Emily Mascitis checks prices at an auto-repair shop in Philadelphia. (Photo from the Wall StreetJournal.)
As we discuss in Macroeconomics, Chapter 9, Section 9.4, (Economics, Chapter 19, Section 19.4) in calculating the consumer price index (CPI) each month, the Bureau of Labor Statistics sends hundreds of employees to gather price data from stores and offices. A reporter for the Wall Street Journal followed a price checker as she visited an auto-repair shop, a grocery store, and other businesses.
The article provides an excellent discussion of the care with which prices are collected, particularly with respect to making sure that the prices are for the same good or service each month. For instance, while in a grocery, the price checker almost made the mistake of recording the price of a can of low sodium chicken noodle soup, rather than the price of regular chicken noodle soup as in previous months.
At one point, the price checker noted that the price of clementines had been increasing rapidly and remarked that when buying fruit for her own family “We need to pick a less expensive fruit.” Switching from buying a fruit, in this case clementines, with a price that is increasing rapidly to a fruit with a price that is increasing more slowly, say regular oranges, is an example of the substitution bias. That’s one of the four biases discussed in Section 9.4 that can cause the measured increase in the CPI to overstate the true rate of inflation.
The article can be found here. (A subscription may be required.)
Source: Rachel Wolfe, “How the Inflation Rate Is Measured: 477 Government Workers at Grocery Stores,” Wall Street Journal, May 10, 2022.
From early March to early May 2022, the Japanese yen persistently lost value versus the U.S. dollar. Between March 1 and May 9, the yen declined by 14% against the dollar, which is a substantial loss in value during such a short time period. What explains the decline in the exchange rate between the yen and the dollar during that time? In Macroeconomics, Chapter 18, Section 18.2 (Economics, Chapter 28, Section 28.2), we saw that the exchange rate between most pairs of currencies fluctuates in response to these factors:
The foreign demand for U.S. goods
U.S. interest rates relative to foreign interest rates
Foreign demand for making direct investments or portfolio investments in the United States
The U.S. demand for foreign goods
Foreign interest rates relative to U.S interest rates
U.S. demand for making direct investments or portfolio investments in other countries
The following figure shows movements in the exchange rate between the yen and the U.S. dollar since 2010. During different periods, the factor that is most important in explaining fluctuations in an exchange rate varies. (Important note: The figure follows the convention of expressing the exchange between the yen and dollar in terms of yen per dollar. Therefore, in the figure, an increase in the exchange rate corresponds to a decrease in the value of the yen versus the dollar because it takes more yen to buy one dollar.)
From early March to early May 2022, the decline in value of the yen versus the dollar was mainly the result of U.S. interest rates increasing relative to Japanese interest rates. As the inflation rate increased rapidly in the spring of 2022, both short-term and long-term interest rates in the United States increased, partly in response to policy actions taken by the Federal Reserve. The Federal Reserve was attempting to increase interest rates in order to raise borrowing costs for households and firms, thereby slowing spending and inflation. Japan was experiencing much lower rates of inflation—well below the Bank of Japan’s 2% annual inflation target—so the BOJ was reluctant to increase interest rates. As a consequence, the gap between the interest rate on 10-year U.S. Treasury notes and the interest rate on 10-year Japanese government bonds had risen to 2.9 percentage points.
Higher U.S. interest rates caused a shift to the right in the demand for dollars in exchange for yen as foreign investors exchanged their yen for dollars in order to buy U.S. Treasury securities and other U.S. financial assets. As we show in Chapter 18, Figure 18.13, an increase in the demand for dollars (holding all other factors constant) increases the equilibrium exchange rate between the yen and the dollar.
What effect does a stronger dollar and a weaker yen have on the two countries’ economies? A weaker yen means that the yen price of imports from the United States will be higher. The higher prices will increase the Japanese inflation rate, but with inflation being low in in the spring of 2022, Japanese policymakers weren’t concerned by this effect. And because the value of U.S. imports is small relative to the size of the Japanese economy, the effect on the inflation rate wouldn’t be large in any case. The dollar price of Japanese exports to the United States will be lower, which should help Japanese firms exporting to the United States.
