Inflation is back together with a new season of finger-pointing. I see some pundits wanting to blame the 2021 inflation on workers. Workers are somehow forcing their improved bargaining positions on employers, raising the costs of production, with some or all of these costs passed on to consumers. Then, as workers see their real wages erode, the cycle begins anew begetting the dreaded "wage-price spiral."
There's no doubt something to the idea that wage demands can lead to higher prices. But what is the evidence that this behavior was the impulse behind the 2021 inflation? While it's tough to tell just by eye-balling the data, I think it's reasonable (under this hypothesis) to see wage growth precede (or at least be coincident with) inflation. Unfortunately (for this hypothesis), this is not what we see in the data. In the diagram below, use the Atlanta Fed's Wage Growth Tracker to construct nominal wage inflation for the bottom (green) and top (yellow) wage quintiles. This is plotted against CPI inflation (blue).
On the other side of the political spectrum, we see pundits and politicians blaming the 2021 inflation on "corporate greed." The idea here is that large firms were able to leverage their pricing power in 2021 into higher profit margins and record corporate profits. There is, in fact, some evidence in support of this. The diagram below plots profit margins for firms in the Compustat database. Profit margin below is computed on an after tax basis (net income divided by sales). The data is divided between large and not-large firms. Large firms are those in the top 10% of sales volume.
Well, if workers and firms are not to blame, then who or what is left? There's the C-19 shock itself, of course, along with the effects it has had on the global supply chain. But the 19 in C-19 refers to the year 2019 (and 2020). We're talking about 2021 here. Sure, the supply chain issues are still with us. But at most, I think they account for a substantial change in relative prices (goods becoming more expensive than services) and an increase in the cost-of-living (an increase in the price-level--not a persistent increase in the rate of growth of the price-level).
While the factors above no doubt contributed in some way to the 2021 inflation dynamic, let's face it--the size and persistence of the inflation was mainly policy-induced. The smoking gun here seems to the third-leg of the sequence of the C-19 fiscal transfers--the 2021 American Rescue Plan (ARP). The Fed also had a role to play here because it accommodated the fiscal stimulus (normally, one might have expected a degree of fiscal offset, e.g., an increase in the policy rate). Below I plot retail sales (actual vs trend) and the timing of the fiscal actions.
I used retail sales here (I think I got this from Jason Furman), but the picture looks qualitatively similar using PCE (the path of nominal PCE went above trend in 2021 and not earlier in the way retail sales did). Just eye-balling the data above, I'd say the CARES Act was a major success. The subsequent two programs and especially the ARP might have been scaled back a bit and targeted in a more efficient manner. And, knowing what we know now, the Fed perhaps might have started its tightening cycle in 2021.
Having said this, I wouldn't go so far as to say these were flagrant policy mistakes (if you feel it necessary, you can vent in the comments section below). First, there's not much time to think through and fine-tune fiscal policies in the middle of a global pandemic. Monday morning quarterbacks are entertaining, but not particularly useful. Second, policies must necessarily balance risks. There was a risk of undershooting the support directed to households. We saw this during the foreclosure crisis a decade ago. And there was a risk of overdoing it in some manner. Keep in mind that it was not clear when the legislation was passed how 2021 would unfold. Similarly, for the Fed, perhaps still feeling the sting of having moved too soon and too fast in the past, hopeful that inflation would decline later in the year, delayed its tightening cycle to 2022. It wasn't perfect. But taken together, the economic policy responses could have been a lot worse.
Finally, what does all this mean for inflation going forward? Well, as I said above, I see little evidence of a wage-price spiral. Profit margins appear to be declining (reverting to their long-run averages). The money transfers associated with the ARP are gone for 2022. No big spending bills seem likely to pass in 2022. For better or worse, we're talking a considerable amount of "fiscal drag" here. Hopefully (fingers crossed), supply-chain problems will continue to solved. Barring some unforeseen event (e.g., a sudden decline in the global demand for USD/UST or a war in the Ukraine), my best guess is that inflation will decelerate in 2022 even without Fed tightening. Of course, it's likely to decelerate even faster with Fed tightening. But as Fed officials have repeatedly stressed, the FOMC will adjust its policy rate with the incoming data.
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PS. I see some people saying it is a "fact" that ARP did not cause the 2021 inflation (see here, for example). The reason, evidently, is because inflation is a global phenomenon. There's something to this, of course. After all, C-19 is a global pandemic. But this reasoning nevertheless seems faulty to me. First, the USD is the global reserve currency. It's quite possible that the U.S. exported some of its inflation to the world (much in the way it did in the 1970s). Second, many other countries (like Canada, for example) adopted similar fiscal policies. Those countries with less expansive fiscal policies also displayed lower inflation, as far as I know. Rather than deflect the blame, we should own it here. The ARP had a lot of positive effects too (e.g., lowering child poverty). The challenge, as always, is to develop ways to calibrate these policies in a more effective manner. People hate inflation and for good reason. Policies need to respect this reality.
from MacroMania https://ift.tt/3FDDgxG
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