The economics establishment in the United States has been putting on a show worthy of World Wrestling Entertainment this month.
Lawrence Summers, the former Democratic treasury secretary, and Olivier Blanchard, a similarly famous economist who once led the International Monetary Fund’s research department, created waves by going public with their worries that President Joe Biden’s US$1.9-trillion stimulus plan could cause inflation to blow past the Federal Reserve’s target of two per cent.
That’s not what Janet Yellen, the current treasury secretary, needed to hear. Summers and Blanchard sounded like the Republican minority in the Senate that could curb the Biden administration’s ambitions. They were supposed to be on her side.
“As treasury secretary, I have to worry about all of the risks to the economy,” Yellen, who, as a former Fed chair, is an intellectual heavyweight in her own right, said on CNN. “And the most important risk is that we leave workers and communities scarred by the pandemic and the economic toll that it’s taken, that we don’t do enough to address the pandemic and the public health issues, that we don’t get our kids back to school.”
Canada’s economic community is also split on whether inflation is a serious threat. However, it lacks stars such as Summers, so its members are mostly talking amongst themselves. That probably should change.
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William White, a retired Canadian central banker who now ranks as a respected critic of his former profession, this week warned against assuming that the low inflation of the past couple of decades was the new steady state. Bond yields have been drifting higher, a sign that traders anticipate inflation. Climate change could be an inflationary force, and globalization, which has exerted downward pressure on prices for decades, has been slowed by resurgent nationalism in important economies, he said.
In other words, inflation may look contained, but the lid isn’t as secure as it used to be. “You can’t extrapolate past performance to future performance,” White, now a senior fellow at the C.D. Howe Institute, said during a virtual event hosted by the Global Risk Institute on Feb. 18.
Bank of Canada governor Tiff Macklem is in Yellen’s camp. He has made it clear that he is far more concerned about disinflation than he is about losing his grip on prices, a stance that was supported by Statistics Canada’s latest update of the Consumer Price Index this week.
The agency on Feb. 17 said the CPI increased one per cent in January from a year earlier, well short of the Bank of Canada’s target of about two per cent. There isn’t even a hint in the data that inflationary pressures are building. The central bank’s three “core” price measures, which cancel out noisier items in the CPI basket, averaged 1.5 per cent, a level that is “unlikely to concern the central bank,” Charles St-Arnaud, chief economist at Alberta Central, said.
Statistics Canada on Feb. 19 reported that retail sales dropped 3.4 per cent in December from the previous month, and 1.4 per cent in 2020 compared with 2019, additional evidence that the pandemic’s second wave has interrupted the recovery from the COVID-19 crisis.
You can’t extrapolate past performance to future performance
The U.S. debate over inflation is interesting because it is a family feud, rather than yet another squabble between dovish liberals and hawkish conservatives. Blanchard and Summers have effectively accepted to play the heels in this drama, former heroes who suddenly and unexpectedly turned on their fans.
Summers is best known these days for having reintroduced the idea of “secular stagnation,” a condition in which savings pile up for lack of decent investment opportunities, resulting in meagre economic growth. His solution to the problem is a big increase in public investment, which is one of the reasons his critique of Biden’s plan was so surprising.
Blanchard disrupted conventional thinking about government deficits in 2019 by showing that growth will erode the debt over time, as long as borrowing costs are lower than the rate at which the economy expands, negating the assumption that new spending must be matched by tax increases and/or spending cuts. It was the weapon liberal policy-makers needed in their fight against knee-jerk austerity. Chrystia Freeland, Canada’s finance minister, cited Blanchard when she made the intellectual case for Prime Minister Justin Trudeau’s deficits last year.
And yet, Summers and Blanchard are now calling on Biden to show restraint, lest he wreck all that was accomplished by finally harnessing runaway inflation in the 1980s and 1990s. Their critique is multi-faceted, but, essentially, they argue that sending US$1,400 cheques to most Americans is unnecessarily generous, given that Congress just approved a US$900-billion stimulus program in December.
Their math suggests the hole left by the COVID-19 crisis simply isn’t that big, so the excess cash risks supercharging the recovery and putting the Fed in the position of having to explain why it’s letting inflation run hotter than its target, or jacking up interest rates to cool the economy, risking another recession. “I’d rather not go there,” Blanchard said in a blog post on Feb. 18.
Biden’s fiscal policy will have repercussions around the world, which is probably why Gita Gopinath, the IMF’s current chief economist, joined the inflation debate on Feb. 19.
Gopinath came down on the side of Yellen, arguing that the global economy remains too weak to stoke inflation pressures. She also said that increased automation would allow companies to keep prices low, as would the growing dominance of larger companies, since their fat profit margins will help absorb any increase in input costs.
All told, the IMF reckons Biden’s plan might cause inflation to rise to 2.25 per cent in 2022, “which is nothing to be concerned about,” Gopinath said.
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