Today, we present a guest post written by Jeffrey Frankel, Harpel Professor at Harvard’s Kennedy School of Government, and formerly a member of the White House Council of Economic Advisers. A shorter version appeared at Project Syndicate.
November 18, 2023 — On November 14, remarkably, the US Bureau of Labor Statistics announced that the CPI had been unchanged in October (whether seasonally adjusted or not). That is, the level of the CPI was unchanged, not the inflation rate, which was zero. Of course, single-month numbers are too volatile to draw much of a conclusion. Not every month will see the price of gasoline plunge by 5.0 %, as it did from September to October.
More informatively, the headline CPI inflation rate over the last 12 months was 3.2 %, far down from 6.5 % in 2022. At the risk of tempting fate, one might say that the inflation battle is being won.
- A rare immaculate disinflation
Contrary to what many economists had predicted, and also contrary to what many Americans still believe, the US inflation rate has, so far, come down without a major decline in economic activity or employment. The economy has added 204,000 jobs per month over the last three months, well in excess of the long-term growth in the labor force. As a result, unemployment remains under 4.0 %, almost the lowest level since the late 1960s. GDP growth has been 2.3 % annualized so far this year, faster than the average for the US growth rate since the turn of the century. This episode has been called “the immaculate disinflation,” since it occurred without loss of income or employment.
The story in other industrialized countries is similar, in that inflation rose in 2021-22 and fell in 2023. But the statistics elsewhere are not as good as in the US. Other industrialized economies — the euro area, the United Kingdom, Canada and Japan — are growing more slowly. Yet inflation is higher in Europe than across the Atlantic. (It remains very low in Japan.)
If one goes by the traditional rules of politics, the Fed and the US Administration should get political credit for the progress that was achieved during this period, regardless of whether they caused it or not. But that criterion — traditional political practice — provides too low a bar. One can reasonably ask whether the policymakers are responsible in a causal sense for the apparent soft landing.
Certainly, two years ago they underestimated the inflation danger. If the subsequent tighter monetary policy is responsible for the disinflation, it does not seem to have operated through the usual causal route of declines in output and employment.
- Some alternative channels for monetary policy
Some possible mechanisms of transmission from interest rates to inflation do not operate via output or employment. Three such channels are housing, the exchange rate, and commodity prices.
- Mortgage interest rates help determine the demand for housing. They have risen sharply over the last two years, the period when the Fed ended quantitative easing and tightened monetary policy. Some measures of housing prices indeed slowed sharply after mid-2022.
- Since March 2022, the month when the Fed began to raise interest rates, the dollar has appreciated more than 8 % against other major currencies. (This is by the narrow effective exchange rate measure). Admittedly, the dampening effect of appreciation on tradable goods prices is much weaker in the case of the United States than it would be in other countries.
- An insufficiently noticed channel is that high real interest rates put downward pressure on the prices of commodities like oil, minerals, and farm products. The global price index for all commodities fell more than 30 %, from March 2022 to October 2023 (as one might have predicted).
But neither the exchange rate, nor housing, nor even commodities, are the main story.
- The best explanation
One possible explanation for why the fall in inflation has been accompanied by very little loss in economic activity is that the Phillips curve becomes much steeper when near full employment. That is, when unemployment is below 4 %, as it has been, and especially when job vacancies run above 7%, as they have, decreases in aggregate demand go almost entirely into lower inflation, rather than into lower economic activity.
Perhaps a better explanation is that supply impediments that had been vexing in 2020-22, melted away in 2023. Snarled supply chains – clogged ports, goods order backlogs, input bottlenecks, worker shortages, and the rest of the Covid19-related disruptions that so dominated life in 2020-22 — straightened themselves out in 2023. The Global Supply Chain Pressure Index produced by the Federal Reserve Bank of New York shows supply disruptions peaking in December 2021 and declining steadily after April 2022. Apparently, the invisible hand, which had gone AWOL, returned to its normal task of facilitating the smooth operation of the economy.
