Paul Krugman, Nobel-prize winning economist and New York Times columnist, has conceded that his prediction that the inflationary wave now battering American households would be benign was wrong and he “didn’t see the current surge coming,” though he continues to see the upward price pressures as “transitory.”
Krugman made the admission in a series of posts on Twitter, which come days after Labor Department data showed consumer price inflation vaulted to an over-the-year 6.2 percent in October, the highest pace in nearly 31 years.
“I got inflation wrong,” Krugman wrote. “I didn’t see the current surge coming.”
Offering an explanation, Krugman said he “didn’t think the fiscal stimulus early this year would boost demand as much as Summers et al predicted,” he added referring to former Treasury Secretary Larry Summers, who was early to sound the alarm on the current bout of surging prices and has been a vocal critic of the Fed’s easy-money policies.
Summers said in a CNN interview last week that, unless the Fed makes a significant change to policy or an “accident” delivers a major disruptive blow to the economy, it’s “quite unlikely” the rate of inflation will fall back to the central bank’s 2 percent target in the foreseeable future. His remarks dealt another blow to the “transitory” inflation narrative that Krugman has vocally defended in the past and, in his recent posts on Twitter, made clear he has not abandoned.
“What’s happened, however, is that we’ve faced supply constraints, both supply-chain issues in meeting huge demand for durable goods and withdrawal of workers from the labor force, i.e. Great Resignation,” Krugman wrote.
The pandemic-related shift in buying behavior led to a rotation of spending from services to goods, with many products seeing a sharp run-up in prices. This has been exacerbated by supply-side constraints, like a lack of semiconductors, a factor widely blamed for the surging prices in used cars, for example.
A used car dealership in Annapolis, Md., on May 27, 2021. (Jim Watson/AFP via Getty Images)
The labor force participation rate, meanwhile, stood at 61.6 percent in October, well below the pre-pandemic level of 63.6 percent in February 2020 and far off the historical peak of 67.3 percent in April 2000, providing an illustrative data point for the current labor shortage that has led businesses to boost wages to attract workers.
“This doesn’t say that the inflation will necessarily be transitory, although I think that’s still the best bet,” Krugman said.
“But it is important to realize that the story is more complicated than excessive stimulus,” Krugman wrote, while sharing an analysis by economist Matthew C. Klein on his blog The Overshoot, titled “The Case for Patience on Inflation.”
“This is a very good analysis of where we appear to be at right now,” Krugman wrote, with Klein making the case in his post that the current price pressures remain “confined to the same batch of idiosyncratic sectors that have been driving inflation all year.”
“Moreover, measures of actual consumer behavior suggest that Americans are responding to higher prices not by hoarding in anticipation of even more inflation, but by postponing their spending in the expectation that affordability will improve,” Klein wrote.
“The risk is that consumers and businesses start believing that even bigger price increases are coming in the future—and adjust their behaviors in response. That would eventually lead to hoarding, tightening financial conditions, less production, and shortages,” he argued.
“Fortunately, that doesn’t seem to be happening—yet,” Klein wrote.
But with prices running high and little sign of immediate relief, consumer expectations for what the rate of inflation will be in the future have risen to all-time highs.
The New York Fed’s most recent consumer inflation expectations survey showed that short-term (one year ahead) inflation expectations rose in October to 5.7 percent, the highest reading in the history of the series. The medium-term (three years ahead) inflation expectations remained unchanged from the prior month’s level of 4.2 percent, which was a record high.
Bond markets, too, are pricing in a more persistent bout of inflation that the “transitory” camp—including Fed policymakers and Biden administration officials—believe. A key measure of the bond market’s expectations for upward price pressures over the next five years, known as the five-year breakeven inflation rate, surged to an all-time high of 3.113 percent on Nov. 10, the day government data was released showing consumer price inflation rising at its fastest annual rate since 1990.
The sharp rise in the bond market-derived gauge suggests that investors expect inflation to average over 3 percent a year for the next five years and that upward price pressures will be more persistent than the Fed’s “transitory” expectations, potentially forcing the central bank to accelerate its timetable for a rate hike.
Former Treasury Secretary and Harvard Professor Larry Summers makes remarks during a discussion on low-income developing countries at the annual IMF and World Bank Spring Meetings in Washington on April 13, 2016. (Mike Theiler/AFP via Getty Images)
Summers told CNN in the interview that he believes the labor market is tight and loose monetary policy is counterproductive.
“We’ve got to recognize our problem is not that not enough people have jobs,” Summers told the outlet.
“The current problem is that we are pushing demand into the economy faster than supply can grow and that we are just going to get more and more inflation until we stop doing that,” he said.
“That’s the real problem,” Summers added, with his remarks coming nearly two weeks after the Fed’s policy-setters met and voted to start phasing out the central bank’s $120 billion in monthly asset purchases by around $15 billion per month, while leaving monetary policy broadly accommodative, saying it’s not yet time to start hiking interest rates.
Summers called for a faster taper of the bond-buying program, urging for it to be phased out over three months, not eight.