Archive for September 2022


It’s services, i.e., it’s NGDP, i.e., it’s monetary policy

So what’s the problem with inflation? John Authers and David Beckworth directed me to the following graph, which shows that the most recent upswing is in services:

I apologize if the graph’s hard to read, you can look at the original here.

If you decompose the 8.3% annual inflation, 1.7% is energy (orange), 1.6% is food (yellow), 1.5% is other goods (teal) and 3.5% is services (blue.) Be careful interpreting these components; they are not annual inflation rates, they are contributions to inflation. Each component is rising much faster than its contribution to the total. Thus services and other goods are rising at 6.3%, which is the core inflation rate, even though they contribute only 5% to headline inflation. And food and energy prices are rising at double digit rates over the past 12 months, despite contributing just 3.3% to a headline inflation rate of 8.3%.

But I’m more interested in recent trends. Stocks plunged today because core inflation is worse than expected, and that’s mostly services. Why is service inflation getting worse? Because it responds with a lag to increases in nominal GDP. It’s almost always thus way. Much of services inflation is wages and implicit rents. Wages are sticky and rents are even stickier, often on one year contracts. The average “spot” rent on new contracts has already peaked and is heading downward, but the measured average rent will get worse for a while.

There are a few lessons here:

1. During periods when NGDP is rising too fast, ignore so-called experts who try to tell you that inflation is caused by this or that supply problem. It’s the NGDP, stupid.

2. Don’t assume that rising interest rates mean that monetary policy is getting tighter. That may be true in some cases, but until we get a slowing in NGDP growth (which is expected to remain quite high in Q3), we don’t actually have a tight money policy. At most, a bit less loose than earlier in the year.

3. Heavily discount any sort of Phillips Curve analysis of inflation, which focuses on tight labor markets. The problem is NGDP growth.

4. Back in January, I criticized the Fed’s pivot to asymmetric average inflation targeting. With every new data point, it becomes more and more obvious that the abandonment of average inflation targeting was a huge mistake. “Keep It Symmetrical, Stupid.”

We’ll be paying the price for this mistake for years.

The most important issues

It’s been awhile since I sat down and tried to figure out the issues that I care about most. Off the top of my head, here is a new list showing my current focus:

The 5 top issues:

1. Ukraine/Russia and the broader war on authoritarian nationalism. This also includes issues like Nato enlargement into Asia and Australia. I see a real risk of WWIII and I’m disgusted by how little effort the US and Europe are making in support of Ukraine. We should have reacted to the invasion the way we reacted to Pearl Harbor, with an all out effort to supply Ukraine with money and weapons (albeit not using American troops.) And somehow our sanctions actually made Russia richer.

2. Immigration: Let’s have much more immigration, both low skilled and high skilled. At least as much as Canada, on a per capita basis.

3. Zoning: Abolish it and fight NIMBYism more broadly. It is the single most effective way to boost living standards of those already here.

4. Drugs: Legalize them. We have 400,000 in prison for violating drug laws. When we repealed alcohol prohibition the crime rate almost immediately plunged sharply. So don’t say the drug inmates would be doing other types of crimes.

5. Abortion: Legalize it. Let mothers and doctors decide. (And my view on this would not change if you convinced me that abortion was “wrong”. Shooting heroin into your veins is wrong, but should not be illegal.)

(BTW. Trump is wrong on all these key issues. So don’t tell me that I agree with Trump but just don’t like his personality.)

Second tier, but still important:

6. Identity politics: End it. The woke are the biggest current threat to free speech, but there are also plenty of GOP politicians trying to restrict it.

7. Free trade: End trade barriers (and that includes barriers to international services such as air travel) with countries that are not trying to conquer foreign countries.

8. Global warming: Enact a carbon tax and legalize clean infrastructure such as nuclear power.

9. Monetary policy: NGDPLT.

10. Occupational licensing: End it.

11. The FDA: Take away their regulatory powers. Limit their power to recommendations.

12. Moral Hazard: End FDIC, the GSEs, Too Big Too Fail, etc.

13. Prostitution and gambling: Legalize them.

14. Public schools: Abolish them, and replace them with private schools plus vouchers.

15. Health care: Stop subsidizing with tax breaks and deregulate to reduce costs. (Also, increase self insurance, although there are limits as to how far that can be pushed. In my own case, I would have preferred going through my life paying 100% of my health care out of pocket. Not everyone can do that.)

16. Internal trade barriers: End them. Here I’m thinking of a wide range of things like agricultural crop restrictions, taxi medallions, and barriers to direct sales from auto manufacturers. There are many, many more such examples. End them all.

17. Tax code: Blow it up and replace it with a progressive consumption tax plus a land tax and a carbon tax.

18: Be less cruel to (non-human) animals: This might be the single most important issue, but I’m not an animal so I don’t have a good sense of how important it is. On animal rights, I’m not yet woke.

Third tier:

19. Privatize Amtrak and lots of other transport infrastructure (airports, airport traffic control, DMV, etc.)

20. Drinking age laws. End them.

21. Free range children: Legalize them.

Existential tier:

22. Think of a way for humanity to avoid destroying billions of people via AI run amok, manmade viruses, nuclear war, etc., etc. This actually may be the number one issue, but I don’t have any policy recommendations here, which is why I put it on the bottom. It’s a separate category from issues where I do have recommendations.

PS. These are off the top of my head; I’m sure I overlooked lots of important issues.

