The Inflation Obsession

On 25 FEB 2014, I created a post about how newly released Fed minutes from 2008 had demonstrated conclusively that the Fed governors barely noticed the oncoming catastrophe that would soon threaten the global economy and instead discussed their inflation worries because that is who they are and what they do.

Now Paul Krugman weighs in on the same subject and comes roughly to the same conclusions.  The boy's going to become an Institutionalist yet!  None of this would be important except that Krugman has become the goto guy for most Liberals on any economic discussion. This is actually pretty amazing since Krugman was awarded John Bates Clark Medal in 1992, given biannually by the American Economic Association to the economist under 40 who has made the most important contributions to (conservative / reactionary) economics.  Clark himself started out as a Christian German Socialist but during the 1880s became this hopeless reactionary.  Thorstein Veblen would spend most of his career taking aim at Clark's newfound nonsense—especially his theory of marginal utility (and doing a fine job of it, thank you very much.)  So for a Clark winner to evolve into something that resembles an Institutionalist is remarkable considering Veblen pretty much invented Institutional Analysis.

I would also point out to Mr. Krugman that this inflation obsession at the Fed level is at least partially caused by the same obsession at our universities.  Krugman has been at Princeton for quite awhile now and I haven't noticed Princeton grads more balanced in their economic concerns.  He's been writing for the NYT for years and that paper is still obsessed with the arguments for "sound" money.  So Mr. Krugman doesn't have to go very far to find influential folks in the economic debates who are certainly no better than the Fed Governors.

The Inflation Obsession

Paul Krugman MARCH 2, 2014

Recently the Federal Reserve released transcripts of its monetary policy meetings during the fateful year of 2008. And, boy, are they discouraging reading.

Partly that’s because Fed officials come across as essentially clueless about the gathering economic storm. But we knew that already. What’s really striking is the extent to which they were obsessed with the wrong thing. The economy was plunging, yet all many people at the Fed wanted to talk about was inflation.

Matthew O’Brien at The Atlantic has done the math. In August 2008 there were 322 mentions of inflation, versus only 28 of unemployment and 19 of systemic risks or crises. In the meeting on Sept. 16, 2008 — the day after Lehman fell! — there were 129 mentions of inflation versus 26 mentions of unemployment and only four of systemic risks or crises.

Historians of the Great Depression have long marveled at the folly of policy discussion at the time. For example, the Bank of England, faced with a devastating deflationary spiral, kept obsessing over the imagined threat of inflation. As the economist Ralph Hawtrey famously observed, “That was to cry ‘Fire, fire!’ in Noah’s flood.” But it turns out that modern monetary officials facing financial crisis were just as obsessed with the wrong thing as their predecessors three generations before.

And it wasn’t just a bad call in 2008. Much supposedly informed opinion has remained fixated on the supposed threat of rising prices despite being wrong again and again. If you spent the last five years watching CNBC, or reading the Wall Street Journal opinion pages, or for that matter listening to prominent conservative economists, you lived in a constant state of alarm over runaway inflation, which was coming any day now. It never did.

What accounts for inflation obsession? One answer is that obsessives failed to distinguish between underlying inflation and short-term fluctuations in the headline number, which are mainly driven by volatile energy and food prices. Gasoline prices, in particular, strongly influence inflation in any given year, and dire warnings are heard whenever prices rise at the pump; yet such blips say nothing at all about future inflation.

They also failed to understand that printing money in a depressed economy isn’t inflationary. I could have told them that, and in fact I did. But maybe there was some excuse for not grasping this point in 2008 or early 2009.

The point, however, is that inflation obsession has persisted, year after year, even as events have refuted its supposed justifications. And this tells us that something more than bad analysis is at work. At a fundamental level, it’s political.

This is fairly obvious if you look at who the inflation obsessives are. While a few conservatives believe that the Fed should be doing more, not less, they have little if any real influence. The overall picture is that most conservatives are inflation obsessives, and nearly all inflation obsessives are conservative.

Why is this the case? In part it reflects the belief that the government should never seek to mitigate economic pain, because the private sector always knows best. Back in the 1930s, Austrian economists like Friedrich Hayek and Joseph Schumpeter inveighed against any effort to fight the depression with easy money; to do so, warned Schumpeter, would be to leave “the work of depressions undone.” Modern conservatives are generally less open about the harshness of their view, but it’s pretty much the same.

The flip side of this antigovernment attitude is the conviction that any attempt to boost the economy, whether fiscal or monetary, must produce disastrous results — Zimbabwe, here we come! And this conviction is so strong that it persists no matter how wrong it has been, year after year.

Finally, all this ties in with a predilection for acting tough and inflicting punishment whatever the economic conditions. The British journalist William Keegan once described this as “sado-monetarism,” and it’s very much alive today.

Does any of this matter? It’s true that the Fed hasn’t surrendered to the sado-monetarists. Notably, it didn’t panic in 2011, when another blip in gasoline prices briefly raised the headline rate of inflation, and Republicans began inveighing against the “debasement” of the dollar.

But I’d argue that the clamor from inflation obsessives has intimidated the Fed, which might otherwise have done more. And it has also been part of a general climate of opposition to anything that might address our continuing jobs crisis.

As I suggested, we used to marvel at the wrongheadedness of policy makers during the Great Depression. But when the Great Recession struck, and we were given a chance to do better, we ended up repeating all the same mistakes. more