsa€’’inflation will be what it is expected to be plus 
policy-change and economic-shock termsa€”it is very hard to see how the bond-market 5-year 5-year 
forward inflation breakeven could not be the best forecast. And if our standard models are
not the best models, what are the best models?

Thus I look at this, and I think those who claim inflation is a€oeout of controla€D are doing their 
audiences and their selves no good servicea€!
Me over at Project Syndicate:

With commentators offering increasingly dismal warnings about the inflation situation in the United 
States, one might think that the US Federal Reserve has failed completely at its primary task. But 
the bond market is telling a different story, and there is no reason to think that it is driven by 
doves.

BERKELEY a€“ As of Friday, May 6, the bond market expected US consumer price inflation to average 
2.5% between five and ten years from now. That is the rate of inflation needed to equalize returns 
on inflation-indexed and non-indexed US Treasury securities. And given that CPI inflation has been 
running higher than the rate associated with the implicit price deflator for personal consumption 
expenditures, I count that 2.5% five-year, five-year-forward rate
as hitting the US Federal Reservea€™ s 2% price-deflator inflation target.

What, then, would it take to get the economy back to the Feda€™ s targeted inflation rate? Since 
the five-year breakeven rate at the close of May 6 was 3.22%, the implicit expectation is that 
inflation will run a cumulative total of 3.6 percentage points above the Feda€™ s target over the 
next five years. If it does not cause the economya€™ s inflation anchor to vanish, a deviation of 
that size would be an exceedingly small price to pay for the rapid recovery from
the pandemic-induced recession. If the recovery delivers the structural economic transformation 
that we need, the higher inflation that we have experienced will have been well worth it.


Accordingly, it seems to me that the Fed should be taking a victory lap. It has done precisely what 
it is supposed to do, by enabling Americaa€™ s sticky-price, sticky-wage, sticky-debt economy to 
return rapidly not just to full employment but to the right version of full employment a€“ the one 
that has workers working in sectors making products for which there is real, fundamental demand a€“ 
after a shock. And it has done so without disrupting confidence in
the monetary system and its stability.

So why does the very sharp Kenneth Rogoff of Harvard University argue that a€oethings are way out 
of controla€d? If you have been diverted from your desired trajectory, and you then find yourself 
on a path where you can expect to return to it, I would think the only way to describe the 
situation is as a case of being a€oein control.a€D

Rogoff makes clear that there is a€oea lot of uncertainty,a€D and that he is a€oenot going to say I 
know exactly what needs to be done.a€D But his observation that inflation is a€oeway out of 
controla€D makes sense only to the extent that he is willing to declare the bond market and its 
implicit expectations to be wrong. Only then could the expected evolution of Fed policy lead to 
inflation significantlyhigher than 3.22%over the next five years, and to average
inflation significantly above 2.5% 5-10 years hence.

Sure, that could happen. The economy is a surprising place, and our models and forecasts are 
ultimately just poorly informed guesses. The Fed might have to change course substantially. It 
might have to send the US economy into a substantial recession with significantly 
higher-than-expected interest rates to return inflation to its target over the five- to ten-year 
medium run.

For Rogoffa€™ s own implied forecast to come to pass, workers and bosses would have to reach wage 
bargains that assume inflation well above 3.2% for the next five years and well above 2.5% for the 
five years after that. Moreover, those inflationary wage bargains would have to be locked in place 
through contracts and institutional arrangements that would make it hard to revise them downward 
should theyturn out tohave exaggerated actualinflation. For
workers and bosses to do that, they would have to be pretty confident that bond traders are 
irrationally Panglossian a€“ that they are inflation doves despite the evidence to the contrary.

Is there any reason to think that bond traders are irrational Panglossian inflation doves? Are 
there any reasons to think that workers and bosses now believe that bond traders are irrational 
Panglossian inflation doves?
I see none.

In our modern economy, an outbreak of inflation is a peculiar expectations-driven process. It 
requires a vicious circle in which expectations of high inflation drive actions that then validate 
those expectations a€“ with higher wages leading to higher consumer prices that in turn lead to 
demands for higher wages, ad infinitum. For this to happen, the expectation of high inflation has 
to come from somewhere, and as of now, it is not in evidence.

