Comment: We’re getting the inflation we had expected

The U.S. economy’s strong recovery in 2021 resulted in optimism, borrowing and spending. And inflation.

By Tyler Cowen / Bloomberg Opinion

Sometimes yesterday’s crazy idea turns out to be sane or even essential. For instance, Fischer Black, the late finance economist and co-discoverer of modern options pricing theory, argued that the rate of price inflation will be whatever we think it will be.

If expectations are that inflation will be high, it will be high. If expectations are that inflation will be low, it will be low. For Black, who died in 1995, this was always true, at least for modern economies.

I never agreed with Black on this point, but increasingly I have begun to wonder if he wasn’t on to something. Plenty of people like to say that they knew at the time that the big money supply increases of 2008-09 were not going to lead to high inflation. There are also people who like to say that they knew at the time that the combined monetary and fiscal response from the pandemic would lead to much higher rates of price inflation. But relatively few people can gloat about getting it right both times.

In Black’s view of the world, if people expected inflation to be high, they would spend and borrow more. Banks would create the money for this process to be self-sustaining. Under this framework, Black might have argued that no major inflation resulted after 2008 because Americans simply were not bullish enough, given the recent financial trauma.

Paul Krugman has argued that there was not high inflation after 2008 because the U.S. economy was in a liquidity trap. Black’s rejoinder to the Keynesians was a subtle one: We are always in a liquidity trap. Since banks can bid for reserves, and reserves can pass in and out of banks freely, the net value of additional bank reserves must be equal to other uses of the funds. The monetary expansion of the U.S. Federal Reserve, which operates through banks, is thus like swapping two nickels for a dime. Whether or not nominal interest rates are zero, after the swap banks can still move back to whichever portfolio they wished to hold. Thus any Fed actions will prove neutral if that is what the banks, and the economy as a whole, desire. (Both market monetarists and Keynesians admit that in a traditional liquidity trap, monetary policy still can be effective if the Fed can make credible promises to inflate. I regard this as a substantive concession to the Fischer Black view, even if it is not usually presented as such.)

One argument is that it is different this time because the U.S. government engineered a major fiscal policy response to the crisis, not just a monetary response. Maybe, but if you focus on the fiscal side, you should be very strongly on Team Transitory; that is, believe that currently high inflation rates will fade rapidly. The fiscal response now lies firmly in the past, and so the inflationary pressures should be subsiding.

I can’t say that view has been refuted — who knows what next month may bring? — but it is looking less likely. If anything, the data are showing the inflationary pressures being transmitted to more sectors of the economy.

The reality is that the U.S. economy, along with many others, saw a recovery of surprising speed and strength in 2021. That produced a lot of optimism, which mostly has persisted, even in light of delta and omicron. In the Black view, that optimism produces a lot of spending and borrowing. Nominal variables will explode accordingly, and indeed they did.

Have you ever wondered why a country such as South Korea had inflation as high as 19 percent during its high-growth years? In general, high-growth countries often have high inflation. Those results make sense in the Fischer Black worldview.

So if Black was right, what does this mean looking forward?

Market expectations for inflation have recently turned up sharply for the one-year horizon, and for the three-year time horizon they still stand above 3 percent. Black did not argue that such expectations had to be stable, but that they may be the best guess for where we are headed. Another idea that is suspect is the notion that the Fed can steer the rate of price inflation as it chooses.

I can’t quite bring myself around to the Fischer Black view on inflation. I was brought up believing in a well-defined quantity of money that causally determines the price level, and I still see central banks commanding a lot of attention from the markets. Nonetheless, as central banks rely more on market expectations to orchestrate macroeconomic outcomes, I no longer see the Fischer Black views as so far from the current mainstream.

I am reminded of Hamlet’s words to Horatio: “There are more things in heaven and earth, Horatio, than are dreamt of in your philosophy.” If the world as a whole is getting weirder, and it seems to be, then maybe inflation is, too.

Tyler Cowen is a Bloomberg Opinion columnist. He is a professor of economics at George Mason University and writes for the blog Marginal Revolution. His books include “Big Business: A Love Letter to an American Anti-Hero.”

Talk to us

More in Opinion

3d rendering Stack of vote button badges.
Editorial: Bring Davis, Hoiby to Marysville School Board

Both women have deep ties to the community and demonstrate commitment to students and families.

Editorial cartoons for Tuesday, Oct. 3

A sketchy look at the news of the day.… Continue reading

There’s no need to reduce carbon emissions; plants need CO2

National Geographic states that “Most life on Earth depends on photosynthesis.” Photosynthesis… Continue reading

There’s a lot we can do to fight the climate crisis

If you are concerned about the climate crisis and are not sure… Continue reading

Comment: Trump committed financial fraud; now comes price tag

All that’s left for a New York court to determine is how big a fine to levy against the deal artist.

Comment: Estate tax would be ample, fitting child care solution

Using it to support child care programs would recognize the literal debt owed by wealthy Americans.

Comment: U.S.’s greatest foreign policy success in jeopardy

PEPEFAR, which provides HIV/AIDS treatment and saved countless lives in Africa, may not be nenewed.

Editorial cartoons for Monday, Oct. 2

A sketchy look at the news of the day.… Continue reading

FILE — In this Sept. 17, 2020 file photo, provided by the Idaho Department of Fish and Game, Chelbee Rosenkrance, of the Idaho Department of Fish and Game, holds a male sockeye salmon at the Eagle Fish Hatchery in Eagle, Idaho. Wildlife officials said Tuesday, Aug. 10, 2021, that an emergency trap-and-truck operation of Idaho-bound endangered sockeye salmon, due to high water temperatures in the Snake and Salomon rivers, netted enough fish at the Granite Dam in eastern Washington, last month, to sustain an elaborate hatchery program. (Travis Brown/Idaho Department of Fish and Game via AP, File)
Editorial: Pledge to honor treaties can save Columbia’s salmon

The Biden administration commits to honoring tribal treaties and preserving the rivers’ benefits.

Most Read