A favorable shift in the aggregate supply relationship should allow lower inflation for a given rate of economic growth. Growth in 2022 and 2023 has gently declined relative to the overheated rate of expansion in 2021. (It really looks like a soft landing.) The withdrawal of US monetary stimulus can explain why the favorable shift in the relationship showed up in the form of a 2023 decline in inflation, rather than in the form of accelerated GDP growth. In other words, if the Fed hadn’t raised interest rates after March 2022, chances are that the overheating of the economy would have continued, notwithstanding the favorable supply shift; inflation would still be high. The bottom line is that the Fed should get credit for lowered inflation after all.
This post written by Jeffrey Frankel.
DeLong has repeated the notion that “high prices are the cure for high prices”, and also that in the face of sticky prices, inflation serves as an adjustment mechanism. These observations are valuable ones as we review economic performance in the Covid era.
Dollar FX strength is to the Fed’s credit, but also to the credit of the economy. Relative economic strength tends to be accompanied by relative FX strength.
Softer commodity prices are partly to the Fed credit, but also to the credit of Ukrainain farmers and to weakening growth outside the U.S. And to record petroleum production in the U.S, no doubt the result of Biden’s “war on fossil fuels”.
Similarly, the global price impulse, which is a substantial factor in modern inflation, has cooled due to slower global growth.
The very fact that we are discussing “immaculate disinflation” means that credit due the Fed is limited. This Fed is strongly oriented to the Phillips Curve, and labor market cooling hasn’t led disinflation. Possibly the other way around:
https://fred.stlouisfed.org/graph/?g=1byAs
Nor is it entirely clear that higher interest rates are having much effect on consumer demand, outside the housing sector.
https://fred.stlouisfed.org/graph/?g=1byBc
When I read:
“high real interest rates put downward pressure on the prices of commodities like oil, minerals, and farm products. The global price index for all commodities fell more than 30 %, from March 2022 to October 2023 (as one might have predicted).
“But … commodities, are [not]the main story”
my head nearly exploded. Is he serious?!?!?
But then I read
“ a better explanation is that supply impediments that had been vexing in 2020-22, melted away in 2023. Snarled supply chains – clogged ports, goods order backlogs, input bottlenecks, worker shortages, and the rest of the Covid19-related disruptions that so dominated life in 2020-22 — straightened themselves out in 2023”
and then I composed myself.
Commodity prices are of course a function of supply and demand. Usually big declines are driven by a decline in demand. But in 2022-23, they have been driven by an increase in supply.
So here is the question to be addressed now: if the supply chains are fully un-kinked, do the effects of Fed rate hikes move back to the fore, or are they simply part of the background conditions? The former would likely mean a recession is nevertheless coming and has just been delayed, while the latter bespeaks the fabled “soft landing.” And how will we know?
My best answer is that it will come from the manufacturing, construction, and durable goods sectors that are typically one step further downstream in the effects of Fed rate hikes. All of them have generally stopped growing, but none has significantly declined.
It’s amazing to see so many highly credentialed experts so flummoxed. Could this be a Humpty-Dumpty moment for macroeconomics?
You really do have trouble seeing past the end of you own nose.
Economists debate unsettled issues in order to push knowledge forward. Non-economists, unaware of the body of knowledge on which debate is based, mistake debate for evidence that economists agree on very little. Johnny, clearly unaware of the body of knowledge on which debate is based, also has a big chip on his shoulder, so we can’t expect him to learn from his mistakes.
Economics is a social science, not a physical science, so the conditions in any case being examined will differ from other cases. There is always debate about the nature of the present case. Johnny cheers for economics being so badly damaged that it can’t be put back together again, but that’s because of Johnny’s ill will toward economics. Sort of like how his ill will makes him unreliable in discussions of Ukraine.
Ducky said, “Economists debate unsettled issues in order to push knowledge forward…” but all too often they presume to know things that they don’t…like what was driving inflation…or what would happen to the Russian economy after February, 2022…or assure us that real wages rise in a tight labor market…or scream that dramatically higher interest rates would lead to a recession…
It’s one thing to try to understand problems and debate causes and solutions…it’s entirely another to have the chutzpah to recommend policy on the basis of shaky theories, models and forecasts…and to denigrate anyone who professes skepticism based on prior track records.
