The ABCs of Inflation

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0:00:07.4 Trevor Burrus: Welcome to Free Thoughts. I’m Trevor Burrus. Joining me today is George Selgin, a Senior Fellow and Director Emeritus of the Center for Monetary and Financial Alternatives at the Cato Institute, and Professor Emeritus of Economics at the University of Georgia. Welcome back to Free Thoughts, George.

0:00:22.8 George Selgin: Hey, nice to be back, Trevor.

0:00:25.3 Trevor Burrus: So today, which is April 12th, we heard that the inflation is continuing to go up, 8.5% over March of last year. So the first question is, is this concerning overall, or is this sort of an expected thing coming out of the recession?

0:00:44.4 George Selgin: Oh, it’s definitely concerning, Trevor. The inflation, besides being high, it’s as high as it has ever been for 40 years, but it’s also been going on longer than many people, including folks at the Fed, had anticipated. And so it’s definitely a concern. It’s definitely a problem, I’d say. And I’d argue that it’s partly because, the high numbers are partly because the Fed has fallen behind, it has not acted quickly enough to contain the inflation.

0:01:28.1 Trevor Burrus: Now, many people do point out, and I think this makes some sense, is that over the last two years, there have been a ton of new economic situations or things we haven’t seen before due to the pandemic and so therefore you have supply chain problems and you have some boost… We have very low unemployment, 3.6% is the official rate right now, so you have possibly a demand increase because of that, so is that what’s really… Is that contributing or how much is that contributing to the overall?

0:02:01.0 George Selgin: Supply side developments are an important part of the overall picture, there’s no question about it. COVID, followed by, more recently, the war in Ukraine and the sanctions that have been put into place in connection with that, have made goods, many kinds of goods, particularly a lot more scarce, and that increased scarcity naturally means that their prices will go up, other things equal. So that’s a big part of the story. And by the way, that’s a part of the story that shouldn’t be the Fed’s responsibility and really in a sense shouldn’t be anyone’s responsibility. And what I mean by that is that if scarcity is behind it, higher prices are something that we should not condemn, the scarcity is a regrettable fact, and the high prices reflect that regrettable fact. But it doesn’t… There’s no way to make them go away, except by producing more of the goods and services in question, and under the circumstances that’s gonna take some time.

0:03:18.3 George Selgin: So some of the inflation we’ve seen, a lot of it I’d say, is in fact based on supply limitations, and that’s fine, but it isn’t all based on that, there is also a demand side to the story, as you suggested. And what I mean by that is that it’s not just that there are fewer goods out there to spend money on, it’s also that people are spending money more than ever. There’s been a very substantial uptick in total spending since the COVID crisis, spending collapsed then because of COVID and lock-​downs and people just started saving a lot, whether they really wanted to or not, they really didn’t have the spending opportunities that they normally would have. And of course, some people also were out of work, but that has changed in a big way and we’ve now, for some months now, passed the point where total spending has not only caught up to where it would have been if there had been no COVID, but has surpassed that level and is still growing gang-​busters, and now that is also a factor driving prices up and it’s the Fed’s fault in this case, that is, it’s the Fed’s responsibility to prevent this.

0:04:42.2 Trevor Burrus: Well, that was… Yeah, that was my next question, because if there’s one “famous” quote about inflation, it’s Milton Friedman’s, that, “Inflation is always and everywhere a monetary phenomenon,” but what you were discussing there didn’t seem like a monetary policy thing, so much supply side, demand side constraints, people spending more. So how is the Fed affecting how much people are spending?

0:05:05.1 George Selgin: Well, so first concerning Friedman’s quote, it was convenient at the time when we had a lot of inflation and there was need to get people’s attention to the need for action to constrain it, because the Fed was, again, not entirely but largely responsible for it. But the truth of the matter is that sometimes inflation is a result of greater scarcity of goods and not just people spending too much. But people are spending too much and the Fed can regulate that, it has the power to do that. And the way it does, at least suit… The proximate way it does is by raising its target interest rates. Okay, what does that mean? Well, essentially, it makes it more… Under the current arrangement, by raising interest rates, the Fed makes it more tempting for banks to hold on to reserves at the Fed and less tempting for them to make loans. It increases the price of credit, so the quantity of loans that people wanna take out diminishes, other things equal. So the idea is that the more the Fed raises its policy rates the less spending will go on, the less borrowing and therefore less spending, and as a result spending will slow down and prices will stop rising as quickly, and ideally they’ll come back down, the rate of inflation will come back down to the Fed’s long run target of 2%.