Yes, additional adverse supply shocks could lie in our future. The COVID-19 virus still has the 
potential to mutate and confront us with dangerous, disruptive new strains. Further disruptions 
could emanate from a widening of Russian President Vladimir Putina€™ s war on Ukraine or from an 
economically catastrophic interaction of new virus variants and Chinaa€™ s zero-COVID policy. These 
kinds of developments could push inflation out of control.
But the fact that such risks exist does not mean we should live as if they have already come to 
pass, and thus ignore the world as it currently is.

LINK: 
<https://www.project-syndicate.org/commentary/bond-market-medium-term-inflation-currently-on-target-
by-j-bradford-delong-2022-05>
First: No, the Fed Is Not (Far) Behind the Curve!

Here is a reason I do not think that the Fed is (far) behind the curve:

Goldman Sachs US Financial Conditions Index YoY% vs. ISM Manufacturing Index

70


40

4                                        II ---------------------- --------------------------- 
—--------- -----

--------------- 1----------------- 1----------------- 1----------------- 1----------------- 1       
 v        । -----------------1----------------- 1----------------- 1----------------- 1        ।    
    1— 30

98     00     02     04     06     08     10     12     14     16     18     20     22

------ US Financial Conditions Index (inv) ----------------- ISM Mfg Index (rhs)          Recession

It seems highly likely that at least the manufacturing part of the economy will slow markedly over 
the next 1 1/2 years, no?

And that is with what the Fed has already done (and is expected to do). Would one want more slowing 
than the FC index tells us is already baking in the cake? If you think so, why?
Yes, bottlenecks, oil shocks, wheat shocks, and China-lockdowns will do what they will do to 
inflation in the short run.

But over the medium and the long run, the bond market is still quite happy with the outlook as far 
as inflation is concerned, at least if you believe the information in TIPS:

— 5-Year, 5-Year Forward Inflation Expectation Rate

MV


0.0

2006   2008   2010      2012      2014      2016      2018      2020     2022

So then why now do we have the extremely sharp Olivier Blanchard, commenting on Reifschneider and 
Wilcox 
<https://www.piie.com/publications/policv-briefs/case-cautiously-optimistic-outlook-us-inflation>, 
writing 
<https://www.piie.com/blogs/realtime-economic-issues-watch/whv-i-worrv-about-inflation-interest-rate
s-and-unemployment>:

Figure 1

The last time the Fed fell this far behind the curve on inflation
was in 1975 and it took 9 years to bring under control

Core inflation and the real policy interest rate, percent


Note: Core inflation is consumer price index inflation excluding food and energy. The real policy
interest rate is the federal funds interest rate minus core inflation over the previous 12 months.

Sources: US Bureau of Labor Statistics and Board of Governors of the Federal Reserve System,
retrieved from Federal Reserve Bank of St. Louis (FRED).


9

Moreover, he is far from alone:

• Neil Irwin: a€oeWhen did the Fed start getting behind the curve? I think it was one year ago this 
week. Between December '20 and March '21 meetingsa€!a€D <

Neil Irwin @Neil Irwin

When did the Fed start getting behind die curve? I think it was one year ago this week. Between 
December '20 and March '21 meetings, $2 8t in pandemic stimulus passed, vaccine rollout got 
underwaya€”yet fed funds rate forecast didn't budge.


axios.comFederal Reserve likely to raise interest rates this weekWith inflation nearing 8%, and 
unemployment below 4%, the Fed is far behind the curve in raising rates.
1:37 PMT™ Mar 14,2022

35Likes9Retweets

• Irving Swisher: a€oeConsensus is that the Fed has fallen behind the curvea€!a€D <

Skanda Amarnath (Neoliberal Sellout) @IrvingSwisher

Consensus is that the Fed is behind the curve, while the Fed itself seems to have fallen short of 
laying out what they really meant by "broad and inclusive" with respect to maximum employment. But 
we should take stock of what has been a historic labor market recovery.

This Recovery Will Likely Not Be Generational ly Disastrous...

-Unlike Previous Recoveries

Prime-Age 25-54 Employment Rate (%) vs Pre-Recession Peak

—1990 Peak      2000 Peak ----------- 2007 Peak     2020 Peak

4

aS
2

■

«*
&

E

4:46 PM r™ Mar 15,2022

18Likes2Retweets

• Squawk Box: a€oea€~We are behind the curve. We have to movea€™ , says Former Dallas Fed President 
Richard Fishera€la€D <

SQUAWK
BOX


Squawk Box @SquawkCNBC

"We are behind the curve. We have to move," says Former Dallas Fed President Richard Fisher. "So, 
yes I'd be advocating to begin the process. Reverse the gears."

