Schrödinger’s inflation

There’s a lot of debate about whether the current burst of inflation is transitory or permanent. I worry, however, that many people misinterpret the question, thinking it’s about the nature of the inflation itself. Sort of like asking their friend whether an animal that they saw walking in the distance is a dog or a coyote.

But the transitory inflation question is not like that at all. The question is not whether this current bout of inflation is transitory or permanent, the question is whether the inflation surge will be transitory or permanent. No one asks whether that animal walking in the distance will be a dog or a coyote—they assume that that reality has already been established.

NGDP growth has been running at a bit below 4% over the past couple of years. That’s about right. If NGDP growth runs at about 4% over the next 3 or 4 years (as it should) then the inflation will be transitory. If it runs at 7% or 8% over the next few years then the inflation will be permanent, or at least relatively persistent. It’s that simple. (During 1971-81, NGDP growth averaged 11%. God help us if that occurs again.)

It is the Fed that will determine the rate of NGDP growth over the next few years, not housing shortages or labor shortages or supply chain disruptions, etc. The Fed will decide whether the inflation is transitory or permanent.

The current surge in inflation is like Schrödinger’s cat; it’s neither transitory or permanent until the FOMC meets and chooses a policy path for NGDP over the next 3 or 4 years. Let’s hope they choose wisely.

PS. Of course I’m a “many worlds” guy, so I’m going to claim that my prediction (and what is my prediction?) is correct in at least one universe. 🙂



43 Responses to “Schrödinger’s inflation”

  1. Gravatar of Rodrigo Rodrigo
    23. October 2021 at 11:59

    I had a professor that once said “(Persistent) inflation is always and everywhere a monetary phenomenon” I believe he was(is) correct. I would go as far as saying markets believe this to be true in that the fed will not let inflation run wild since longer term rates have not moved very much. Did we not get a similar situation in 2008 when oil and commodities cause inflation to run above target causing the fed to delay the eventual rate cuts? Is this not proof that the current situation will eventually resolve itself and moving to quickly by the fed would actually be harmful for the economy? I never understood why so many very well educated people have been so critical of the fed when, in my mind, they prevented another great recession by acting so aggressively during the covid onset.

  2. Gravatar of Matthias Matthias
    23. October 2021 at 16:47

    Rodrigo, the Fed doesn’t even need to be smart. They can just look at TIPS spreads to make their decision.

    Apropos TIPS spreads: compared to earlier Fed performance they did will during the start of the pandemic. But they still let inflation expectation drop very low (according to TIPS spreads.)

  3. Gravatar of Spencer Bradley Hall Spencer Bradley Hall
    24. October 2021 at 08:28

    The Phillips Curve was denigrated in the 60’s. When inflation rises faster than incomes, that’s a bad policy, irrespective of N-gDp.

    “In fact, compensation is now lower than it was in December 2019, when adjusted for inflation, according to an analysis by Jason Furman, an economics professor at Harvard University.”

  4. Gravatar of Jeff Jeff
    24. October 2021 at 13:00

    They will simply claim that they have no choice but to let inflation run because it is due to things that “already happened”. That is the messaging strategy Janet Yellen used this week. “The inflation rate will remain high into next year because of what’s already happened.” They will say they lack agency over the situation and blame future events on the past.

  5. Gravatar of David S David S
    24. October 2021 at 13:31

    I’m trying to forget what value I picked for NGDP in 2021 on Hypermind–just like I’m trying to forget a lot of things about 2021 and 2020. I’m trying to feel encouraged about the herd forecast for 2022. The “We” of Hypermind think it’s going to be something less than 5%–so hotter than the 4% you suggest, but at least indicative of mean reversion that could lead back to sustainable levels in 2023-2024.*

    My dumb question of the afternoon is about the composition of that 2021 NGDP. If it’s 4% PCE inflation and 1.5% RGDP growth will that be bad? If those values are reversed, is that better–or does it not matter?
    I just read a book on this subject, but my brain is still processing things—although I did take your suggestion and buy a Ferrari so now I feel wealthier.

    *If you want to be evil, set up a contest for 2023 and 2024. If you do that, would the prize money be in U.S. dollars or Bitcoin?

  6. Gravatar of henry henry
    24. October 2021 at 18:19

    Uh yes, the weatherman is back writing more posts.

    A few months ago he wrote “inflation is only temporary”.

    Today, he informs us that it might be temporary or it might not be temporary. What a profound thing to say. It’s like saying “I might have coffee, or I might not have coffee”.