0:06:52.2 Trevor Burrus: One thing you haven’t mentioned, being sort of popular since, and libertarians are pretty big on saying this too, is this idea of printing money in the sense that what really causes inflation, and there’s the famous examples of the Weimar Republic and Zimbabwe more recently and Venezuela, is that the government just starts printing money and doesn’t really care about how much it’s putting on the balance sheets, and one thing we definitely have seen since 1981, which is the last time we’re talking about when inflation was this high, is a gargantuan increase in the amount of national debt. Does that matter when it comes to inflation?

0:07:28.4 George Selgin: Yeah, the national debt does matter. What happens is this, the more the government borrows, of course, the greater the interest burden, other things equal that it faces. Of course, a lot of the borrowing that’s gone on recently was while interest rates and inflation were still very, very low, but as inflation worsens, and particularly as the Fed responds to it by raising interest rates, then the interest burden on the debt also goes up, and when we’re talking about interest rates rising one or two percentage points today, we’re talking about a very big increase from where they were percentage-​wise. And so all of this means that the fiscal situation becomes more difficult with so much debt outstanding and interest rates on the debt rising… By the way, the way the Fed operates today is by regulating the interest it pays banks on their reserves, as I mentioned before, and that really is like interest being paid on the government debt, because a lot of the reserves in question are backed by government securities or they’re backed by agency securities, which are the next closest thing. So really, when the Fed raises its policy rates, it’s directly increasing the amount of interest the government is having to pay out, in this case, to banks rather than to other persons, but it also ends up paying out more to everybody. Okay, what does this have to do with controlling inflation?

0:09:12.9 George Selgin: Well, the argument is that because raising interest rates in these conditions can pose a great burden on the Treasury, the Fed can be placed under a lot of pressure to resist raising rates, and there are situations in which the government is able to exert enough pressure to get the Fed to not do its job and not raise interest rates enough to control inflation, and then hey, presto the inflation raises the debt… The interest rates rising raise the debt burden, but if interest rates stay low and prices rise, it actually erodes the amount or the real value of the government’s outstanding debt, there’s a motive for the government to wanna see its real debt eroded through inflation, and so that’s a way it pays off the debt by getting everybody else to bear the burden through higher prices. And that’s the sort of thing that happened in hyper-​inflations, like The Weimar hyper-​inflation, it was partly and largely in a way, for the government to pay its debts without really paying them, to get rid of its debts.

0:10:33.3 George Selgin: So we’re not there yet, but it is disturbing to think that we have a higher ratio of debt to GDP than we’ve had since the Second World War, and the higher that ratio is the more you start to worry about this kind of fiscal dominance scenario, fiscal dominance of monetary policy scenario as it’s called.

0:10:58.5 Trevor Burrus: Clarify that, you mean that the monetary policy is being run by the fiscal policy as opposed to vice versa?

0:11:04.5 George Selgin: That the fiscal authorities are, as it were, calling the shots or at least putting pressure on the Fed to modify its monetary stance with the treasury’s needs in mind instead of with its proper mandates in mind.

0:11:25.3 Trevor Burrus: So does that come from… ‘Cause it does seem somewhat shocking, I think to even casual observers, definitely to libertarians, but it seems that particularly the Democrats can’t stop proposing more spending bills, and would that be the kind of fiscal pressure that would be exerted, like $4 Trillion for infrastructure and $1.5 Trillion for stimulus and that they seem to think there’s no feasible limit on how high the debt can go, or at least they’re not approaching it, and then if they did pass, let’s say a $4 Trillion infrastructure bill, that new money that was needed by treasury would put the pressure on the Fed to find that money somewhere and make it cheaper for the government to have that debt?

0:12:09.3 George Selgin: Yes, well, it’s not… I guess you could put it in terms of the Fed finding the money, but really what’s going on is this, and here’s where I think a lot of the MMT rhetoric is highly misleading, modern monetary theory rhetoric.

0:12:26.7 Trevor Burrus: Which basically says that doesn’t matter if it’s not denominated in your own currency. Correct?

0:12:31.2 George Selgin: Yes, and that governments need never worry about how they’re gonna pay for whatever it is they’re doing, and in a sense that’s true, governments to the extent that they issue fiat currency and dependent fiat currency, floating paper money, it’s not tied to anything they can, in principle, print as much as they want to to pay any debts denominated or expenses denominated in that currency they want to incur. That’s true, but it doesn’t follow that they can do it with impunity without causing problems, and ultimately, when you’re particularly in a… When you’re in a situation like we are today, where arguably we’re quite close to full employment, if not there, indeed we have more job vacancies than people out of work right now, which is quite unusual by the way… But anyway, it’s a situation that doesn’t suggest that there’s a great deal of slack in the economy, and therefore whatever resources are going into government projects, I mean real resources, they have to come from somewhere. And there’s two places that they can come from, or three. One is taxing people, obviously. The other is borrowing more, but if you’re borrowing more and the Fed isn’t helping out, that means higher interest rates and that’s the non-​inflationary version of borrowing.