Even the great Krugman noted that “I do think it’s time for quite a few economists to engage in some soul searching. (Yes, even economists have souls. Some of them, anyway.) I’m not necessarily asking for mea culpas similar to those issued by some of us who got the first phase of this inflation cycle wrong, although it would be nice. Instead, I’d like to see some hard thinking about how so many of my colleagues got this story so wrong and maybe even a bit of introspection about their motivations.”
Besides soul searching, I would welcome a little humility when promoting policy prescriptions.
Lying about what Krugman wrote again? Damn!
“it’s entirely another to have the chutzpah to recommend policy on the basis of shaky theories, models and forecasts…and to denigrate anyone who professes skepticism based on prior track records.”
Total BS. You have no clue what economic theories are being used or how forecasting track records are because you are the most economic illiterate troll ever. And yet little Jonny boy constantly denigrates economists who are at least trying to provide insight. Come on Jonny boy – everyone know you are pathetic little liar. So maybe you should just SHUT UP as your obnoxious comments are wasting everyone’s time.
Johnny, it is clear that you are a proponent of very socialist or communist societies. but let’s be very clear. the societies that you advocate for have NEVER had long term success, especially in comparison to capitalist societies. Cuba, Venezuela, USSR, Mao’s china, North Korea, the list goes on and on. all of them have been failures compared to capitalist societies, in the long run. Johnny, why do you keep criticizing modern capitalism while ignoring the failures of the system you so much want to promote?
Instant laugher!
YOU would welcome humility?
And YOU are?
Always a good sign of a non-scientist when they believe that not automatically knowing the answer to something automatically means the entire field is bogus.
JohnH in 1910: This photoelectric effect sure has a lot of highly credentialed experts flummoxed. Could this be a Humpty-Dumpty moment for physics?
JohnH in 1760: This combustion sure has a lot of highly credentialed experts flummoxed. Could this be a Humpty-Dumpty moment for chemistry?
JohnH in 1990: This Fermat’s theorem sure has a lot of highly credentialed experts flummoxed. Could this be a Humpty-Dumpty moment for math?
Bingo. Well said!
Oh come on – admit it. You are Humpty-Dumpty. And when you fell off that wall, you cracked your skull. That would explain the incessant tirade of really dumb comments you write.
Thanks, Menzie! Another possibility is that most of the disinflation has been caused by a reversal of global supply shocks (supply chain and oil) as indeed monetary policy has been relatively accommodative.
https://open.substack.com/pub/gianlucabenigno/p/has-the-fed-monetary-policy-been?r=nm3g&utm_campaign=post&utm_medium=web
The monetary policy stance is restrictive when the real interest rate exceeds the neutral real interest rate (i.e., when R-R*>0).
Interesting chart. Now if one could show a similar graph for Russia’s neutral real interest rate etc. I say this in light of the usual stupidity from Princeton Steve but that’s another discussion.
With luck we may end up giving the Fed credit for not having screwed things up, worse.
Yep, but in this view, the Fed has removed any inflationary impulse resulting from monetary policy. To that extent, the Fed might deserve credit. If we take this view together with DeLong’s point about inflation facilitating economic adjustment, then policy timing appears quite clever.
However, comments from Fed policy makers reflect none of this cleverness. They didn’t anticipate inflation very well, didn’t seem to consider that the neutral rate had increased greatly, didn’t discuss accommodating economic adjustment. Rather, their long-standing effort to stoke inflation led them to delay in responding when inflation arose, they played policy catch-up in a way that they clearly thought risked recession, and may have gotten lucky in avoiding recession because the economy is more resilient than they expected. Public statements from Fed officials suggest no real foresight, but considerable luck.