    Brilliant. Genius.

    All the number crunching, the new age econometric models that side step human nature for a new age mathematical approach – “look at me daddy, I can do math, I’m a scientist now”.

    Thank you for the intellectual insights and possibly quackery. I will make sure to tell my colleagues that there might be inflation or might not be inflation. It will certainly help us and our clients tremendously.

  7. Gravatar of Jeff Jeff
    24. October 2021 at 23:56

    In fairness henry is basically correct, what most people call “economics”–this blog included–is the naked propounding of value judgments gussied up with a mathematical flourish. The “models” are little more than curve fitting around some tiny area of phase space that society likely hasn’t occupied in in decades. They are not predictive of anything. Perhaps most risible is the idea that a futures market–one which is being actively manipulated by policymakers’ own forward-looking statements–can provide any sort of “anchoring” or “stabilization” of the future economic trajectory. If anything, such inventions only increase instability by creating the illusion of market consensus that Daddy “has things under control”….based entirely on Daddy’s own petulant insistence that he “stands ready to intervene” or some other such nonsensical empty promise.

    I see Jack Dorsey has just tweeted that hyperinflation is upon us. Perhaps that or some other spark will ignite a panic. Human beings are fascinating creatures and anyone who claims to have a “model” of their behavior should be laughed out of the room. Hyperinflation…deflation…it doesn’t much matter….anything that puts to rest this fraudulent scam that has been masquerading as a “science” for so many generations is well worth it.

  8. Gravatar of David S David S
    25. October 2021 at 03:14

    Scott, to save you the annoyance of a smackdown I’m answering my dumb question from yesterday. Precedent suggests that a composition of 2.5% growth and 2.1% inflation Y/Y for 2022 would be nice. A tiny bit hot, but probably okay. I’m still wondering if we could drift into a “stagflation lite” scenario that could yield a bizarre composition of NGDP growth like I suggested.

    The Ferrari is wicked cool.

  9. Gravatar of Michael Rulle Michael Rulle
    25. October 2021 at 04:39

    I am still reading this book on monetary economics I picked up somewhere on Amazon for a ridiculous price, but the author’s name was familiar. I am a novel addict——plus I am reading some guys named Smith and Hume and they are very interesting—-as is the monetary guy, btw.

    What has actually begun to consume part of my thinking is the nature of “news”. Since it is highly likely political news is exaggerated it occurs to me that economic news might also be exaggerated. 4% Nominal GDP appears to be where we are still at——so I question just how strong our “supply side” delivery problem really is. When the Journal takes rides on a LA port ship and is shown all the ships lined up—-it makes me laugh—-as if they would know what an uncrowded port looks like.

    I have read we have a Chip shortage, for example. It is not that I don’t think there might be less supply than the market wants at a certain price—-I have no idea—-but that is a different issue all together. I still get Lenovo and Dell adds daily——with pretty decent prices. I live in car central (northern NJ)——and we have lots of ads—-and prices seem normal. I just bought 3 new iPhones and were all delivered within a week.

    I read that grocery stores are “tricking” the public by making shelves look more filled than they are. Maybe——but not the way the article states. The only thing I did notice was I could not buy pre-made packaged burgers——but I could buy plenty of ground beef.

    Gasoline prices are definitely higher—-but it it is certainly not a delivery problem——in fact, I can drive into any gas station with no lines at all.

    Scott is clearly right about Schrodenger’s inflation——but that’s pretty straight forward. Also, the stock market certainly is not acting like there are supply shortages.

    Maybe I just notice the supply shortage articles—and I am the exaggerator!

  10. Gravatar of Spencer Bradley Hall Spencer Bradley Hall
    25. October 2021 at 06:25

    If the FED hadn’t raised the returns on O/N RRPs then the U.S. $’s exchange rate would have plunged raising input prices – accelerating inflation. That’s the difference between July 2008 @5.60 % and January 1991 @5.65 % and today @5.4 %.

    The FED is surreptitiously tightening monetary policy. The FOMC needs to reduce the remuneration rate @.15% on IBDDs. The remuneration rate is above all money market funding rates (which will negatively impact T-Bill issuance). The money market is differentiated by its position on the yield curve (i.e., short-term borrowing and lending with original maturities from one year or less).

    The Fed’s administered policy rate, inverts the short-end segment of the retail and wholesale nonbank funding yield curve (reversing maturity and credit transformation). This destroys money velocity and induces nonbank disintermediation (where the volume of available credit is reduced).