Powell and I explain our policies to Joe Sixpack

WSLee recently commented as follows:

Scott, aside from the European issues on this post, last night Jerome Powell briefly denounced NGDP targeting at a Cato Institute virtual conference. (at about 25:00 on the video)
According to him, NGDP targeting looks good as a model, but it is hard to implement and communicate it with the public. He also seems to believe that NGDP targeting may not be able to properly deal with changes in trend of growth. I guess you would disagree with him. Especially, on implementation and communications issues, you have repeatedly mentioned on those, but how would you rebut Powell about the argument that changes in growth trend cannot be appropriately managed with NGDP targeting?

To begin with, the Fed doesn’t need to explain its policy to the public, most of whom don’t even know what the Fed is. They need to explain their policy to the financial markets.

But let’s play this game just for the fun of it. A competition between me and Powell as to who can most easily explain their policy to the public. I’ll go first:

Joe Sixpack: OK Sumner, what’s your policy?

Me: The Fed puts new money into the economy, and also influences interest rates. I’ll have the Fed adjust policy with the goal of increasing the average American’s income at 3%/year over the long run. That’s just the average—some will get bigger raises and some will get smaller raises in any given year. But the average increase in incomes will be 3%/year.

Joe Sixpack: OK Powell, what’s your policy:

Powell: Simple! We are going to try to have the Fed achieve 2% inflation, on average.

Joe Sixpack: You mean you want the CPI to rise at 2%/year on average?

Powell: No, we target inflation using the Personal Consumption Expenditure price index.

Joe Sixpack: Never heard of it. So with the current high inflation, does that mean you plan to push inflation way below 2% going forward, so that it averages 2% over the long run?

Powell: No, technically we have flexible average inflation targeting. That means we don’t always offset high inflation with lower future inflation. Because of our dual mandate, we allow above normal inflation when it’s caused by supply shocks. Our main focus is demand shocks. We don’t care about the price of stuff like food and gasoline.

Joe Sixpack: But those are what I most care about!

Powell: Let me clarify that in the long run we do account for food and energy inflation, it’s just that in the short run we don’t try to offset them. In the short run, we focus on inflation caused by excess demand, not supply shortages.

Joe Sixpack: OK, but let’s say inflation is high because of demand shocks. Can I assume you’ll offset that high inflation with below 2% inflation going forward, so that inflation averages 2% in the long run?

Powell: Not quite. Technically, we have asymmetric flexible average inflation targeting. When inflation falls below the 2% target, we try to average it out with above 2% inflation going forward. But when inflation accidentally rises above 2%, even if due to excess demand, we don’t average it out with lower than 2% inflation going forward. Is that clear?

Joe Sixpack: I understand Sumner’s idea of having the average American get 3% raises each year. I’m not to sure about this asymmetric flexible average personal consumption expenditures price index inflation targeting system. Sort of seems like it allows you to do whatever the hell you want.

Normally I’d challenge Powell to a dual—put us both in a room and explain our views to 20 average people. But I’m not a good debater. So I’ll suggest that George Selgin advocate my position and Powell can also designate someone else if he prefers. Bring it on.

PS. My plan does deal with changes in growth due to variations in labor force growth. It does not account for changes in productivity growth, but that’s a feature, not a bug (and a minor consideration when considering the long run trends in inflation, which would be roughly 2%/year under my plan.)

The Eurozone black box

I find it difficult to get data on the eurozone. The second quarter NGDP data didn’t even show up until a couple of days ago. Other data is also hard to find. I wonder if that’s part of the problem.

Eurozone NGDP growth has averaged 3.44% since 2019:Q4. That seems low, but it may actually be a bit too high to achieve the ECB’s 2% inflation target in the long run. A few months back I argued that ECB policy had been about right (at a time when the Fed was too expansionary.) I’ll stick with that for now.

The bigger problem is the recent trend in NGDP growth is quite high, and needs to slow sharply if the eurozone is to avoid overheating. Indeed if Covid reduced economic potential, then it’s reasonable to assume that there has already been at least some overheating.

Thus I don’t necessarily buy the argument that the ECB has nothing to worry about, that it’s all supply-side inflation. But . . . and this is important . . . I suspect the dovish critics of the ECB will end up being correct. Given the hawkish bias of the ECB, they might well tighten into another recession, just as they did in 2008 when commodity prices were rising sharply. The ECB just raised rates by 75 basis points.

For the moment, I don’t feel I have enough data to offer a firm opinion. Looking backward, ECB policy has been pretty good during Covid. The German government bond yield curve is not inverted. That’s good. I wish I knew more about eurozone wage growth, eurozone inflation expectations, and other relevant variables. If commenters have any relevant data then please add it below.

PS. In 13 years of blogging, I think this might be my single most wishy-washy post!

Britain’s Silver Age (RIP Queen Elizabeth II)

Queen Victoria presided over Britain’s Golden Age (1837-1901).

Many people view the post-WWII period as one of decline for Great Britain, with economic difficulties and a loss of colonies. I see Queen Elizabeth’s reign as a Silver Age. Not quite peak performance, but very good.

In 1952, Britain was still somewhat depressed from the war. Since then it’s done pretty well in absolute terms, even if it fell a bit in relative terms.

During Elizabeth’s reign, the UK’s economic performance has been mediocre by Western European standards. But Britain is now a world leader in popular culture, higher education, science, media, finance, and many other areas that will become increasingly important in the 21st century.

I don’t know a lot about her personal qualities, but she certainly handled the glare of modern media with grace and dignity. (British commentators are much more qualified to write on that topic.)

PS. Queen Elizabeth was born and got married at roughly the same time as my mom (who is 96), so I’ve always thought of her as one generation older.

PPS. The first famous person I ever met was Prince Charles, when he visited the University of Chicago around the late 1970s.