The 2022-23 Economic Crisis Megathread

[Tamas]

Surprised we haven't been discussing this.

Lots of worries worldwide, and I think central banks are being slow to react to inflation finally leaving asset bubbles and storming into product and service prices. Even though "transitionary inflation" seems to have disappeared from their narrative.

The Fed acknowledge hard times ahead but continue -so far- to plan with 0.5% rate hikes despite, what, 8% official inflation? They are also stopping asset buying I think, which is showing in the stock market, as capital flees "risk on" assets.

In the UK it is even slower, and the Bank of England president would rather have people forego salary increases to combat inflation.

Meanwhile some ECB dude expressed his concern over the apparent return of wage indexing. So, even if the Fed also feels like behind the curve and playing catchup, at least they acknowledge they need to do things. Their European counterparts appear to rather blame the plebs and remain largely passive.

[Tamas]

Another choice quote from an ECB guy called Lane: "that households are upwardly revising their inflation beliefs is a concern"

If only the plebs stopped eating inflation would stop, without having to risk the value of investment portfolios.

[celedhring]

I feel like I've been living through one crisis or another since 2008. It's becoming a bit wearisome.

I managed to get a decent raise from my main employer, so looks like I'm in the ECB naughty list.

[Tamas]

On the flip side, I guess, the ECB admit they were entirely incapable to predict the current inflation:

[Sheilbh]

I'm broadly on the ECB's side and think their approach is the right one - if the central banks believe their own forecasts/projections. I think it is still likely to be transitory but probably for the next couple of years. But I know nothing.

I still think a lot about this piece by Duncan Weldon from last autumn - as I think the BofE and Fed are doing things to be seen to be doing things for the sake of their credibility, which, so far, the ECB has avoided (but is saying rates will rise and are likely to be positive by autumn):

Stories about inflation
Stories matter whether they are true or not. Especially when it comes to monetary policy.   
Duncan Weldon
Oct 18, 2021

Charles Goodhart, as I wrote a couple of weeks ago, thinks that economics currently has "no general theory of inflation". But if the profession lacks a generally accepted theory, it certainly has stories about inflation. And stories, as Robert Shiller has convincingly argued, have power. They are worth taking seriously whether they are true or not.

Looking at current market pricing, investors are definitely leaning more towards the "not transitory" side in the great – and ongoing – "is above-target inflation transitory or not?" debate. Still, I think the debate is far from settled. And more importantly, I think it is worth constantly keeping in mind that transitory does not necessarily mean "short-lived". Inflation could be above target for 12-24 months and, as long as the underlying dynamics have not shifted, this could still prove transitory.

Stories are a useful frame for thinking through inflation dynamics and asking if they have changed.

The stylised facts of advanced economy inflation over the last five decades are clear:
    Inflation was high and volatile in the 1970s, 1980s and, in some countries, into the early 1990s.
    From the early 1990s until the financial crisis of 2007-09 inflation was low and stable. This period is often called the Great Moderation as a result.
    From the crisis until the pandemic advanced economy inflation was generally subdued, aside from energy price related spikes that drove up the headline numbers.

But if the facts are relatively undisputed then the stories explaining those facts are still disputed.

I think one can tell two different stories about the taming of inflation that led to the Great Moderation.

The first story runs something like this and is rooted in structural changes in the shape of the macroeconomy, the supply side and changing political economy:
Beginning in the 1980s the structural bargaining power of labour was reduced a period of high unemployment following tight macro policy, by a breaking of trade union power and by the further liberalisation of the jobs market. The end of the cold war, the entry of China into the global economy and the globalisation of supply chains from the late 1980s into the 1990s supercharged these trends. The pool of labour available to Western capital almost doubled in the space of two decades. Meanwhile advanced economies became less energy-intensive. The result of less feedthrough from energy price spikes and lower goods prices due to globalisation was reduced headline inflation and lower volatility of inflation. Weaker labour bargaining power ruled out the kind of wage-price spirals which had bedevilled policymakers in the past and helped to keep services inflation low and stable.

Or one can tell a very different story, one rooted in inflation expectations and credibility. This one goes something like this:
Inflation was high and volatile in the past because macro-policy was ineffective. Monetary policy was too subject to political whims and fiscal dominance. Fiscal policy was often firmly set to manage a political business cycle (easier before elections and then overcompensating afterwards) rather than an economic one. Firms, workers and investors came to expect that policymakers would lack the resolve to tackle inflation so they set prices and wages ever higher. The solution was credible, independent central banks with a mandate to keep inflation low. These banks demonstrated their credibility by keeping policy tight to drive down inflation, even at a high cost in terms of joblessness. By the mid-1990s that hard-won credibility had helped to anchor inflation expectations. Now that firms, workers and investors had a clear view of the reaction function of central banks in the face of rising inflation they expected inflation to remain and low and stable and so set prices and wages on that basis.

Most central bankers it seems still prefer the second story – and who doesn't like a story in which one is cast as the hero?

For an example, take a look at some recent work from some ECB economists on the role of globalisation in modern inflation dynamics, which drew upon a longer paper published as part of the ECB strategy review (and which is well worth taking the time to read).

The research notes that inflation has indeed moderated among all major advanced economies. But after discussing the profound deepening of global value chains and the intensification of trade flows over the 1990s and 2000s, the authors conclude:

The most intuitive explanation is that the concurrent inflation decline across advanced economies is due to (1) the monetary policy strategies adopted by the central banks of advanced economies over those years; (2) the wage concertation mechanisms consistent with those strategies (i.e. lower wage indexation); and (3) the consequent stabilisation of expectations.