    Link Zoltan Pozsar:

  11. Gravatar of Spencer Bradley Hall Spencer Bradley Hall
    25. October 2021 at 06:41

    re: “Human beings are fascinating creatures and anyone who claims to have a “model” of their behavior should be laughed out of the room.”

    That’s preposterous. I predicted both the flash crash in stocks and the flash crash in bonds (6 months in advance and within one day) – that’s how I denigrated Nassim Nicholas Taleb’s “Black Swan” theory (unforeseeable event)

  12. Gravatar of ssumner ssumner
    25. October 2021 at 06:45

    David, Yes, you’d prefer more RGDP and less inflation, but for now we are getting the opposite.

  13. Gravatar of Spencer Bradley Hall Spencer Bradley Hall
    25. October 2021 at 06:59

    “On a 12-month basis, the inflation rate will remain high into next year because of what’s already happened. But I expect improvement by the middle to end of next year… second half of next year,” Yellen added.

    Yellen’s a little early. At this time (based on some bad #s), inflation spikes in January, and doesn’t decelerate substantially until October.

    Like Dr. William Barnett said (a former NSA Rocket Scientist).
    “the Fed should establish a “Bureau of Financial Statistics”.

  14. Gravatar of jdnym jdnym
    25. October 2021 at 07:21

    If NGDP composition is temporarily goods-heavy and services-light, should that affect the Fed response, or am I just restating the transitory vs permanent debate?

  15. Gravatar of Lizard Man Lizard Man
    25. October 2021 at 07:39

    Why should NGDP grow at 4% a year, and not 5% or 6%? Right now RGDP growth is lower than many people would like, but the Fed is letting NGDP keep growing at the same rate, so inflation has increased. In response, the press is writing tons of articles about supply chain problems, and just generally about problems that limit productive capacity. And the White House has felt compelled to be seen to be doing something to address these problems, so they somehow got involved in a dispute between labor and ports in So.Cal., with the end result that the ports now have much expanded operating hours, which should boost both RGDP and measured productivity, as the assets of the ports are being used more intensively.

    Given the politics of the US, it would seem that at the current margins, a higher NGDP is better than a lower target. Inflation that the press and public deem too high gets even Democrats to respond by looking at what is happening with the real economy and thinking about deregulation, as evidenced by Jimmy Carter. Inflation that is too low gets you in things the auto and bank bailouts of the Great Recession.

  16. Gravatar of ssumner ssumner
    25. October 2021 at 07:46

    jdnym, If you want to go beyond NGDP, I’d look at wage inflation, not sectoral shifts. If nominal wage inflation is higher than normal, that suggests that policy is too expansionary.

    Lizard, I don’t think it’a wise for monetary policy to chase ojne goal after another. Set a policy and stick to it.

  17. Gravatar of Don Don
    25. October 2021 at 09:20

    I think politicians use the word “transitory” to make it sound like the price hikes will go away soon. I have not seen any economist predict that price levels will return to 2020 levels.

  18. Gravatar of Ray Lopez Ray Lopez
    25. October 2021 at 10:29

    Absurd article that ignores Jeremy Rudd’s recent paper* by implying ‘expectations’ drive inflation, and presumes the Fed controls NGDP, when in fact velocity has dropped off the chart (go to the St. Louis Fed website and check M2 for yourself), so the quantity theory of money no longer holds. Other than that, “good post”. – RL

    *A recent Fed paper by Jeremy Rudd also poured cold water on the idea that inflation expectations are central in determining actual inflation outcomes. Rudd convincingly argues that there’s little evidence to show that consumers or businesses act in anticipation of higher inflation, especially in a low inflation regime—when inflation is not on people’s radars

  19. Gravatar of ssumner ssumner
    25. October 2021 at 13:05

    Ray, If your trolling isn’t even funny, then what’s left?

  20. Gravatar of Spencer Bradley Hall Spencer Bradley Hall
    25. October 2021 at 13:24

    re: “you’d prefer more RGDP and less inflation”

    It’s economics 101. Lending by the Reserve and commercial banks is inflationary (increases the volume and turnover of new money), whereas lending by the nonbanks is noninflationary (is a velocity relationship). If savings are not activated, a dampening economic impact is generated.

    Only bank depositors can activate their own funds. From a system’s standpoint, the banks can’t use it deposit liabilities. Banks are credit creators, not credit transmitters.