12:02 PM r™ Mar 14,2022

37Likesl2Retweets

• > (never mind that Fisher made precisely zero correct calls his entire time at the Fed);

•  Mohamed El-Erian: a€oeThe US Federal Reserve, the worlda€™ s most powerful central bank, is 
already dealing with self-inflicted damage to its inflation-fighting credibility. With that comes 
the likelihood of de-anchored inflationary expectationsa€!a€D 
<https://www.ft.com/content/db9e3706-84dd-47bc-a943-90d7dfef6abe>;

• Eric Rosenbaum: a€oeFed 'behind the curve' on inflation, says former Obama economist Jason 
Furmana€!a€D 
<https://www.msn.com/en-us/monev/markets/fed-behind-the-curve-on-inflation-savs-former-obama-economi
st-iason-furman/ar-AAQybLT>.
a€oeSelf-inflicted damage to [the Feda€™s] inflation-fighting credibility a€ I a€D:

FRED^       5-Year, 5-Year Forward Inflation Expectation Rate

2.6


2016        2017        2018        2019        2020        2021        2022

a€oeSelf-inflicted damage to [the Feda€™s] inflation-fighting credibility a€ I a€D:

FRED — 5-Year, 5-Year Forward Inflation Expectation Rate

2.5


2021-04               2021-07               2021-10               2022-01

I simply do not see this a€oeself-inflicted damage to [the Feda€™ s] inflation-fighting 
credibilitya€!a€D

Now maybe there is an argument did the people treating in the bond market are weirdos, disconnected 
from the inflation expectations embedded in the actors in the economya€’’those whose beliefs and 
expectations really matter because they drive decisions. Maybe there is an argument that we need to 
fear not bond-market vigilantes, but rather other actors and agents. Maybe it is their expectations 
of inflation have become substantially de-anchored already.
Maybe they are already taking steps that will produce a persistent inertial inflationary spiral.

But who are they?

What are their expectations?

How are their expectations now being translated into actions?
And how are those actions not easily reversible?

I have not seen any of those arguments made.

Blanchard writes, apropos of the 200 basis-point increase in the Federal Funds rate we expect to 
see over the next two years:

Is it reasonable to think that a 200-basis-point increase in the policy rate, so only 1/6 of the 
rate increase from 1975 to 1981, will do the job this time when the gap between core inflation and 
the policy rate is 2/3 of what it was in 1975? And that unemployment will barely budge? I wish I 
could believe ita€!

But why is the rate increase from 1975-1981 relevant? We have a target: inflation from five to ten 
years out. We have an instrument: the current level and planned forward path for the Fed Funds 
rate. We have a reading on whether we are on a glide path to the targeta€”the bond marketa€™ s 
5-year, 5-year forward expected inflation rate. That reading says we are.

FRED      5-Year, 5-Year Forward Inflation Expectation Rate

I  . i iki A


2006      2008      2010      2012      2014      2016      2018      2020     2022

Is there a better reading available as to whether we are on the glide path?
If so, what is it?

I believe that there is not. So why is the conclusion not: a€oePolicy is appropriate. The Fed is 
not behind the curvea€D? This is, to me, a very genuine mystery.
Blanchard writes:

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maniz fii-npc in tKo nacf cVii'Ft onrl tPot tlio lanJmn nri11 IAO harrier tlion P oifcnhnpirl^r on 
ri \X7I1O/AV pnnp1iirl4»                                tho mflofinn nri11 1     IJAAJ crr\ on/av 
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lAaoV' t/A itc


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LAO AL A A LAO UAU/AAUz AAALAAAJ'     LA A A AV/ O AAA LA AV p/LAOL^ OAAAAL, LAAAVA LA A LAL LA AV 
ALAAAVAAAA^ VV AAA L/V/ AALAA VAV/A     LA A LAA A   XWAADVAAAAVAUVA LAAAVA ▼ ▼ AAWA Vz V/AALzA 
LAVAVz • A CALL V/A     LA AV AAAAALALAU/AA VV AAA AAAVAV/V/VA ^UX LA VV LA^ V/AA ALO VWAA, L/LAL 
LA AV A V/VA A A ALAAAUVV LUS AAAVAVUOV 111 L VI VOL ALALV/O  LX J     LLL\JL\j LA A LA A A      
X^U/UX    LX LAO AO p/U/AAALO LUX ^V/L LXLAVzAU LUS ALO LLAA^V/LLA'

Indeed. The Fed may have to raise interest rates by more than 200 basis points. The Phillips Curve 
may well shift. And when there is evidence that the Fed is indeed behind the curve and not on an 
appropriate glide path, it will be time for the Fed to use forward guidance that it has changed its 
policy plans to shape expectations.
But why is today that day?