The effect on the U.S. economy will be the mirror image of the effect on the Japanese economy. The dollar price of Japanese imports being lower will help reduce the U.S. inflation rate, but not to a great extent because the value of Japanese imports is small relative to the size of the U.S. economy. The yen price of U.S. exports to Japan will be higher, which will be bad news for U.S. firms exporting to Japan.
Finally, many banks, other financial firms, and non-financial firms borrow money in dollars. They do so because over time the advantages of borrowing dollars has increased, even for foreign firms that receive most of their revenue in their domestic currency rather than dollars. In particular, the value of the dollar is relatively stable compared with the value of many other currencies. In addition, the Federal Reserve has made available short-term dollar loans to foreign central banks that allow those banks to provide short-term loans to local firms that are having temporary difficulty making dollar payments on their loans. By late 2021, the total amount of dollar loans made outside of the United States had risen to more than $13 trillion. In the spring of 2022, the value of the dollar was rising not just against the Japanese yen but also against many other currencies. The increase was bad news for foreign firms borrowing in U.S. dollars because it would take more of their domestic currency to buy the dollars necessary to make their loans payments. A large and prolonged increase in the value of the U.S. dollar could possibly upset the stability of the international financial system.
Sources: Yuko Takeo and Komaki Ito, “Japan’s Stepped-Up Warnings Fail to Stem Yen’s Slide Past 128,” bloomberg.com, April 19, 2022; Jacky Wong, “Japan Gets a Taste of the Wrong Type of Inflation,” Wall Street Journal, April 1, 2022; Megumi Fujikawa, “Yen Hits Lowest Level Since 2015, and Japan, U.S. Are OK With That,” Wall Street Journal, March 28, 2022; Bank for International Settlements, “BIS International Banking Statistics and Global Liquidity Indicators at End-September 2021,” January 28, 2022; and Federal Reserve Bank of St. Louis.
On Thursday morning, April 28, the Bureau of Economic Analysis (BEA) released its “advance” estimate for the change in real GDP during the first quarter of 2022. As shown in the first line of the following table, somewhat surprisingly, the estimate showed that real GDP had declined by 1.4 percent during the first quarter. The Federal Reserve Bank of Atlanta’s “GDP Now” forecast had indicated that real GDP would increase by 0.4 percent in the first quarter. Earlier in April, the Wall Street Journal’s panel of academic, business, and financial economists had forecast an increase of 1.2 percent. (A subscription may be required to access the forecast data from the Wall Street Journal’s panel.)
Do the data on real GDP from the first quarter of 2022 mean that U.S. economy may already be in recession? Not necessarily, for several reasons:
First, as we note in the Apply the Concept, “Trying to Hit a Moving Target: Making Policy with ‘Real-Time’ Data,” in Macroeconomics, Chapter 15, Section 15.3 (Economics, Chapter 25, Section 25.3): “The GDP data the BEA provides are frequently revised, and the revisions can be large enough that the actual state of the economy can be different for what it at first appears to be.”
Second, even though business writers often define a recession as being at least two consecutive quarters of declining real GDP, the National Bureau of Economic Research has a broader definition: “A recession is a significant decline in activity across the economy, lasting more than a few months, visible in industrial production, employment, real income, and wholesale-retail trade.” Particularly given the volatile movements in real GDP during and after the pandemic, it’s possible that even if real GDP declines during the second quarter of 2022, the NBER might not decide to label the period as being a recession.
Third, and most importantly, there are indications in the underlying data that the U.S. economy performed better during the first quarter of 2022 than the estimate of declining real GDP would indicate. In a blog post in January discussing the BEA’s advance estimate of real GDP during the fourth quarter of 2021, we noted that the majority of the 6.9 percent increase in real GDP that quarter was attributable to inventory accumulation. The earlier table indicates that the same was true during the first quarter of 2022: 60 percent of the decline in real GDP during the quarter was the result of a 0.84 decline in inventory investment.