    Trading Economics: “Over the last several decades, US GDP growth rates have been declining. In the 50’s and 60’s the average growth rate was above 4 percent. In the 70’s and 80’s dropped to around 3 percent. In the last ten years, the average rate has been below 2 percent.”

    The fact is that an increase in bank CDs adds nothing to GDP. In fact, it shrinks AD.

  21. Gravatar of Ray Lopez Ray Lopez
    25. October 2021 at 21:27

    @ssumner – calling somebody a troll when they are making a serious point is trolling. My post speaks for itself. Anybody can verify it’s true. Other than that,”good reply”

  22. Gravatar of ssumner ssumner
    26. October 2021 at 08:44

    Ray, I’ve never argued that expectations determine inflation, I argue that market expectations are a way of estimating inflation. You are in so far over your head that you can’t even see the surface.

  23. Gravatar of steve steve
    26. October 2021 at 10:00

    I read this blog when I want to get to sleep

  24. Gravatar of agrippa postumus agrippa postumus
    26. October 2021 at 14:58

    no one reads sumner anymore. its too fuliginous there.

  25. Gravatar of Ray Lopez Ray Lopez
    26. October 2021 at 22:45

    @ssumner- thanks, I see your point. Sumner: “Ray, I’ve never argued that expectations determine inflation, I argue that market expectations are a way of estimating inflation.”. So this is one step closer to admitting money neutrality, if you think about it. The market can estimate inflation but they don’t act on this estimate? Think it through: it implies money is neutral. Thought experiment: Fed drops helicopter money, the market (people) realize it will cause inflation, but they wait and see before going out and buying things with the extra money. That’s money neutrality. For your NGDP level targeting to work (for money NON-neutrality to work), people (the market) have to act on their inflation beliefs, especially if their believes are erroneous (this is the essence of money illusion).

    It’s official: Sumner has officially renounced money non-neutrality and the money illusion, the entire raisin entry (raison d’être) of this blog. Sumner admits people don’t act on their inflation beliefs. In the immortal words of the character Walter White in Breaking Bad, “I win”.

  26. Gravatar of David S David S
    27. October 2021 at 01:30

    No matter how crazy the trolls on this blog get, at least no one is advocating for a return to a gold or silver standard. I suppose the gold bugs are now Bitcoin bugs now.

    And The Economist does a cover story on real time economics data and doesn’t once mention Hypermind. Those poxy British bastards.

  27. Gravatar of Spencer Bradley Hall Spencer Bradley Hall
    27. October 2021 at 06:34

    The problem with N-gDp targeting is that it increases prices faster than incomes (because it relies on money products). There isn’t a single economist in the world worth his salt.

  28. Gravatar of d w d w
    27. October 2021 at 07:00

    one question, how do we detect inflation? is that by comparing current year to previous year? and how do we adapt to comparing a major down year caused by an external (say a pandemic) to one where the pandemic is slowing down (compared to the previous year)? and if inflation is the biggest bogyman in economics, how is it we didnt seem all that happy with deflation? or in some cases a depression? and why do we think that only wages can cause inflation?

  29. Gravatar of ssumner ssumner
    27. October 2021 at 08:32

    Ray, LOL, what a word salad. This is priceless:

    “Sumner admits people don’t act on their inflation beliefs.”

    dw, In a better world we’d ignore inflation entirely.

  30. Gravatar of Spencer Bradley Hall Spencer Bradley Hall
    27. October 2021 at 09:32

    Tyler Cowen: “Yet I remain committed to the view that higher inflation is, in fact, transitory: After a few years of above-average price inflation, prices will return to a steady state of about 2% annual growth, as has mostly been the case since the early 1990s.”

    How absurd. For inflation to be transitory, prices would have to fall back to previous levels, not to prior rates-of-change. Incomes won’t keep up with inflation.

    How’s FAIT going? Just another name for N-gDp targeting. Latest Atlanta R-gDp estimate: 0.2 percent — October 27, 2021

  31. Gravatar of Ray Lopez Ray Lopez
    27. October 2021 at 13:56

    SS: ““Ray, I’ve never argued that expectations determine inflation, I argue that market expectations are a way of estimating inflation.”.

    Care to take back that talk? If expectations don’t determine inflation, then money is neutral. If inflation is an exogenous shock that people cannot anticipate, then NGDPLT does not work

    I win. Again.