0:14:04.2 George Selgin: The third option is the Fed does help out by letting inflation get loose, by letting goods become more and more expensive. In that case of course, the price is paid not by in the form of higher interest rates, but in the form of a reduction in consumption by the general public. That is, we all are implicitly being taxed by inflation instead of normal taxes. So those are the options. And the modern monetary theorists, they waive these issues away on page one and then they bring them up on page three, and in that way they can promise people to have the moon on one page and then deny that they’re saying anything irresponsible or incorrect by pointing to the other page that is like the footnote or the fine print. But the fine print on modern monetary theory essentially says that the principal claims it makes shouldn’t be taken too seriously. That’s what it says.

0:15:16.6 Trevor Burrus: They’re often, I know even within the econ profession, considered pretty fringe, these sort of famous modern monetary theorists. But it seems to me that one place where they might have come from is the fact that for some people, libertarians especially, there’s been a lot of banging the drum of inflation for 40 years and we’ve had basically 2%. And we said, “Well look, I remember when we hit a billion dollars in debt, it was about ’86 or so, I think, and now we’re 30 trillion.” And so we had 2% inflation with that just unbelievable gain in debt. And if you go to the CATO basement with all these old books that we have, I can pull out a half dozens of libertarian predictions of financial collapse in 1989 or 1994… Something like that. So maybe the inflation hawks were over-​playing their hand too much in the last 40 years. Yes?

0:16:09.9 George Selgin: Oh absolutely, absolutely. The reason we have modern monetary theorists and the reason that their arguments are at least half plausible is because we have both monetary hawks and deficit hawks who have, in some cases, grotesquely exaggerated the risks involved in either deficit spending or money creation, who have been a crying wolf every time the Fed engages in expansionary monetary policy, even when it only serves to avoid unemployment and deflation, and who have argued that deficit spending is always a bad thing, and even that we can’t possibly sustain large deficits for a long time under any circumstances, and all of these wrong arguments, which it should be said, are usually not arguments of professional economists, and there I think the modern monetary theorists have been very misleading. They’re taking pop arguments, maybe I should say popular arguments, mostly enunciated by lay people, including prominent government officials, and they’re treating them as representing orthodox economic theory, and that’s absolutely not true. So the reality and what’s recognized by most economists is that, yes, a monetary expansion can be perfectly non-​inflationary and perfectly desirable under many circumstances, usually a little bit as desirable, and deficits are perfectly reasonable under many circumstances, and a perpetual government debt, we know very well is something that’s sustainable.

0:18:06.4 George Selgin: So talks on both extreme views I say, the modern monetary theorists want to push the pendulum all the way in one direction and the hawks wanna push it in another, the truth is somewhere in between.

0:18:24.0 Trevor Burrus: What changed then? We have… We talked about the pandemic and these unique economic circumstances, but what did the Fed do right for 40 years that it is not doing right anymore?

0:18:36.9 George Selgin: Well, some people say the Fed was pretty lucky. It wasn’t… It didn’t encounter many serious crises and shocks for a long period, but we should remember that before we were worrying about inflation, as we have been only for a couple of years, we were worrying and complaining that the Fed wasn’t keeping the inflation rate high enough, the Fed was struggling to get it high. So in retrospect, we can say, “Well, see the Fed did a good job controlling inflation after 2008, during and after, for a long stretch of time, but for almost all of that time, or certainly for most of it, the inflation numbers were coming in too low, the Fed really couldn’t therefore claim that it was responsible for the inflation, that it had a handle on it, rather it seemed to be incapable of getting inflation where it really wanted it to be.

0:19:38.3 George Selgin: So we shouldn’t exaggerate the Fed’s success post-​2008 and pre-​COVID, it was struggling then as well. Now, why the Fed has had a hard time since, starting in 2007 and ’08 and until today, controlling inflation is a good question, there are many different explanations involved. The lack of inflation or low inflation, I think, was mostly because interest rates were so low, this is the popular explanation. When market interest rates are very low or when the so-​called natural rate of interest, which is the rate you need to keep inflation, at 2%, is negative, which it seems to have been for a while, the Fed can’t necessarily get its own policy rates down there for legal and other reasons, so this is regarded as a very important cause of the low target inflation.