We don’t know whether the decline in inventories indicates that firms had trouble meeting demand for goods from current inventories or whether they decided to reverse some of the increases in inventories from the previous quarter. With supply chain disruptions continuing as China grapples with another wave of Covid-19, firms may be having difficulty gauging how easily they can replace goods sold from their current inventories. Note the corresponding point that the decline in sales of domestic product (line 2 in the table) was smaller than the decline in real GDP.
The table below shows changes in the components of real GDP. Note the very large decline exports and in purchases of goods and services by the federal government. (Recall from Macroeconomics, Chapter 16, Section 16.1, the distinction between government purchases of goods and services and total government expenditures, which include transfer payments.) The decline in federal defense spending was particularly large. It seems likely from media reports that the escalation of Russia’s invasion of Ukraine will lead Congress and President Biden to increase defense spending.
Notice also that increases in the non-government components of aggregate demand remained fairly strong: personal consumption expenditures increased 2.7 percent, gross private domestic investment increased 2.3 percent, and imports surged by 17.7 percent. These data indicate that private demand in the U.S. economy remains strong.
So, should we conclude that the economy will shrug off the decline in real GDP during the first quarter and expand during the remainder of the year? Unfortunately, there are still clouds on the horizon. First, there are the difficult to predict effects of continuing supply chain problems and of the war in Ukraine. Second, the Federal Reserve has begun tightening monetary policy. Whether Fed Chair Jerome Powell will be able to bring about a soft landing, slowing inflation significantly while not causing a large jump in unemployment, remains the great unknown of economic policy. Finally, if high inflation rates persist, households and firms may respond in ways that are difficult to predict and, may, in particular decide to reduce their spending from the current strong levels.
That’s what Elon Musk did in April 2022. In early April, Musk purchased about 9% of Twitter’s shares. On April 25, he became the owner of Twitter by buying the roughly 90% remaining shares for $54.20 per share. The total he paid for these remaining shares came to $44 billion. Following his often unorthodox style, Musk announced his plans in a tweet on Twitter. Where did he get the money to fund such a large purchase?
According to Forbes magazine, in March 2022, Musk was by far the richest person in the world with total wealth of about $270 billion—nearly $100 billion more than Amazon founder Jeff Bezos, who is the second-richest person. While it appears that Musk could afford to buy Twitter without having to borrow any money, Bloomberg estimated that in April 2022 Musk had only $3 billion in cash. Much of his wealth was in Tesla stock or his ownership shares in SpaceX and the Boring Company, both of which are private companies that, therefore, don’t have publicly traded stock. Musk was reluctant to fund all of his offer for Twitter by selling Tesla stock or finding investors willing to buy into SpaceX and Boring.
Musk turned to investment banks to help him raise the necessary funds. Investment banks, such as Goldman Sachs, differ from commercial banks in that they don’t accept deposits, and they rarely lend directly to households. Instead, investment banks have traditionally concentrated on providing advice to firms issuing stocks and bonds or to firms (and billionaires!) who are looking for ways to finance mergers or acquisitions. A syndicate of investment banks, including Morgan Stanley (which served as Musk’s lead adviser), Bank of America, Barclays, and what an article in the Wall Street Journal described as “nearly every global blue-chip investment bank aside from the two [Goldman Sachs and JP Morgan Chase] advising Twitter,” put together the following financing package. Initially, Musk wanted to raise $46.5 billion in financing—more than in the end he needed. Of that amount, Musk would provide $21 billion and the investment banks would provide loans for the remaining $25.5 billion. As collateral for the loans, Musk pledged $60 billion of his Tesla stock.