Especially since errors in not raising interest rates quickly enough are errors from which we can 
recover, but at and near the zero lower bounda€’’which we area€’’errors in raising rates too 
quickly are errors from which we cannot reasonably recover.
FIRST: There Are Now 250-Basis Points of Long-Term Monetary Tightening That Have Not Yet Hit the 
Economy

As of now, nobody knowsa€’’especially not the Federal Reservea€’’whether the very substantial 
monetary tightening that the Federal Reserve has induced over the past nine months is too little, 
too much, or just right:

FRED — Market Yield on U.S. Treasury Securities at 10-Year Constant Maturity, Quoted on an 
Investment Basis, Inflation-Indexed

2.0

FRED^   Personal Consumption Expenditures Excluding Food and Energy (Chain-Type Price Index)

10.0

7.5

o
oo
c
Q

u    5.0

o
o

aj   2.5


Jan 2018         Jul 2018         Jan 2019         Jul 2019         Jan 2020         Jul 2020       
  Jan 2021         Jul 2021         Jan 2022 Jul 2022

The one thing that is clear is that we do not have a bond-market expectations problem:

FRED — 5-Year, 5-Year Forward Inflation Expectation Rate

2.8

2.6

2.4

2.2

2.0

CU

1.8

QJ

1.6

1.4

1.2

1.0

0.8

2018-01         2018-07          2019-01         2019-07          2020-01          2020-07         
2021-01         2021-07          2022-01          2022-07

There are thus two and only two credible positions right now:

•  The Fed needs to pause, and see what its policy moves over the past nine months have 
donea€’’which means waiting until after the turn of the year to move again.

•  We remain just one supply shock away from a de-anchoring of inflation expectations, and so the 
Fed needs to keep talking very tough.

My view is that the bond market will tell us when it is time for additional tightening: the Fed 
should pause unless and until the 5-year/5-year-forward inflation breakeven crosses 2.5% heading 
upwards.

(Yes, there are problems in a fully rational-expectations world of conditioning policy on market 
variables that are primarily expectations of what that policy will be. But is there any reason to 
think that we are in such a world?)
1.

2.


-2.5

-5.0

-7.5

Jan 2018         Jul 2018         Jan 2019         Jul 2019         Jan 2020         Jul 2020       
  Jan 2021         Jul 2021         Jan 2022      Jul 2022

The one thing that is clear is that we do not have a bond-market expectations problem:

FRED    5-Year, 5-Year Forward Inflation Expectation Rate

2.8

2.6

2.4

2.2

2.0

CU

1.8

QJ

1.6

1.4

1.2

1.0

0.8

2018-01         2018-07          2019-01         2019-07          2020-01          2020-07         
2021-01         2021-07          2022-01          2022-07

There are thus two and only two credible positions right now:

• The Fed needs to pause, and see what its policy moves over the past nine months have 
donea€’’which means waiting until after the turn of the year to move again.

• We remain just one supply shock away from a de-anchoring of inflation expectations, and so the 
Fed needs to keep talking very tough.

My view is that the bond market will tell us when it is time for additional tightening: the Fed 
should pause unless and until the 5-year/5-year-forward inflation breakeven crosses 2.5% heading 
upwards.

(Yes, there are problems in a fully rational-expectations world of conditioning policy on market 
variables that are primarily expectations of what that policy will be. But is there any reason to 
think that we are in such a world?)
1.

2.


