Economically, 2023 will go down in the record books as one of the best years in history: a year in which inflation fell astonishingly quickly and at no apparent cost, contradicting many economists' predictions that disinflation would require years of high unemployment.
At least so far, public opinion appears unwilling to believe the good news or give the Biden administration any credit. But this column is not about the obvious gap between voters' perceptions and reality, but rather about some influential economists and officials unwilling to accept the fact that they were wrong.
Why should we care? It's not about scoring personal points, although I am a strong advocate that one should acknowledge the mistakes of the past because that is how you learn and it is also good for the soul. What worries me is that if we cling to a view of the economy that has been contradicted by recent events, we are more likely to make mistakes and expose the economy to a recession that, as it now turns out, we neither needed still need. to control the economy. Inflation.
To what extent was the economic performance spectacular? In March, the Federal Reserve's monetary policy-setting committee still forecast that we would end this year with an unemployment rate of 4.5% and the Fed's preferred indicator, “core inflation,” at 3.6%. Last week, the same group forecast unemployment at just 3.8% and core inflation at just 3.2% by the end of the year. However, the news is actually even better as the final number is inflation for the entire year. In the six months to October, core inflation was 2.5%, and most analysts I follow believe November data, when it arrives later this week, will show inflation around 2%, which is the long-term The Federal Reserve's goal is . Soft landing achieved.
How did we manage to do that? The answer seems pretty clear. Economists who argued that the rise in inflation in 2021-22 was “transitory” and due to disruptions caused by the Covid pandemic and the Russian invasion of Ukraine were apparently right, but these disruptions were larger and longer-lasting , than almost anyone could imagine, so “temporary” ended up meaning years instead of months. What has happened in 2023 is that the economy has finally solved its post-pandemic problems, such as supply chain disruptions and the mismatch between job vacancies and unemployed people.
This is not a random guess. Rising employment coupled with falling inflation is exactly what would be expected in an economy with improved supply chains. We also see this when we look closely at the economy: the fastest-growing sectors saw the largest decline in inflation. And statistical inflation models that incorporate supply chain indicators track inflation trends in recent years more closely than more conventional models.
But many of the economists who have been overly pessimistic about inflation – particularly Larry Summers, although he is not alone – remain reluctant to accept the obvious. On the contrary, they claim that the disinflation is due to the Reserve, which began to drastically raise interest rates in 2022.
The question is how that should have worked. The original pessimistic argument was that the Fed would have to create a lot of unemployment to bring down inflation. As I understand it, the current argument is that the Fed's crackdown convinced people that inflation would fall and that this was a self-fulfilling prophecy.
To my knowledge there is absolutely nothing that can prove this claim. Although financial markets pay close attention to Federal Reserve statements, the producers and workers who set prices and wages do not; They base their decisions on what they see around them.
Here we notice some historical echoes. About a decade ago, some economists and policymakers insisted that cutting public spending would increase employment by encouraging greater investment; I mocked this view, which turned out to be completely wrong, and called it belief in the trust fairy. What we are seeing now could be described as trusting the credibility fairy.
I want to be clear that I do not blame the Federal Reserve for raising interest rates earlier. We didn't know last year that the inflation story would end so well, and to be fair, rate hikes haven't triggered a recession, at least so far.
What worries me is the future. In general, the same people who were wrong about their pessimism about disinflation are now warning the Federal Reserve not to cut interest rates quickly. Because? Well, if you believe that a rise in inflation will be very difficult to reverse, and you also believe that the Fed's perceived firmness has been crucial in bringing inflation down, then you would probably be willing to take big recession risks in order to maintain the credibility of the Fed Fed to preserve the reserve when it comes to fighting inflation. But neither belief is supported by evidence.
Has the war against inflation finally been won? No. But a recession appears to be a greater risk than a rise in inflation. And I worry that this risk will increase if policymakers listen to people who refuse to admit they were wrong about inflation and cling to a false theory about how we control it brought.
Paul Krugman is a Nobel Prize winner in economics. © The New York Times, 2023. Translation news clips.
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