Musk’s financing was a combination of equity—the $21 billion in cash—and debt—the $25.5 billion in loans from investment banks. To fund his equity investment, he was considering selling some of his stock in Tesla but hoped to attract other equity investors who would put up cash in exchange for part ownership of Twitter. According to press reports, Apollo Global Management, a private equity firm was considering becoming an equity investor. (As we saw in Chapter 9, Section 9.2, private equity firms raise equity capital to invest in other firms.) Musk’s purchase is called a leveraged buyout (LBO) because (1) he relied on borrowing for a substantial part of his purchase of Twitter and (2) he intended to take the company private—the company would no longer have publicly traded stock.
Why would Musk want to buy Twitter? He shared the view of some industry analysts that Twitter’s management had failed to take advantage of opportunities to increase the firm’s profit. The actions of Musk and the investment banks were part of the market for corporate control. As we discuss in Microeconomics, Chapter 8, Section 8.1 (Macroeconomics, Chapter 6, Section 6.1), in large corporations there is often a separation of ownership from control. Although the shareholders legally own the firm, the firm’s top management controls the firm’s day-to-day operations. The result can be a principal-agent problem with the management of a large firm failing to act in the best interests of the firm’s shareholders. The existence of a market for corporate control in which outsiders buy stakes in firms that appear to be poorly managed can make firms more efficient by overcoming these moral hazard problems.
But Musk had another reason for buying Twitter. As he stated in an interview, “Having a public platform that is maximally trusted and broadly inclusive is extremely important to the future of civilization.” It was unclear whether this and similar statements meant that after gaining control of Twitter he might take actions that won’t necessarily increase the firm’s profitability.
Elon Musk’s purchase of Twitter is a high profile example of the role that investment banks can play in determining control of large corporations.
Sources: Kurt Wagner, “Elon Musk Lands Deal to Take Twitter Private for $44 Billion,” bloomberg.com, April 25, 2022; Cara Lombardo and Liz Hoffman, “How Elon Musk Won Twitter,” Wall Street Journal, April 25, 2022; Michele F. Davis, “Elon Musk Vets Potential Equity Partners for Twitter Bid,” bloomberg.com, April 21, 2022; Sabrina Escobar, “Elon Musk Isn’t Twitter’s Only Problem. It Faces a Number of Short-Term Headwinds,” barrons.com, April 21, 2022; Cara Lombardo and Liz Hoffman, “Elon Musk Says He Has $46.5 Billion in Funding for Twitter Bid,” Wall Street Journal, April 21, 2022; Andrew Ross Sorkin, Jason Karaian, Vivian Giang, Stephen Gandel, Lauren Hirsch, Ephrat Livni, and Anna Schaverien, “Elon Musk Wants All of Twitter,” New York Times, April 14, 2022; Rob Copeland, Rebecca Elliott, and Cara Lombardo, “Elon Musk Makes $43 Billion Bid for Twitter, Says ‘Civilization’ At Stake,” Wall Street Journal, April 14, 2022; “The World’s Real-Time Billionaires,” forbes.com, April 24, 2022; Musk’s tweet announcing his offer to buy Twitter can be found here.
Adam Smith bronze statue on Royal Mile Market square in front of Saint Gilles Cathedral in Edinburgh, Scotland.
Growth matters. A lot. A slightly higher rate of economic growth, sustained over time, can make the difference between a big increase in living standards and relative stagnation. Whether we can still generate strong and steady growth is a “$64,000 question” for the economy — the question. Nobel Prize–winning economist Robert Lucas famously observed that once economists think of long-term growth, it is hard to think of anything else. A pro-growth policy agenda is a good idea because growth is a good idea.
But a deeper question remains: Is public support for growth guaranteed? Oren Cass of American Compass refers to growth and economists’ fealty to economic participation for all as “economic piety.” This critique resonates for a simple reason: Forces that propel growth invariably leave a wake of economic disruption for people in many places and political disruption for the nation. A serious discussion of pro-growth policy must account for that disruption.
A conventional pro-growth policy agenda can be enhanced by support for openness to markets, ideas, and new ways of doing things, and for the ability of firms to adapt to change. Such an enhanced agenda would center on infrastructure broadly defined, development and dissemination of better management practices, and reduced barriers to competition.