0:20:46.8 George Selgin: Now, of course, the situation is quite different, there’s no lack of, there’s no material reason why the Fed couldn’t have raised interest rates sooner and more to keep inflation from exceeding 2%, or at least exceeding a much higher number, but I think in the later, in this later mistake-​making, the culprit is more the new inflation targeting strategy that the Fed adopted. Not long before everything went haywire, it adopted what it calls average inflation targeting or flexible average inflation targeting and that qualifier flexible is already pointing to part of the problem because the framework was one that was so flexible that no one actually understood what it meant and what the Fed would be up to. So credibility in this new framework was sort of lacking from the get-​go. But the other thing that happened, and this I think, is even more important, is when COVID struck, Fed officials made pronouncements, which they should never do, about the likelihood that they would leave interest rates near zero for an extended period of time and they talked about how it was unlikely they’d raise rates or start raising them till 2023.

0:22:28.5 Trevor Burrus: Was that unique in terms of… Like in the past, had it been very rare for them to say, “This is what to expect?”

0:22:36.0 George Selgin: No, they made this mistake… It’s frustrating because they’ve screwed this up a million times, it’s like Alan Greenspan before the big crisis of 2007. And they said, “We’re gonna keep inflation… We’re gonna keep interest rates low, we’re gonna keep them low.” Those commitments trap the Fed in the following sense; The Fed does not like to hurt its credibility or hurt it further by saying it’s gonna do X and ending up doing Y. So whenever the Fed makes a specific promise, in this case, not a promise that’s very specific, but specific enough to give people pretty expectations, “Okay, the interest rates are gonna stay way down at zero for some time until some time in 2023.” And then conditions emerge where it starts to become clearer and clearer that the interest rates need to go up way before, then the Fed is caught in a trap and it says, “Oh, well, you know, we really wanna keep our promises, so what do we do? Do we sacrifice a little more credibility, or do we break up… Do we stick by hook or by crook to our promise no matter what?”

0:23:50.0 George Selgin: And what often happens, and what I think has happened in this case, is they do a little bit of both, they compromise. They are raising rates now, as we know. They’re probably gonna now end up raising it even more dramatically than they had planned because of the numbers that are coming out, but they didn’t start raising them when I think they ought to have. And so between the Fed’s imprudent forecasts of what it was planning to do and an inflation-​targeting framework that’s vaguely specified that says, “Well, we can allow inflation to go up sometimes to make up for past low numbers, but then eventually, we’ll get it right,” where the eventually is never specified. Between these things, you had a kind of perfect setup for the Fed to fall behind the curve.

0:24:52.3 George Selgin: And I say that… It’s easy to be a Monday morning quarterback when if you… And it’s unfair to be one if you could look back at the statistics and say, “Well, how were they to know?” But you can look back at the statistics in this case and say, “Yes, they should have known,” because not only were the inflation numbers going up for a long time, that’s clear, but also you can look at spending data, we were talking about how… What really matters for the Fed is whether spending is growing to rapidly, and the statistics suggested that that was true as well, that is, they suggested it some time last year by late August. Sorry. By the Autumn, certainly by the Autumn. You could look at the numbers that had come out, and assuming they were all reliable, you could say, “Okay, by most reasonable estimates of what the pre-​COVID trend and spending was,” and let’s assume that would have been, staying there would have been fine, roughly consistent with the Fed’s inflation target, and I believe it was.

0:26:00.5 George Selgin: Then we’ve caught up, we’re there, it’s time now to not let spending grow too much more. And I argued this, I was arguing this last fall, others were arguing it last fall. So it wasn’t as if we are only realising now and saying, “Oh, the Fed should have, could or whatever.” No, we were saying it then. And the Fed didn’t, of course, start tightening or raising rates and of course, the higher inflation goes, this is an important point, tightening monetary policy, Trevor, is really about making real inflation-​adjusted interest rates go up, right. ‘Cause the interest rates people are paying that matter, that determine how tight credit is are the ones that are adjusted for expected inflation.

0:26:48.9 Trevor Burrus: Yeah. Just to clarify, so that means if you got an interest rate of 3% but inflation is 4%…

0:26:54.8 George Selgin: You’ve got a negative interest rate, so that’s a pretty good deal.

0:26:58.0 Trevor Burrus: Yeah.

0:26:58.1 George Selgin: Even though it’s 3%, whereas if you had an interest rate of 2% with zero inflation, it wouldn’t be such a good deal. Okay, exactly. So as inflation worsens, the amount of interest rate increases, the extent to which you have to increase the nominal interest rates, non-​adjusted interest rates, in order to discourage borrowing, in order to get spending down, goes up as well. So the more this thing gets away from the Fed, the more dramatic its tightening and nominal terms has to be, and we don’t wanna go there because we don’t wanna see double digit interest rates or anything like it. So it was important that the Fed act quickly. This is always true, you always… If inflation is getting out of line, the sooner Central Bank’s corrected, the less drastic action they have to take, so you don’t end up in a Paul Volcker type situation like that of the early 1980s, where the inflation rate, of course had gotten very high and he put the brakes on very, very drastically, he was like stomping on them, and the economy came to a screeching halt. That’s not something…

0:28:14.6 Trevor Burrus: I think my parents bought their house in 1979 and the interest rate was 17%.