Personally, I am not sure that is indeed the "most intuitive" explanation. "Macro policy got better everywhere at the same time" may indeed be the reason for the Great Moderation but ruling out "common factors changed the dynamics across the advanced economies" feels a step too far.

Of course both stories can have an element of truth in them. The stories are certainly not incompatible – macro policy can have become more effective at stabilising inflation alongside structural changes that made stabilising inflation easier.

My worry though is that central banks are so convinced of their own story that preserving their credibility becomes an end in and of itself. Global supply disruptions are going to hit output in the months ahead, fiscal policy is set to tighten sharply and the pandemic is not over. And yet still too many central bankers are focussed on fickle measures on inflation expectations and fretting about credibility.

[Tamas]

What I know is that the Fed have abandoned using "transitory" since, like, March.

[The Larch]

I feel like I've been living through one crisis or another since 2008. It's becoming a bit wearisome.

Yeah, it's all been crisis of one sort of the other for years already. It's as if it's the permanent mood since the mid 00s, we barely exit one to enter the next. From the subprimes one to the sovereign debt one to the Covid one to the current one about inflation. We just can't catch a break, It feels as if the last time there was economic optimism was in the early 00s.

[DGuller]

I think the root of all problems is ultimately increasing wealth inequality.  The reason inflation could take refuge in asset bubbles for so long is because the rich getting richer doesn't spike demand for goods and services, but the poor getting richer does.  They just sit there and watch runaway compounding multiply their Monopoly money without bound. 

For multiple reasons I think the dam finally burst, and I agree that it seems downright silly that the sign of central banks taking inflation seriously is nudging the interest rates up by a quarter point more than previously planned.  I think a lot of "really smart people" over the years have convinced themselves that inflation is no longer a thing, and are struggling to adapt to the reality.

[The Minsky Moment]

Although I agree that wealth inequality is both cause and symptom of economic dislocations, I am very skeptical of a link to inflation.  Inflation was low during the last great gilded age.  And generally speaking, the assumption is that the superwealthy tend to save higher proportions of income and that increasing income inequality is associated therefore with lower consumption - a pattern not usually a contributor to inflationary pressure.

[The Minsky Moment]

What I know is that the Fed have abandoned using "transitory" since, like, March.

It was a transitory use of the term.

[The Minsky Moment]

[

I still think a lot about this piece by Duncan Weldon from last autumn

Two thoughts on that

The stylised facts of advanced economy inflation over the last five decades are clear

Sure.  But why focus on only the last five decades?  Why isn't the post WW2 experience relevant?  Or the interwar period?  Or the Gilded Age?  The simple answer is that the people running bank econ departments, or the central banks, or the newspaper or cable news business sections weren't around then and it isn't part of their lived experience.  But it is relevant data.

Of course both stories can have an element of truth in them. The stories are certainly not incompatible – macro policy can have become more effective at stabilising inflation alongside structural changes that made stabilising inflation easier.

I agree with this.  As tempting as it is to reduce the story to a conflict between rival interpretive models, reality doesn't always work that simply and cleanly.

[DGuller]

Although I agree that wealth inequality is both cause and symptom of economic dislocations, I am very skeptical of a link to inflation.  Inflation was low during the last great gilded age.  And generally speaking, the assumption is that the superwealthy tend to save higher proportions of income and that increasing income inequality is associated therefore with lower consumption - a pattern not usually a contributor to inflationary pressure.

To clarify, I'm not saying that gilded ages lead to higher inflation.  I'm actually saying that they lead to apparently low inflation (if you ignore asset bubbles).  The reason central banks could print money with abandon is because it was going to the rich, who were not spending it on goods and services, and Bitcoin is not part of consumer goods basket.

What I'm saying is that gilded ages give potential energy for inflation to kick off for other reasons.  All that asset bubble wealth eventually has to go somewhere, sooner or later you or someone else have to spend that money.  If enough people do it at the same time, they suddenly realize that the printed money does exist after all.

[Sheilbh]

What I know is that the Fed have abandoned using "transitory" since, like, March.

Yes - although I think part of that is political and reaction in the discourse plus confusion of transitory = short. I think there's still a couple of banks, maybe Morgan Stanley, that are on team transitory but I acknowledge that it is lonely here

I think there are a number of factors that push us to a higher price level/baseline but that will not be inflationary year-on-year if that makes sense. We're taking the hit of them as well as other shocks which are broadly temporary.

Sure.  But why focus on only the last five decades?  Why isn't the post WW2 experience relevant?  Or the interwar period?  Or the Gilded Age?  The simple answer is that the people running bank econ departments, or the central banks, or the newspaper or cable news business sections weren't around then and it isn't part of their lived experience.  But it is relevant data.

Yes. I also think we tend towards explanations of the present and times close to us that over-emphasise agency and role of key decision makers. That's not to say that people aren't aware of or don't also flag the structural factors, or the path dependency of previous decisions shaping what our options are - I just think we see them less clearly and balance them differently when looking at the near past. I also think it is something that central bankers, politicians, business leaders etc are likely to emphasise (especially when claiming credit).

[Josquius]

Inequality is a huge problem.
Where its particularly dodgy in the modern day is how abstract spending is from most people's real world. Gone are the times when a rich local would invest in a new mill, instead they're putting their money into a digital wotsit company based halfway across the world.

[viper37]

Surprised we haven't been discussing this.

Lots of worries worldwide, and I think central banks are being slow to react to inflation finally leaving asset bubbles and storming into product and service prices.

If the interest rates rise up to quickly, it can end up triggering a real economic crisis.