Yet the political process, and even many a conservative, is openly skeptical of such an agenda. This skepticism is rooted not in disagreement over the future of scientific advances or of organizational adaptation — but in a concern that growth’s benefits be shared broadly. Addressing this skepticism head-on is essential for rebuilding social support for growth and for countering well-meaning but potentially harmful policies.
The system that needs defending is a mature and successful one. Adam Smith, the great proponent of the “invisible hand” (not the visible hand of a state-directed economy), saw openness and competition as worth the candle. His 1776 publication of The Wealth of Nations came before what we would recognize today as industrial capitalism, though technological change and globalization were features of economic debates in the aftermath of Smith’s ideas.
Smith’s radical insight is central to economic policy today: National prosperity (the “wealth of a nation”) is represented by consumption of goods and services by its people — i.e., their living standards. The goal of the economy in Smith’s telling was to make the economic pie as large as possible. His advocacy of free markets and competition rested on their ability to boost consumption possibilities.
Two centuries later, Nobel laureates Kenneth Arrow and Gérard Debreu added the jargon and mathematics of contemporary economics to formalize Smith’s intuition. While individuals and firms act independently, competitive markets lead to an efficient allocation of resources and a maximized economic pie. Friedrich Hayek, another Nobel laureate, hailed the virtue of a decentralized competitive price system in maximizing economic activity.
Smith’s radicalism draws from his attack on mercantilism—the economic orthodoxy of the day—which stressed a zero-sum view of trade and state intervention to promote and protect certain firms and industries. (Sound familiar?) His second radical insight was that the “nation” did not mean the sovereign and the well-connected. In Smith’s view, individuals as consumers—all people—were kings. Finally, channeling the sympathetic concern espoused in his earlier classic, The Theory of Moral Sentiments, Smith championed mass participation in the productive economy as a precondition for human flourishing.
It is fair to say that Smith lacked a theory of per capita growth in the economy over time; indeed, he wrote before the massive increase in living standards attendant upon the Industrial Revolution. After 1800, per capita income in the United Kingdom — and the United States — witnessed a 30-fold increase. There have also been major improvements in the quality of goods and services that such a statistic doesn’t quite capture. And, of course, many of today’s offerings — from smartphones to computers to air-conditioning — were not available even in 1900, let alone 1800.
That lacuna in Smith’s theory partly reflects technical difficulties in modeling growth. Higher output can come from growth in inputs such as labor and capital, but what determines their growth? Today’s economists highlight population growth and society’s willingness to work, save, and invest. Still more important is growth in productivity, or the efficiency with which inputs are used to produce goods and services.
Smith’s pin-factory example — in which output rose with the specialization of tasks — links how things are done with the level of productivity. But what factors determine productivity growth over time? Today’s economic analysis focuses on technology and the process of generating ideas. Since economic growth is still crucial for people seemingly marginalized by capitalism, it’s worth asking whether the economic foundations expressed in The Wealth of Nations are still relevant today. Where does growth come from now? And do those sources still require openness and competition?
The short answer is that they do, but to see why, we need to focus on the ideas of two prominent economists after 1800: Edmund Phelps and Deirdre Nansen McCloskey.
Phelps, a Nobel laureate, has done much to connect growth to Smith’s foundational ideas. He starts with Smith’s emphasis on a great many individuals (not the state or privileged firms) searching for new and better ways of doing things. This relentless search produces innovative ideas, processes, and goods that drive growth — but only if the political economy allows openness. Smith’s messy, “bottom up” version of the market therefore puts mass innovation at the heart of economic growth. Phelps’s argument reflects how Smithian societies committed to openness are best able to prosper and promote growth.
This argument has two important applications. The first is to debunk the sometimes fashionable view of secular productivity decline — that we have run short of new things to discover and exploit. The second is to give an answer to economies struggling with growth in a period of structural changes from technology and globalization. Slowdowns in innovation are likely not due to scientific barrenness but to walls against openness and change — that is, fears of disruption.