0:28:20.5 George Selgin: That’s right. It started in the late ’70s and continued and the real collapse of the economy was in the early ’80s. So we certainly don’t wanna go there. In fact, I believe, and this goes against what a lot of people… A lot of people out there saying, “Oh, we don’t… If the Fed does something about inflation, it’s gonna hurt a lot of people, it’s gonna throw people out of work.” I don’t believe this is true if the Fed acts early and prudently, doesn’t let things fall far behind. Now, usually you would expect that some people’s jobs might be at stake, but if they remember here, first of all, we’re only talking about slowing down the rate of spending, not making it shrink and we’re not even talking about making it not grow anymore, just grow at a slower rate.

0:29:08.7 George Selgin: Second, we’re not talking about the Fed trying to get inflation all the way down to 2%. You only wanna eliminate the component of inflation that isn’t driven by the supply side factors we talked about earlier. So we’re talking about knocking it down a couple of percentage points. Finally, most importantly I think, are all those job vacancies, the unusual situation today where the problem isn’t workers who can’t get jobs, but employers who can’t get workers. And when you have a lot of vacancies, the first thing that clamping down on spending does is to reduce the employer’s capacity to hire, which means there’ll be fewer vacancies, but it has to go down more and more until there are no vacancies or fewer vacancies before employment actually starts to suffer, before you start seeing anybody get fired.

0:30:02.0 George Selgin: Now, that’s probably a bit of an exaggeration because we’re talking about, in general, there are some places where there aren’t labour shortages and there aren’t vacancies. And there are some firms that are teetering, tottering, where a little less demand could mean the difference between some of the workers staying employed and not. So yeah, some people might… Workers might be affected by any attempt to reduce inflation. But of course, if the argument is we should never do that, if anyone might lose a job anywhere, then that’s a recipe for letting inflation just completely get out of control and never trying to stop it and that ends badly, that ends with… That ends up, most importantly, perhaps given the argument, that kind of policy almost inevitably ends up leading to such a complete collapse, that unemployment goes way up in the end, if you avoid a little bit in the beginning and you end up with a lot of it at the end. So you don’t wanna go there.

0:31:04.6 Trevor Burrus: That situation in the ’70s is referred to as stagflation and I knew that the… See, if I remember here, I’m not an economist, something about the relationship between employment rates, unemployment rates and inflation was thought to be impossible, except for this period of time. And so what did the Feds screw up in the ’70s? Are they doing the same thing today that they screwed up in the ’70s?

0:31:28.2 George Selgin: Well, we’re not there yet and no, they’re not. What happened in the ’70s was really a consequence, in part, there’s a lot to what the inflation… We have to talk about OPEC and that’s the supply side part of the story again. But the Fed’s mistake dates back to the beginning of the ’60s. At that time, a particular idea took hold, which is the Phillips curve idea and it’s first the most infamous guys. It was an idea that was promoted by certain Keynesian economists, though it should be said that there’s nothing…

0:32:16.7 George Selgin: This thing, this idea doesn’t exist in Keynes himself, he might have disavowed it for all anyone knows, but they believed they had uncovered an empirical relationship showing that the higher the inflation rate gets, the lower the unemployment rate gets. And if you look at the data for the US in the ’60s, ’60, ’61, ’62, ’63, ’64, ’65 right up to ’69, holy moly, traces out a lovely Phillips curve, just like the theory says. Well, you can imagine that armed with the theory and noticing where these data points are lining, people believed it. More importantly, they should believe that there was a relationship, sure enough, but they also believed that it was something they could continue exploiting and it would stay fit and stay put, that things wouldn’t change. But then what happened was, it turned out that as the inflation rate rose, first the employment benefits started to get lower and lower, the unemployment rate didn’t continue to fall very much.

0:33:25.2 George Selgin: And then lo and behold, as inflation rates got really high in the ’70s, early ’70s, the data point started on landing, moving in the wrong direction and on the employment scale. So the inflation rate kept going up, but now employment was starting to go, unemployment started going up again. And by the later ’70s, you ended up with a double digit inflation and unemployment that was higher than when you started in the ’60s, so the Phillips curve, in other words, had fallen apart, or as a more sophisticated way of putting it, is the darn thing shifted. And it shifted because in the labour market, workers caught on to the fact that they were responding to higher wage rates, higher wage offers by offering more employment, but then those offers started to not look so good because their higher wage rates were fully compensated by and perhaps even exceeded by the rise in the cost of living. So they started saying, “Okay, you need to pay us even more.”