  32. Gravatar of Ray Lopez Ray Lopez
    27. October 2021 at 14:02

    @SS: here is a paper to get you started on what I pose above. It’s about 36 years old but still good. (“Rational Expectations and Non-Neutrality of Money” by Kiyoshi Otani)

  33. Gravatar of Ray Lopez Ray Lopez
    27. October 2021 at 14:14

    @myself- just to be clear, I mean if people can anticipate inflation they can estimate it, and act on it, nullifying it. But Sumner seems to suggest people’s expectations do not determine inflation, which means inflation just happens. Left unsaid is whether Sumner believes in the Lucas critique of perfect information or not, once this inflation just happens. I will guess Sumner thinks people don’t have perfect information even though they can estimate inflation and they are subject to money illusion, but I doubt he can provide a citation to that, it’s metaphysics.

  34. Gravatar of Carl Carl
    27. October 2021 at 17:38

    I think you’ve set up a false dichotomy that there is either perfect elasticity of demand or complete ignorance of future NGDP levels.

  35. Gravatar of Sean Sean
    28. October 2021 at 04:55

    I can’t figure this out myself. Can you explain why the Fed would hike interest rates next year when the US 30 year is sub 2%.

    The only explanation I get is inflation mandate encourages hiking. But seems wrong if hikes get priced in while long term rates fall.

    It’s possible to have 30 year rates at 2% and have AIT at 2% but still seems weird to me.

  36. Gravatar of David S David S
    28. October 2021 at 06:40

    Compared to the comments on Tyler’s recent post on transitory inflation us trolls here are calm and rational. In other news, Dean Baker has some useful commentary on recent GDP numbers which point to both PCE and general growth rates bending downwards. This probably doesn’t mean much for the NGDP 2021 predictions, but a sub-5% for 2022 is looking more solid–maybe even less than 4.5%. I think the Fed has to be very careful over the next few months because the Christmas shopping season may be strange compared to pre-pandemic baselines. If I were Powell I would do almost nothing until spring of next year because data will by very choppy.

  37. Gravatar of Spencer Bradley Hall Spencer Bradley Hall
    28. October 2021 at 09:29

    re: “If I were Powell I would do almost nothing until spring of next year because data will by very choppy.”

    Correct. It’s math. The “sweet spot” has passed.

    Unfortunately, the lag for inflation is longer than the lag for real output. You can’t tighten (lower inflation), without lowering R-gDp. Powell should act like the idiot Paul Volcker inadvertently did, and let inflation burn / work itself out.

  38. Gravatar of Christian List Christian List
    28. October 2021 at 10:27

    About the ending of your post: so in other words, Lagarde and the ECB have already made their decision??? Oh my god.

  39. Gravatar of Spencer Bradley Hall Spencer Bradley Hall
    28. October 2021 at 11:26

    The FED is too tight now. They should grow the money stock by at least 100b every month.

    May ,,,,, 186.1
    Jun ,,,,, 257.7
    Jul ,,,,, 132.3
    Aug ,,,,, 073.1
    Sep ,,,,, 004.4

  40. Gravatar of Justin of Texas Justin of Texas
    28. October 2021 at 16:49

    With today’s GDP print, we’re now back within the reasonable range of where we “should” be based on the pre virus NGDP trend. I’ll spend the next decade being amazed at how well the FOMC handled this situation. The Fed can now sit back, steward expectations, and maybe pull NGDP a little below 4% in the second half of ’22. By ’23 people will have forgotten about inflation.

    I know Powell isn’t the real ideas man behind average inflation targeting, but he’s the one who allowed himself to be convinced, and so I think he should be heavily praised. He’s the new maestro. The sad thing is both people on the left and right are attacking him, they have no idea how much misery he and his team spared us. Money printer go brrr indeed.

  41. Gravatar of ssumner ssumner
    28. October 2021 at 19:06

    Everyone, NGDP comments should be at my other blog.

  42. Gravatar of henry henry
    30. October 2021 at 12:55

    Do you guys remember when Sumner was quoting the Lincoln project billboards in NYC as “evidence” of Trumps “wrong doing”.

    This radical left organization, to which Sumner subscribes, thought it would be morally just to hire fake white supremacists in an effort to win over independent voters in Virginia.

    Stop voting left, until that party comes back to the center of the aisle. They will absolutely, and fundamentally, destroy your country.

    America needs moderates, not socialist thugs. Trust me. My parents fled from these apparatchiks forty years ago. You don’t want Sumner’s running your country.

  43. Gravatar of ssumner ssumner
    31. October 2021 at 08:48

    “Do you guys remember when Sumner was quoting the Lincoln project billboards in NYC as “evidence” of Trumps “wrong doing”.”


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