A couple of weeks ago, we featured Russell Napier’s take on inflation who has been consistent with his view right from the first pandemic induced stimulus in the west. Napier attributes the current high inflation to the western governments taking over monetary policy through stimulus programmes such as credit guarantee schemes, ofcourse further exacerbated by supply shocks from the pandemic, war and China. Here’s another detailed take on inflation by Kenneth Rogoff, a Harvard economics professor and former Chief Economist of the IMF. Rogoff is also known (albeit not without controversy) for the book on the financial crisis – This Time is Different, co-authored with Carmen Reinhart. Whilst Napier showed why free market economics is nothing short of fantasy, Rogoff shows how politics drives everything. More importantly, he shows how central bank independence is a myth and much of the central bank action or inaction lately as well as back in the notorious 70s had political influence. This comes at an important time when political compulsions to show the fight against inflation ends with this week’s mid-term elections in the US and hence begs the question if the Fed will soften its stance hereon:
First, Rogoff’s take on the fiscal stimulus:
“Inevitably, stimulus spending is political, and those who promote large rescue packages are often also motivated by the opportunity to expand social programs whose approval in Congress might in ordinary times be impossible. This is one reason why there tends to be far less talk about reducing stimulus once a crisis is over.
As a candidate, Biden pledged that he would expand government spending if elected, partly with the aim of facilitating the post-COVID economic recovery but mainly to share the benefits of growth more equally and to put significant resources into the national response to climate change. As a lame-duck president, Trump attempted to frustrate his winning opponent’s ambitions by passing his own $900 billion COVID-19 relief package in December 2020, even though the economy was already rebounding strongly. Just three months later, although the economy was continuing to recover, Democrats under Biden passed a new $1.9 trillion stimulus package, with a number of prominent economists, including New York Times columnist and Nobel laureate Paul Krugman, cheering them on. Krugman and others argued that the package would enhance the recovery and provide insurance against another wave of the pandemic and that it carried minimal risks of igniting inflation.”
But there were a few critics:
“Most notably, Harvard economist and former U.S. Treasury Secretary Lawrence Summers began warning that the bill being contemplated could lead to inflation. Although serious inflation had not occurred in decades, Summers had a simple and compelling insight. Throwing trillions of dollars into an economy with severe supply constraints and only a modest demand shortage had to be inflationary. If too many people are trying to buy cars at the same time and have the cash to do so, car prices will rise.
A key element of Summers’s logic was that the stimulus-fueled consumption binge would not be satisfied by foreign suppliers, including China. Normally, when U.S. consumers go on a spending spree, the U.S. trade deficit supplies at least a partial outlet from internal price pressures: if U.S. demand exceeds U.S. production, Americans can still buy from abroad. But in the spring of 2021, with the U.S. economy emerging from the pandemic faster than most and with global supply lines in even greater disarray than domestic U.S. supply lines, the availability of foreign goods was limited. Although economists have differed over the precise figure, a reasonable guess is that excess demand accounted for as much as half the cumulative rise in prices in the United States immediately after the pandemic.”
How even monetary policy is politically motivated:
“…Yet the Fed delayed taking action even after it became clear that inflation was rising. By the fall of 2021—six months after the Biden stimulus—the economy was rapidly heating up, yet the Fed left interest rates untouched. It is hard to escape the fact that Jerome Powell’s term as Fed chair was set to expire at the end of the year and Biden had not yet announced his reappointment. If Powell had chosen to initiate a cycle of interest-rate hikes, it is entirely possible, indeed likely, that Biden would have replaced him with a different chair, perhaps Lael Brainard. A well-respected economist and prominent former treasury official in the Obama administration, Brainard was viewed by financial markets as more dovish on interest rates, more willing to risk inflation to sustain growth. In the event, the Fed held back on raising rates, and Biden eventually reappointed Powell. Only then, with Powell comfortably in his new term, did the Fed finally raise interest rates in the spring of 2022. If the administration had wanted the Fed to raise interest rates sooner, as some later argued it did, the right move would have been to reappoint Powell in the summer of 2021, giving him a clear mandate to act as the Fed saw fit.
…At the start of the 1970s, the chair of the Fed at the time, Arthur Burns, recklessly expanded the money supply in what many viewed as an effort to help President Richard Nixon get reelected. …Far less noted, however, is that the Volcker Fed initially held back, worried that causing a recession would affect the 1980 presidential election; instead, it allowed inflation to rise initially, possibly causing the later recession to be even larger.”
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