0:34:41.9 George Selgin: Well, if you pursue that logic, if you think about where it ultimately leaves, it leads you right back to where you would have been if you had no inflation increase at all with the unemployment rate kind of being stubbornly indifferent to the total amount of inflation, the only thing changing is that the inflation rate’s higher, the workers say, “Okay, I want my wages to go up that much faster as well,” and everything cancels. And so that’s where things were going, except it didn’t stop with that return to where you started, it got worse, and it got worse because at a certain point, Volcker writes, says, “Okay, we’re gonna… We’re really gonna stop inflation.” Now, they’ve been promising to do this a long time but he said, “We’re gonna stop it” and he meant it, but workers’ expectations didn’t change. They’re saying, this thing’s been going up forever, it’s gonna keep going up and we’re gonna get our costs of living increases by hook or by crook. And so now the labour market wage rate demands are racing ahead faster than the equilibrium price level because the Fed is putting on the brakes.

0:35:47.7 George Selgin: What happens then? People get tossed out of work ’cause the earnings just aren’t there to support the wage demands, and that was the stagflation. It’s a complete… It’s great, it’s an Elizabethan tragedy, right? You start out thinking, “Oh, we’re gonna exploit this tradeoff by… ” We know inflation’s costly, everybody admitted that, but look, getting a few more people employed, that’s worth a considerable increase in the rate of change of prices, so let’s do it. And they did it and they did it until they ended up with the worst of both worlds. And so, nobody wants to go there again, we’re not close.

0:36:27.4 Trevor Burrus: So we’re doing better now, we’re doing better than that. Or we’ve at least learned something.

0:36:28.9 George Selgin: Yeah, because we have that experience behind us. Nobody at the Fed, I don’t think anybody at the Fed is thinking, “Well, if we just increase the inflation rate more, the unemployment rate will keep going down.” Nobody’s talking that way. The Phillips Curve still exists in people’s heads anyway, and it still leads to some stupid policies but it is not quite… The misunderstanding is not quite as gross as, in retrospect, it appears to have been back in the ’60s, so I don’t think anybody is about to say, “Oh, there’s nothing wrong with letting the inflation rate keep on creeping up because we can expect the unemployment rate to keep on going down.

0:37:13.0 George Selgin: Now, there is some talk like that. You still have, again, modern monetary theorists trying to argue that even at its very low rate now, or where it was before COVID, the unemployment rate was still way above where it could be. They believed you could get way below 3.9 or 3.6, whatever percent. And so you had the argument that says… And the Fed bought into this a little bit, we keep on, we won’t tighten… Until we actually see the inflation rate get up very high, we won’t assume any particular value of unemployment where if we go below, inflation is gonna go up, which is how they used to think. But that strategy is also dangerous because by the time you see the whites of the inflation’s eyes, so to speak, you can fall behind the curve. But the bottom line is that we no longer believe that there’s any lasting unemployment inflation trade off. Fed officials don’t believe it. So they’re not inclined to try to excuse high inflation by claiming that it’s buying us a considerably lower unemployment rate, that doesn’t mean they take adequate steps to keep inflation where it ought to be, but they’re less likely to let it run away.

0:38:56.8 Trevor Burrus: Let me ask you about something, you’ve mentioned this a couple of times with the inflation being too low, and I know this goes directly to a lot of your work, why do we accept inflation as a fact of life? It seems odd to me that we just sort of accept that prices will be higher 40 years from now than they are today. You could buy a 10-​cent paperback book in 1955 or 1975, and it just seems this odd thing that we could say… What is too low inflation, why do we have any of it?

0:39:26.9 George Selgin: No, I agree with that, of course. I’ve been… In our discussion, I just didn’t… Taking for granted that, okay, 2% is what the officials want, so let’s just accept that and talk about why it’s higher or lower, but in fact, the current situation where 2% inflation is regarded as normal isn’t, terribly, normal. In a normal, what you and I both consider something more normal, would be a situation where as the cost of production, unit costs of production of stuff, unit costs of producing things fall, which they tend to do outside of wars and other crises, but then the long run result, that seems natural to us, is that prices would fall through…

0:40:27.3 Trevor Burrus: Prices fall.

0:40:27.5 George Selgin: To reflect falling unit cost. And back in 1997, as you know, but some of your listeners might not, I wrote a book called Less Than Zero, the case for a falling price level in a growing economy that argued this point, not for the first time, but for some time, nobody else had been arguing it, and what I said there is that, you know what, it is desirable that certain prices shouldn’t have to fall regularly or even at all. A notorious case being the price of the low skilled labor, hourly wage rates, to put in more concrete terms, because nobody likes to take a pay cut, that doesn’t mean workers wages have to rise though, wage rates.

