Revisiting the Summer of Stagflation

I don’t know whether there will be any surprises in the State of the Union address. I do know that the background to the speech will be very different from what a great majority of pundits expected just a few months ago.

After all, at this point Joe Biden’s presidency was supposed to be effectively over — his political clout destroyed by a devastating red wave in the midterms, his policy credibility eviscerated by a recession and high inflation.

Well, the red wave was more of a ripple. And recent economic numbers have been astonishingly favorable. Half a million jobs were added last month, bringing total job creation under Biden to 12 million so far, with the unemployment rate dropping to 3.4 percent, its lowest level since 1969. Inflation was high in 2021 and part of 2022, but it has plunged since; over the past six months, consumer prices have risen at an annual rate of less than 2 percent.

If the economic news seems too good to be true, that’s probably because it is. Most of the experts I talk to think that monster employment report for January was a statistical anomaly. The inflation numbers reflect various temporary factors, although these go in both directions; I won’t be surprised if inflation rises somewhat in the months ahead, but that’s by no means certain.

What is clear, however, is that until a few months ago many if not most economic prognosticators were far too negative about America’s prospects. In particular, we went through what I think of as the summer of stagflation — a period, actually extending some way into fall, when many influential economists were making extremely grim pronouncements about what it would take to bring inflation under control.

And I think it’s important to ask why they were so wrong.

Now, show me an economist who hasn’t made any incorrect predictions and I’ll show you someone who doesn’t take enough intellectual risks. I’ve made plenty of bad calls over the years; in particular, I didn’t expect inflation to surge the way it did.

That said, I’ve been revisiting the most influential of those downbeat analyses, and it’s really astonishing just how grim they were compared with what has actually happened. Most famously, last June Larry Summers declared — with praiseworthy specificity — that containing inflation would require five years of 6 percent unemployment, two years of 7.5 percent unemployment or a year of 10 percent unemployment.

Another influential paper, presented at the Brookings Institution in September, similarly predicted that inflation would remain very high unless there was a huge increase in unemployment.

To be fair, inflation may not yet be fully under control. But it has fallen enough, without any rise in unemployment at all, to make it clear that such predictions were wildly over-pessimistic. So why did people believe them?

Not everyone on Team Stagflation used the same approach. But much if not all of the pessimism rested on the assumption that the inflation of 2021-22 was just like the inflation of the 1970s, which was indeed contained only via an extended period of very high unemployment.

The thing is, there were always good reasons to believe that this was a bad analogy. Economists who got it mostly right, like Joseph Gagnon of the Peterson Institute, argued from the beginning that the Korean War — which produced a sharp but short spike in inflation — was a better model than the ’70s for what was happening. I and others pointed out that disinflation was difficult in the 1980s largely because expectations of persistent inflation had become entrenched, which they clearly hadn’t this time around.

Why, then, did economists make such confident predictions of doom, and why did so many others — especially in the news media — accept them? We’re not talking about intellectual dishonesty here: Inflation pessimists were admirably clear about their data and assumptions. But there was and is a mind-set — possibly affecting economists themselves, definitely affecting much of their audience — that is always ready to see any economic setback as a replay of that ’70s show, that always sees stagflation looming.

That mind-set isn’t explicitly political; I’m not talking about Heritage Foundation types who spent much of the past year proclaiming a Biden recession and will never, ever apologize.

But it does, I think, reflect the urge to see economics as a morality play, in which attempts by policymakers to make things better are severely punished (while doing too little isn’t). The Biden administration’s initial spending package was bigger than it should have been; the Federal Reserve was slow to realize how broadly inflation was rising. Surely such sins must invite terrible retribution from the gods of macroeconomics!

But they didn’t. So will the prophets of inflation doom acknowledge that they got it wrong? More important, will policymakers, especially at the Fed, who understated inflation risks in 2021 be flexible enough to accept that they overcompensated in 2022? Because if they don’t, the policy response to imaginary stagflation may yet produce an unnecessary recession.

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