Phelps’s concern with economic dynamism draws him to Smith’s arguments against mercantilist tinkering in the economy. Like Smith, he worries about the hidden costs of tinkering with competition by blocking change from the outside and by enabling rent-seeking on the inside. These “corporatist” policies — fashionable among some conservatives at present — inevitably embolden vested interests and cronyism, slowing change and growth. Even seemingly small interventions can subtly diminish innovation, a point to which I’ll return.
Yet such a critique must acknowledge the political consequences of disruption. Dynamism is messy. It creates growth in the aggregate, but with many individual losers as well as individual gainers.
McCloskey, an economic historian, has similarly identified the continuous, large-scale, voluntary, and unfocused search for betterment as the source of new ideas that can produce economic growth. She sees this “innovism” as primarily a cultural force, preferring the term to the more familiar “capitalism,” and connects innovism to economic liberalism. Echoing Smith, she emphasizes how an open economy allows individuals—from the moderately to the spectacularly talented—to “have a go.” This economic liberalism allows competition to enshrine liberty and mass flourishing.
In McCloskey’s telling, growth depends on a liberal tolerance and openness to change, which encourage many people to be alert to opportunity. Sustaining that tolerance as structural shifts bring economic misfortune to many individuals, however, requires more than devotion to Smith.
Therein lies the current economic-policy rub. Economists’ theories of growth bring to mind a coin: Sunny descriptions of growth and dynamism are “heads,” and hand-wringing over disruption is “tails.” As I observed earlier, growth is messy. It can push some individuals, firms, and even industries off well-worn and comfortable paths.
But Smith offers more in defense of growth than paeans to laissez-faire. Though he is sometimes caricatured as being anti-government in all cases, Smith was principally opposed to mercantilist privileges for specific businesses and industries and to the governmentalization of social affairs. He wanted government to provide what economists today call “public goods,” such as national defense, the criminal-justice system, and enforcement of property rights and contracts the institutional underpinnings of commerce and trade. He also favored support for infrastructure to keep commerce flowing freely.
But Smith went further: To prepare workers and enrich their lives, he called for government to provide universal education, and he drew a connection between education and liberty as well as work in a free society. But boosting participation in today’s economy—participation that provides support for growth—will require a bit more.
Not surprisingly, political reaction to economic disruption brings about — pardon the econ-speak—a “demand” for and “supply” of policy actions. Job losses, firm failures, and diminished industry fortunes bring about a demand for help, for adaptation. The political process responds with a supply of ideas in one of two forms: walls or bridges. Walls are protections against disruption or change. Bridges, ways to get somewhere or back, prepare individuals for the changed economy and help those whose economic participation has been disrupted reenter the workforce.
Proposals for walls are familiar. They can be physical, of course, but they needn’t be. Conservative populists advocate limits on trade and technology, in order to advance industrial policy. Some progressives advocate universal basic income. All these policies would diminish the prospects for economic advances.
The most prominent sort of wall today is what I call “modern corporatism.” It assumes that Smith was wrong: The “wealth of a nation” lies not in consumption or living standards (and so ultimately in growth) but in jobs, good jobs, even particular good jobs, with good manufacturing jobs the very paradigm. The sort of tinkering with the market that drew Smith’s ire may actually be a necessary way of recentering economic policy on jobs, so the theory goes. Opportunities for work, and for the dignity it can bring, are surely important.
A gentle industrial policy devised by social scientists who are worried about jobs is not the answer. It results in state tinkering for special interests, precisely the kind of thing that prompted Smith’s criticism of mercantilism. Moreover, as University of Chicago economist Luigi Zingales argues in A Capitalism for the People, it risks a vicious cycle: A little bit of tinkering becomes a lot of tinkering—and anyone who cannot justify special privileges is left out, calling into question social support for growth. Nevertheless, industrial policy has caught the attention of elected officials on the right, from Donald Trump to Josh Hawley to Marco Rubio. While national security and the border can be exceptions as concerns, advice from Milton Friedman to the party of Ronald Reagan this is not.