Thanks Dr. Frankel for this much more nuanced explanation for what is going on. (Perhaps we can give a little credit to the Biden administration’s Inflation Reduction Act https://en.wikipedia.org/wiki/Inflation_Reduction_Act and improvements to supply chain infrastructure https://www.whitehouse.gov/briefing-room/statements-releases/2022/11/15/fact-sheet-one-year-into-implementation-of-bipartisan-infrastructure-law-biden-%E2%81%A0harris-administration-celebrates-major-progress-in-building-a-better-america/ ? )
Also I wonder if anyone is considering that the U.S. population growth is slowing https://calculatedrisk.substack.com/p/lawler-new-census-long-term-population For my day job one of the things I track is Wisconsin population – in 2010 WI was projected to pass 6 million by 2020 but we have yet to do so (currently at 5.9 million in 2023 – excess deaths from Covid threw us for a loop) Also WI population is older and aging (Can the WI GOP please take the Medicaid expansion money – it would really help alleviate the care giver crisis in WI.) . What implications does this have for our economic activity going forward?
I would not take a victory lap just yet. Prices continue to reset from abnormally high levels associated with the pandemic and related fiscal and monetary policy. We are no even close to being back to zero.
But the reset looks like it’s picking up speed. Stellantis (Chrysler) just offered buyouts to 6,400 of its 12,700 nonbargaining unit U.S. employees with five or more years of employment, according to CNBC. So a company which just agreed a quite hefty pay increase for union employees finds itself needing to lay people off. Not a good look.
stellantis-buyouts-us-salaried-workers.html
Meanwhile, I think EV’s may be on the brink of becoming a political problem. Prices of pick-ups, for example, have soared and remain high by historical standards. Part of those proceeds are going to offset obscene spending and losses on EVs. Are the cross-subsidies from ICE vehicles to EV’s going to make cars unaffordable for middle income US consumers? If so, it could morph into a serious political issue heading forward.
https://www.forbes.com/sites/jimgorzelany/2023/09/29/heres-how-much-pickup-truck-prices-skyrocketed-during-the-pandemic-era/?sh=1ae2693412fa
“I would not take a victory lap just yet. Prices continue to reset from abnormally high levels associated with the pandemic and related fiscal and monetary policy. We are no even close to being back to zero.”
Stevie – this is Bruce Hall level of stupidity. Get an effing clue about the difference between price levels v. the rate of change of price levels (inflation). Now if you are a gold bug, that might explain part of your utterly insane comments re monetary policy.
“Stellantis (Chrysler) just offered buyouts to 6,400 of its 12,700 nonbargaining unit U.S. employees with five or more years of employment, according to CNBC. So a company which just agreed a quite hefty pay increase for union employees finds itself needing to lay people off.”
Now I get you are reading impaired but Kevin Drum has tracked the path of auto real wages over time which basically sucked until these new deals. Look – the economics of this sector requires a little knowledge – none of which you have.
“Meanwhile, I think EV’s may be on the brink of becoming a political problem. Prices of pick-ups, for example, have soared and remain high by historical standards.”
Did you actually READ this Forbes article? The price of pick ups trucks are high even for gasoline versions. Lord – I need to stop reading your comments as they dumb down conversations to the gutter.
Off topic – VoxEU has recently carried a piece on China’s role in international farm trade:
“The other China shock: How surging Chinese imports transformed global agriculture”
https://cepr.org/voxeu/columns/other-china-shock-how-surging-chinese-imports-transformed-global-agriculture
A central finding is that China’s demand for imported food did not lead to increased agricultural efficiency (increased output per acre/hectare), so much as conversion of pasture to cropland. And not just pasture:
“We find that Chinese demand for agricultural products was the likely cause for between one third and two thirds of global deforestation since 1995.”
China’s population has stabilized, but global population is still rising, so food demand will rise. The authors conclude that:
“Pasture still constitutes more than half of global agricultural land, so further conversion of pasture into cropland could meet much of the shortfall. Such intensification reduces biodiversity, however, and our results suggest that global forests will continue to be under pressure as well.”