0:41:22.4 George Selgin: And it doesn’t mean that they don’t get any richer because if the prices of goods are going down the way we want them to, of course, the real wages are going up even if the money wages don’t but… So I’m in that pamphlet and that’s where I argue that really if we want a sound monetary policy, we should have a policy that worries more about avoiding wage rate deflation and about price deflation, and that would be a overall deflationary policy, that is, it would allow the consumer price index to gently fall over time with occasional spikes when there’s a crisis or war or whatever…

0:42:03.2 Trevor Burrus: But no one does this. No country does this.

0:42:04.6 George Selgin: Nobody does it anymore. Nobody… The last deflation we had, I think it was sometime around in the early 1950s, we had a year where the price level fell. I think they might have made a very slight one in 2008, very very slight.

0:42:17.5 Trevor Burrus: But is that… Is this for political reasons in the fiscal policy, controlling monetary policies?

0:42:21.8 George Selgin: No not necessarily, I wouldn’t say so. I think what happened was after the high… After the 1980s, of course, we learned after the inflation of the ’70s, in the crisis of the early ’80s, we learned that we didn’t want to have very high inflation rates, but we didn’t quite get the inflation bug out of our system. Instead, there was a debate, there were people arguing that zero inflation or a constant price level was ideal, it tended to be monetarists, in the long run, constant price level, but the Keynesians were, to lump them all together with that label, they felt that getting all the way back down to zero was gonna have at very least very high transition costs, that we didn’t wanna have any more Volcker Type crisis just for the sake of getting inflation down from 5% to 0%.

0:43:18.6 George Selgin: I see the 2% ideal that came out of that era as just basically a compromise between the people who wanted to go down all the way to zero and the people who didn’t wanna go down at all ’cause they thought it would be too costly. And this 2% number started out as just a very pragmatic thing without any substantial theoretical basis at all, and of course, I was arguing for a less than zero long run inflation rate on the basis of the fact that if there was any theory for any rate, that one made more sense than either of the others and the others that… There was really never anything solid.

0:43:57.9 Trevor Burrus: Pulling a number out of the hat is what… Yeah.

0:43:58.9 George Selgin: The other one is we’re all completely… The argument for 2% for 5% for 0%, completely ad hoc, completely ad hoc. Anyway, of course, 2%, won out, and over time, instead of being perceived as just a kind of compromise, a pragmatic compromise, it started to acquire a kind of the…

0:44:26.4 Trevor Burrus: This is the natural state of affairs, this is how it must be.

0:44:28.4 George Selgin: Yeah, it started to be perceived as natural, perfect, sensible. And as you know, more recently now, you have more people arguing that we should go up from 2% to 3 or even 4% as a safer long-​run inflation rate, and this is partly driven by the fact that real interest rates have fallen secularly and we don’t wanna get ourselves back into a zero lower bound problem like we had after 2008, where we were in… Where whatever you think the inflation should be, you can’t get there.

0:45:02.2 Trevor Burrus: You couldn’t lower the… You couldn’t actually fix it.

0:45:04.4 George Selgin: Yeah, you can’t fix it. Anyway, so now, this all ties in to nominal GDP targeting, which I know you were getting to but…

0:45:14.5 Trevor Burrus: Yeah, because the next question, so what should the Fed be doing? And that’s how… Sorry I set you up, George.

0:45:19.1 George Selgin: Yeah. So what I was arguing in that pamphlet was a form of nominal GDP targeting actually, where this… Nominal GDP, I should explain. I think most people know GDP is a measure of the economy’s real output, usually annual. The nominal GDP is the dollar value of the output and real GDP is when you deflate to account for inflation, so you’re trying to get a handle on how much real output, the output of real goods and services is growing. Alright. The argument that I made was one for stabilizing nominal GDP, which is a spending measure, just keep spending, growing at a stable rate. And to hearken back to an earlier part of our conversation, the idea here is that nominal spending, that’s the thing the Fed needs to control, not the price level, because the price level is a function, or maybe I should say, the inflation rate is a function of two things, how much people spend and how scarce goods are, because more, fewer of them are being produced. The Fed shouldn’t be concerned about preventing the latter kind of inflation rate changes, the kind that come from supply-​side factors, it should only be concerned with not contributing to inflation or deflation by letting the flow of spending grow too rapidly or shrink.