That said, economists’ invocation of Smith as a proponent of let-’er-rip laissez-faire is neither faithful to Smith nor particularly helpful to individuals and communities buffeted by disruption. With today’s rapid and long-lasting technological change and globalization, “having a go” requires support for acquiring new skills when they are needed.
That is why we need more bridges. Bridges take us somewhere and bring us back. The journey to somewhere is about preparation for new opportunities. The journey back is about reconnecting to the productive economy when economic forces beyond our control have knocked us away.
Economic bridges have three features. The first is that they help people overcome a specific challenge on their way to economic flourishing — they don’t provide that outcome directly. The second is that wider society builds the bridge, through private organizations, governments, or public–private partnerships, as globalization and technological change have introduced significant risks that individuals by themselves cannot avoid. The third feature is that they avoid restraints on openness to changes in markets and ideas.
We once did better, much better. During the Civil War, President Abraham Lincoln worked with Congress to pass the Morrill Act, directing resources to the development of land-grant colleges around the country, extending higher education to citizens of modest means, and enabling workers to develop skills for new industries, particularly in manufacturing. As World War II drew to a close, President Franklin D. Roosevelt and Congress came together to enact the G.I. Bill, helping to educate returning troops for a changing economy.
Supporting economic growth and undergirding broad participation in the economy require similarly bold ideas. To begin, community colleges are the logical workhorses of skill development and retraining, and their presence in regional economies makes them attractive partners for employers. Yet community colleges have seen their state-level public support wither. The Biden administration calls for free tuition, which would boost demand but provide no support for community college to offer a practical education and an emphasis on completion. Amy Ganz, Austan Goolsbee, Melissa Kearney, and I proposed an alternative approach based on the land-grant-college model. We proposed a supply-side program of federal grants to strengthen community colleges — contingent on improved degree-completion rates and labor-market outcomes. To further encourage training, the federal government could offer a tax credit to compensate firms for the risk of losing trained workers. It could also increase the earned-income tax credit for workers with or without children.
New ideas are also needed to promote workers’ reentry into the workforce. Personal reemployment accounts, for example, would support dislocated workers and offer them a reemployment bonus if they found a new job within a certain period of time. The “personal” refers to individuals’ choosing from a range of training and support services. Another idea is to beef up support for place-based assistance to areas with stubbornly high rates of long-term nonemployment. Such support could be integrated with an increase in the earned-income tax credit and the supply-side investment in community colleges. Building on the decentralized approach in the land-grant colleges and grants to community colleges, expanded place-based aid would be delivered via flexible block grants encouraging business and employment.
Broad public support required for growth and dynamism requires both bridge-building and a political language that frames it. Growth, opportunity, and participation are good, and we do not need a new economics. But phrases like “transition cost” and “inevitable economic forces” must give way to bridges of preparation and reconnection.
‘Why did nobody see it coming?” a quizzical Queen of England questioned a quorum of economists at the London School of Economics about the global financial crisis as it emerged in late 2008. How could major disruptive forces build up over time and yet escape the attention of experts and leaders?
Of the disruptive structural changes accompanying economic dynamism, one might ask a similar question. Growth matters. But that growth is one side of a coin whose flip side is disruption is known, certainly to economists. Why has our political discourse not emphasized this basic point?
Why did we not see fatigue with change coming among the people who most had to bear its ill effects?
However foolishly, we did not. Some so-called conservatives today have responded by saying that we should limit change. Surely a better response is that we should seek ever more growth by allowing unfettered change, but also facilitate the establishing of ever more connections in a growing economy. That classical-liberal answer has the better place in American conservatism — and in American economic life.
— This essay is sponsored by National Review Institute.Originally published here.
Lawrence Summers (Photo from harvardmagazine.com.)John Cochrane (Photo from hoover.org.)
