Three Things I Think I Think – Learning From Bad Inflation Takes

by
Cullen Roche
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The great thing about Twitter is that the instant you put a bad take into the universe you will get roasted for it. The bad part about Twitter is that the instant you put a bad take into the universe you will roasted for it. I kid, kind of. There’s actually a lot to learn in saying the wrong things and I’ve surely benefitted from putting my wrong opinions out into the universe only to have someone correct me. So I guess you could say that there’s no such thing as a stupid take, only stupid responses. Or something like that. Anyhow, here are some bad takes on inflation that I think are learning experiences. And don’t worry, bad inflation takes don’t have a political bias so you should be able to find something to confirm your preferred political bias in here:

1. AOC on inflation. AOC was on CNN explaining why inflation isn’t really a worry and why we actually need even more fiscal policy to solve the inflation problem. Specifically, she said:

“If this was an overall inflationary issue, we would see prices going up in relatively equal amounts across the board no matter what the good is.”

This interview was pretty popular on the Internet. But this comment is just not true. In fact, inflation rarely occurs evenly across goods and services. For instance, in the 1970s the price of oil and food was rising disproportionately relative to other goods and services. But that inflation was still very damaging. Now, today is nothing like the 70s for reasons I’ve mentioned before, but we shouldn’t downplay the fact that overall prices have been rising for reasons that are more complex than just supply chains. And that’s where AOC’s comments are misleading and somewhat disconcerting. She’s trying to peg the inflation issue as a purely supply side issue. As if the massive fiscal stimulus programs didn’t contribute to higher than otherwise aggregate demand.

Now, she’s not wrong that there are supply side issues. After all, corporations were preparing for a collapse in aggregate demand due to COVID. What they didn’t predict was that the federal government would spend $6.5 trillion and actually create aggregate demand that was even higher than the pre-COVID environment. So, yes, there were supply chain issues. I predicted all that as soon as COVID hit. I also predicted that core inflation would hit 3-4% specifically because aggregate demand from fiscal policy was going to be humongous. We don’t need to hide from that reality and I don’t think it helps to frame this situation as if fiscal policy didn’t contribute to the current inflation.

Look, I was in favor of the stimulus for the most part because the alternative was a potentially horrific recession that would have caused a lot more pain than 3-4% core inflation has. But we shouldn’t sit around here and try to claim that fiscal policy didn’t or couldn’t contribute to higher inflation. And to be honest, I think this is part of what worries people about MMT and their supporters like AOC. When confronted with inflation they not only deny that fiscal policy contributed to it, but they actually say that we need even more fiscal policy to solve the inflation. Maybe they’re right. I don’t know. I always say that no one knows what actually causes inflation, but it’s very clear that fiscal policy massively boosted personal income and aggregate demand so it’s simply illogical to think that more fiscal stimulus at this time wouldn’t potentially further boost inflation and aggregate demand….Again, maybe that’s fine, but these comments are worrisomely blasé regardless of the outcome.

2. Crypto people with all the same old money myths. We covered the Democrats so now I guess I need to cover a popular Libertarian-style view. Here’s a popular narrative promoted by most of the top thinkers in crypto:

The creation of money IS inflation. When the Fed creates 40% new dollars in a year, the inflation rate is 40%.

This is the Austrian econ definition of inflation. Basically, any increase in the money supply is inflation. I don’t see how this definition is helpful. In an endogenous money system anyone can create money as credit. I can go to the bank right now and borrow $100,000 to build a new house if I want to. Whether that $100,000 of new money ends up being inflationary depends on lots of factors. Do I actually build the resources to support that new money? Do I pay it back? Do I default on it? Do I even spend it? This is a really complex matter.

More importantly, the idea that the Fed creates inflation when they implement a policy like QE has been pretty well debunked over the last 10 years. As regular readers know all too well, when the Fed implements QE they print new deposits and swap them with T-bonds. The T-bonds are effectively retired from the private sector and are held outside of the real economy on the Fed’s balance sheet. This transaction is a pure asset swap of one safe interest bearing asset for a similarly safe lower yielding asset. You aren’t wealthier when the Fed implements QE. In fact, our incomes go down. So this idea that QE is necessarily inflationary is misleading at best. I guess if you wanted to say that the private sector’s quantity of “money” has increased then sure. But you have to also acknowledge that their quantity of bonds has declined. You wouldn’t say you have more money if you swapped a savings account for a checking account….

Of course, this crypto advocate could have said that the US Treasury created trillions of dollars of new bonds during COVID that resulted in a huge net financial asset increase. That has indeed contributed to inflation, but it hasn’t resulted in 40% inflation. Again, the issue is much more complex than that, but this overly simplistic idea that Fed created deposits are inflationary puts the cart before the horse and gets the order of operations (and causality) wrong.

3. Larry Summers on MBS. Larry Summers has been all over the place saying that high inflation is a much bigger risk than many people assume. And he believes that the Fed should be winding down its purchases of Mortgage Backed Securities because of this. Now, I actually think that Summers has been making some good points about housing. The fact that the real estate market is this hot is potentially worrisome. I mean, you could have a scenario here where real estate prices continue to surge and all of the sudden the ballooning prices start to look a lot like 2006/7. Given that the real estate market is such a big piece of the US economy you really don’t want wild swings in prices here. But blaming the Fed for house prices is like blaming stock buybacks for high stock prices. Secondary market purchases can certainly matter, but at the end of the day the dominant price changes are caused in primary markets at a more fundamental level. Buying MBS is just buying an instrument that was already packaged and sold in the primary market. So it’s not really the dominant causal factor in housing demand even if it can have second order impacts. More importantly, we pretty much know that the unusual surge in house prices in recent years was mostly due to a massive housing shortage, fiscal stimulus and the unusual way in which COVID increased housing demand.

I am probably being a bit harsh here, but blaming the Fed for everything gets a little old when we know that the Fed spent 10 years throwing all of their tools at the US economy only to generate meager growth and inflation. If the Fed was as powerful as everyone thought then their multi-trillion dollar balance sheet expansion after 2008 would have had a much bigger impact than it did. I am a broken record here, but maybe people should start considering the potential that the US Treasury is really powerful and that Fed just isn’t everything it’s cracked up to be?