Cropland is a fairly poor carbon sink. Pasture is better. Forests better still.
Pasture is also pasture for a reason, and in some cases, the reason is limited or unreliable water. This is among the earliest ideas in economics, fundamental to the notion of rents and marginal analysis.
“This column shows that Chinese demand for food imports resulted in a significant increase in global cropland and higher profits for farmers exposed to this demand shock. It further highlights that this Chinese food shock served as the main impetus for global deforestation over the period.”
Something tells me that the higher farm profits and the global deforestation will both make CoRev all giddy.
Nonetheless an interesting discussion so thanks. That China is importing a lot of food should not surprise people as its enormous population is seeing a rise in real income. Now I doubt all the cheerleading from ltr about how China is improving the efficiency of its domestic ag sector but maybe we should pray that it does.
Figure 1 clearly illustrates the relentless rise of Chinese manufacturing in terms of both exports of final goods and imports of inputs. Also visible in the figure is another, less publicised shock to the global economy: after joining the WTO in 2001, China quickly went from being a net exporter of agricultural products to being the world’s largest importer. China currently imports more than 10% of all internationally traded agricultural goods, and more than 5% of global agricultural production.
I love it when authors make their points as clearly as this figure does.
“The trade-off between food security and environmental degradation in a world with a rising demand for calories and animal protein can only be eased by increasing crop yields. High-yielding crop varieties associated with the Green Revolution and genetically modified crops have, for instance, substantially increased agricultural production without any expansion of cropland, on balance leading to better outcomes for both the environment and the poor (Gollin et al. 2021, Hansen and Wingender 2023b). Further investments in such innovations should have a high priority for both humanitarians and environmentalists.”
I need to read up on this. It turns out that the United Nations has a team of transfer pricing types writing on these issues and one of their smart advisors is seeking my input on their work. Crop science in its own unique reminds me of R&D for the pharmaceutical sector.
Off topic but about time!
Groups increasingly use defamation law to ward off US election subversion
Rudy Giuliani and MyPillow’s Mike Lindell are among election deniers sued for defamatory statements regarding 2020 election
https://www.theguardian.com/us-news/2023/nov/18/election-2020-defamation-lawsuit-giuliani-lindell
Trump’s former lawyer Rudy Giuliani, the My Pillow CEO, Mike Lindell, and conspiracy theorist Dinesh D’Souza are among the individuals named in a spate of high-profile defamation cases targeting those who tried to overturn the 2020 election. Prominent rightwing media outlets such as Fox News and Gateway Pundit are also on the hook.
Already the legal pain is mounting. Giuliani has been found liable for defaming two election workers in Georgia whom he falsely accused of criminally miscounting votes in 2020 in favour of Joe Biden.
The case will go to trial in December with Giuliani facing possibly swingeing punitive damages.
Lindell has notched up millions in legal fees in the $2bn defamation suits that have been brought against him by the voting machine firms Dominion and Smartmatic for falsely saying they rigged the count. His ongoing libel woes follow the April settlement in which Fox agreed to pay Dominion a shattering $788m for broadcasting similar lies.
“This is lawfare,” Lindell protested in an interview with the Guardian. “Lawfare hasn’t been used in our country since the late 1700s, and that’s what they are doing.”
Poor Mike Lindell – not sleeping well these days, maybe he needs a new pillow. People trying to use the law too go after those who they don’t like – its as if Trump was back in office. But just like with Trump, the only reason they can go after you, is that you broke the law – without evidence the case gets thrown out (just like those 64 cases claiming election fraud).
The huge fauz news settlement does a couple of things. One is that it sets a precedent, plowing ground for legal action to come. The other is that it signals to potential plaintiffs that the payoff can be worth the effort. That’s a poisonous combination for lying liar defendants.
Does the current US administration under the leadership of President Biden deserve credit for continuing the Marxist-Keynesian fiscal policy of former President Trump?
They passed the inflation reduction act and inflation was reduced. Nothing like a competent President with an administration that can work out and implement effective policies.