-2.5

-5.0

-7.5

Jan 2018         Jul 2018         Jan 2019         Jul 2019         Jan 2020         Jul 2020       
  Jan 2021         Jul 2021         Jan 2022      Jul 2022

The one thing that is clear is that we do not have a bond-market expectations problem:

FRED    5-Year, 5-Year Forward Inflation Expectation Rate

2.8

2.6

2.4

2.2

2.0

CU

1.8

QJ

1.6

1.4

1.2

1.0

0.8

2018-01         2018-07          2019-01         2019-07          2020-01          2020-07         
2021-01         2021-07          2022-01          2022-07

There are thus two and only two credible positions right now:

• The Fed needs to pause, and see what its policy moves over the past nine months have 
donea€’’which means waiting until after the turn of the year to move again.

• We remain just one supply shock away from a de-anchoring of inflation expectations, and so the 
Fed needs to keep talking very tough.

My view is that the bond market will tell us when it is time for additional tightening: the Fed 
should pause unless and until the 5-year/5-year-forward inflation breakeven crosses 2.5% heading 
upwards.

(Yes, there are problems in a fully rational-expectations world of conditioning policy on market 
variables that are primarily expectations of what that policy will be. But is there any reason to 
think that we are in such a world?)
1.

2.


-2.5

-5.0

-7.5

Jan 2018         Jul 2018         Jan 2019         Jul 2019         Jan 2020         Jul 2020       
  Jan 2021         Jul 2021         Jan 2022      Jul 2022

The one thing that is clear is that we do not have a bond-market expectations problem:

FRED    5-Year, 5-Year Forward Inflation Expectation Rate

2.8

2.6

2.4

2.2

2.0

CU

1.8

QJ

1.6

1.4

1.2

1.0

0.8

2018-01         2018-07          2019-01         2019-07          2020-01          2020-07         
2021-01         2021-07          2022-01          2022-07

There are thus two and only two credible positions right now:

• The Fed needs to pause, and see what its policy moves over the past nine months have 
donea€’’which means waiting until after the turn of the year to move again.

• We remain just one supply shock away from a de-anchoring of inflation expectations, and so the 
Fed needs to keep talking very tough.

My view is that the bond market will tell us when it is time for additional tightening: the Fed 
should pause unless and until the 5-year/5-year-forward inflation breakeven crosses 2.5% heading 
upwards.

(Yes, there are problems in a fully rational-expectations world of conditioning policy on market 
variables that are primarily expectations of what that policy will be. But is there any reason to 
think that we are in such a world?)
1.

2.


-2.5

-5.0

-7.5

Jan 2018         Jul 2018         Jan 2019         Jul 2019         Jan 2020         Jul 2020       
  Jan 2021         Jul 2021         Jan 2022      Jul 2022

The one thing that is clear is that we do not have a bond-market expectations problem:

FRED    5-Year, 5-Year Forward Inflation Expectation Rate

2.8

2.6

2.4

2.2

2.0

CU

1.8

QJ

1.6

1.4

1.2

1.0

0.8

2018-01         2018-07          2019-01         2019-07          2020-01          2020-07         
2021-01         2021-07          2022-01          2022-07

There are thus two and only two credible positions right now:

• The Fed needs to pause, and see what its policy moves over the past nine months have 
donea€’’which means waiting until after the turn of the year to move again.

• We remain just one supply shock away from a de-anchoring of inflation expectations, and so the 
Fed needs to keep talking very tough.

My view is that the bond market will tell us when it is time for additional tightening: the Fed 
should pause unless and until the 5-year/5-year-forward inflation breakeven crosses 2.5% heading 
upwards.

(Yes, there are problems in a fully rational-expectations world of conditioning policy on market 
variables that are primarily expectations of what that policy will be. But is there any reason to 
think that we are in such a world?)
1.

2.


QJ
CL

1.6

1.4

1.2

1.0


0.8

2018-01         2018-07          2019-01         2019-07          2020-01

2020-07         2021-01         2021-07          2022-01         2022-07

There are thus two and only two credible positions right now:

•  The Fed needs to pause, and see what its policy moves over the past nine months have 
donea€’’which means waiting until after the turn of the year to move again.

•  We remain just one supply shock away from a de-anchoring of inflation expectations, and so the 
Fed needs to keep talking very tough.

My view is that the bond market will tell us when it is time for additional tightening: the Fed 
should pause unless and until the 5-year/5-year-forward inflation breakeven crosses 2.5% heading 
upwards.

(Yes, there are problems in a fully rational-expectations world of conditioning policy on market 
variables that are primarily expectations of what that policy will be. But is there any reason to 
think that we are in such a world?)
1.

2.