0:46:41.9 George Selgin: So let it stabilize a measure of the flow of spending and just leave the price level out of it, right? The price level will do its thing, given that spending is stable, and whatever it does is presumably reflecting changes in underlying scarcity of goods and services, so fine. So let’s stabilize NGDP. Well, now, since I wrote that pamphlet, there’s a bunch of people who have taken up the same argument, not necessarily because I wrote about it, but independently, most famously Scott Sumner of course, but David Beckworth, who I can claim to have made… Familiar with the argument, and a bunch of others, and we’re all still out here trying to plead for that. One of the subtle ways in which nominal GDP targeting would help is it actually is an alternative to raising the long-​run interest rate target, nominal interest rate, if you’re worried about hitting the zero lower bound. And the reason for that is this, with a spending target, right? Well, let me step back, the most… When the natural real rate of interest falls, it’s usually because output isn’t growing as fast. The rate of growth of output, particularly the productivity growth rate, is a major determiner of where the natural interest rates go.

0:48:07.3 George Selgin: Well, under an NGDP targeting scheme, when you’re targeting spending, you’re naturally gonna let inflation rate rise when output growth shrinks. So at those times when there’s the biggest threat of real interest rates being low, with a fixed inflation target you are more likely to approach the zero lower bound, with a fixed NGDP growth target, that doesn’t happen, because you automatically are allowing a higher inflation rate and keeping the interest rate from falling that much, but, and this is where this targeting is better than just letting the inflation rate go to 3% or 4%, it doesn’t call for higher inflation when real output growth is robust. In that case, prices might even… Inflation rate might even go down, but there’s no danger of the zero lower bound because real output is growing rapidly, so real interest rates are high. Bottom line, you get the sort of… The people who are arguing, “Let’s have 4% inflation to avoid hitting bottom once in a while,” it’s like saying, “Let’s make the river… Let’s get the dredges in there and dig so that our boat won’t… The keel won’t hit the bottom as often.” What you’re doing with an NGDP target is you’re having the, as it were, the height of the river rise just when there’s an obstruction below to compensate, and you end up avoiding the problem of the keel hitting just as well, with a lower inflation rate on average and therefore it’s a superior policy.

0:49:56.1 Trevor Burrus: So what should people be watching to… Because there’s increasing fears and there’ll be some political consequences, probably, for this. What should people be watching and maybe even doing with this sort of uncertain inflation environment going forward? Should we be hoarding gold, should we be buying crypto like crazy, should we just, should we maybe be optimistic?

0:50:19.5 George Selgin: Yeah, I don’t… I’m gonna steer clear of giving investment advice, because I don’t think I’ll be any good at that, but I think what the most useful thing people can do, they’re already starting to do, which is complain about inflation, complain about it so that people understand that this isn’t something people perceive to be no big deal. There’re a lot of people out there who would like the monetary authorities to believe, and would like government officials to believe, that the American public isn’t that concerned about inflation and only is concerned about jobs, jobs, jobs, but I don’t think that is in fact the way many people think, including people… Workers of all kinds, but they have to make that clear. And they should be looking out for what the Fed does in the coming months. They should want it to raise and keep on raising interest rates, not dramatically, but with a clear determination that they shouldn’t be too low, but if I could get them to do so, and of course this only really applies to a few people, I would have people pay more attention to what’s happening to spending, as being really much more fundamentally important than what’s happening to prices. Prices may need to keep going up.

0:51:49.8 George Selgin: The war is certainly a factor, sanctions are a factor. We’re not gonna make scarcity any… We’re not gonna do away with the problems of increased scarcity that these events involve. We’re not gonna make it go away and we should face the reality that if prices go up only enough to reflect that fact, that that is not the fault of the Federal Reserve. However, we should absolutely want not to throw fuel on the fire by failing to raise interest rates enough to keep a lid on spending. Spending needs to grow, spending needs to grow, but it mustn’t grow too much, that doesn’t make anyone better off, it just means prices go up that much faster and we’d start getting wage and factor price inflation, and besides the fact that these things ultimately cancel out and they don’t make anybody better off, they can be the basis for asset market booms and bubbles that are unsustainable and ultimately, people end up worse off. We don’t need any more financial crises and we don’t need the Fed creating a situation where those crises are more likely, and that’s what too much spending often tends to do. You look at every big financial crash in the past and you look at spending growth, NGDP, and you’ll see it’s very high before the crash, and then of course, it collapses and both things are very bad. So we don’t wanna go there again.

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0:53:37.7 Speaker 3: Thanks for listening. If you enjoy Free Thoughts, make sure to rate and review us in Apple podcasts or in your favourite podcast app. Free Thoughts is produced by Landry Ayres. If you’d like to learn more about Libertarianism, visit us on the web at lib​er​tar​i​an​ism​.org.