The federal government’s fiscal stance has been highly variable during the Covid era, with automatic stabilizers (not particularly sensitive to the policies of presidential administrations) accounting for a substantial share of that variability.
Here is the federal budget balance as a share of GDP:
https://fred.stlouisfed.org/graph/?g=1bChp
As you can see, the deficit was a smaller share of GDP in Q3 of this year than in the final pre-recession quarters of Q4, 2019 and Q1, 2020, but not quite as small as in Q3, 2019.
Now, your turn. Show, in reasonable detail, how either Trump or Biden, by pursuing fiscal expansion, was engaging in Marxism. You made the statement in such absolute terms that, surely, you have a solid basis for it.
my guess is erik cannot even give you an accurate, valid definition of marxism. because if he could, he would not have made such a statement to begin with.
Here’s what clear thinking looks like:
https://theconversation.com/the-worlds-280-million-electric-bikes-and-mopeds-are-cutting-demand-for-oil-far-more-than-electric-cars-213870
Little vehicles, adequate for their purpose, are cutting down on greenhouse gas emissions far more than electric cars and trucks. My impression is, this is relative to some baseline, rather than in absolute terms. So not great news, but showing how progress can be made.
Anyhow, substituting electric scooters for petroleum-powered vehicles has reduced fuel demand by 1%. Four-wheeled EVs are nowhere close.
One thing missing from the analysis, as far as I can tell, is the environmental cost of producing the vehicle itself. Batteries are mentioned, but not the entire vehicle. An electric SUV is an environmental disaster, but on a smaller scale than a petroleum-powered SUV. An electric Moped is a vast improvement on an electric SUV or any other motorized 4-wheeled vehicle.
With 280 million E-bikes vs 20 million EV it should not take much to have those bikes beat the EVs. The bike just have to save 10% of what an EV saves. My guess is they compared E-bikes to ICE-scoters and EVs to ICE cars but its not clear from the article. Getting someone to substitute an ICE car for a E-bike would be even better.
Brad Setzer is really good at what he does. Here’s his take on China disinvestment (sic) from US$ assets:
https://www.cfr.org/blog/china-isnt-shifting-away-dollar-or-dollar-bonds
In his usual follow-the-money way, Seltzer shows that China’s holdings have shifted from Treasuries in official accounts to Agency bonds in unofficial accounts. U.S. bonds remain steady at about 50% of China’s holdings since 2015.
It makes sense that China would have slowed reserve accumulation from the period of the mid-oughts because it’s current account surplus is smaller now:
https://data.worldbank.org/indicator/BN.CAB.XOKA.GD.ZS?locations=CN
And official reserves have fallen:
https://fred.stlouisfed.org/series/TRESEGCNM052N
Slower reserve accumulation, with a roughly constant share for U.S. bonds, would mean China has slowed its purchases, but doesn’t mean it now disfavors U.S. assets.
Defense of the yuan could mean outright selling of reserve assets, so a contribution to Treasury price decline, but that’s likewise not the same as disfavoring U.S. assets.
Rich people. Stinkin’ rich people. What van ya do?
https://policy-practice.oxfam.org/resources/climate-equality-a-planet-for-the-99-621551/
“Rich” here means millionaires, billionaires and anyone earning over $140,000/year. Apparently, that’s what it takes to get to 1% globally.
And the focus on the rich vs the rest, while clearly important, ignores the push from the rest to become more like the rich. Bumping off (or taxing) the top 77 million won’t actually do enough to remedy climate change.
@Macroduck: Marxist-Keynesianism refers to the fiscal policy of constant deficit financing regardless of the stage of the business cycle.
The Neo-Marxist have some great ‘theory’ as to why deficit-financing should be a permanent feature. Enjoy the humour.
erik, your comments still do not make any sense.
Comrade baffling,
Are you familiar with the conservative Keynesian approach to macroeconomic policy, and if so, can you explain why consecutive US administrations ignore that policy?
I am still trying to decipher your claim that recent economic policy is marxist. your comments simply do not make any sense.