In several of our blog posts and podcasts, we’ve discussed Lawrence Summers’s forecasts of inflation. Beginning in February 2021, Summers, an economist at Harvard who served as Treasury secretary in the Clinton administration, argued that the United States was likely to experience rates of inflation that would be higher and persist longer than Federal Reserve policymakers were forecasting. In March 2021, the members of the Fed’s Federal Open Market Committee had an average forecast of inflation of 2.4 percent in 2021, falling to 2.0 percent in 2022. (The FOMC projections can be found here.)
In fact, inflation measured by the CPI has been above 5 percent every month since June 2021; the Fed’s preferred measure of inflation—the percentage change in the price index for personal consumption expenditures—has been above 5 percent every month since October 2021. Summers’s forecasts of inflation have turned out to be more accurate than those of the members of the Federal Open Committee.
In this podcast, Summers discusses his analysis of inflation with four scholars from the Hoover Institution, including economist John Cochrane. Summers explains why he came to believe in early 2021 that inflation was likely to be much higher than generally expected, how long he believes high rates of inflation will persist, and whether the Fed is likely to be able to achieve a soft landing by bringing inflation back to its 2 percent target without causing a recession. The first half of the podcast, in particular, should be understandable to students who have completed the monetary and fiscal policy chapters (Macroeconomics, Chapters 15 and 16; Economics, Chapters 25 and 26). Background useful for understanding the podcast discussion of monetary policy during the 1970s can be found in Chapter 17, Sections 17.2 and 17.3.
Neel Kashkari, president of the Federal Reserve Bank of Minneapolis. Photo from the Wall Street Journal.Pat Toomey, U.S. Senator from Pennsylvania. Photo from http://www.toomey.senate.gov.
As we discuss in Macroeconomics, Chapter 17, Section 17.4 (Economics, Chapter 27, Section 27.4), the Federal Reserve is unusual among federal government agencies in being able to operate largely independently of Congress and the president. Congress passed the Federal Reserve Act, which established the Federal Reserve System, in 1913, and has amended it several times in the years since. (Note that, as we discuss in the Apply the Concept, “End the Fed?” in this chapter, the U.S. Constitution does not explicitly authorized the federal government to establish a central bank.) Section 2A of the act gives the Federal Reserve System the following charge:
“The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.”
Elsewhere in the act, the Fed was given other specified responsibilities, such as supervising commercial banks that are members of the Federal Reserve System and serving on the Financial Stability Oversight Council (FSOC), which is charged with assessing risks to the financial system.
Because Congress can change the structure and operations of the Fed at any time and because Congress has given the Fed only certain specific responsibilities, traditionally the Fed has avoided becoming involved in policy debates that are not directly concerned with its responsibilities. Over the years, most members of the Board of Governors have believed that if the Fed were to become involved in issues beyond monetary policy and the working of the financial system, Congress might decide to revise the Federal Reserve Act to reduce, or even eliminate, Fed independence.
In the spring of 2022, though, there were two instances where some members of Congress argued that the Fed had become involved in policy issues that went beyond the Fed’s responsibilities under the Federal Reserve Act. The first instance involved President Joe Biden’s nomination in January 2022 of Sarah Bloom Raskin to serve on the Fed’s Board of Governors. In 2010, Raskin was nominated to the Board of Governors by President Barack Obama and confirmed by the Senate in a voice vote without significant opposition. (In 2014, she resigned from the Board to accept a position in the Treasury Department.)
Her nomination by President Biden encountered significant opposition, however, largely because in July 2020 she had suggested that when the Fed expanded its lending programs during the Covid-19 pandemic it should have excluded firms in the oil, natural gas, and coal industries: “The Fed is ignoring clear warning signs about the economic repercussions of the impending climate crisis by taking action that will lead to increases in greenhouse gas emissions at a time when even in the short term, fossil fuels are a terrible investment.” Although her supporters argued that in formulating policy the Fed should take into account the threats to financial stability caused by climate change, when it became clear that a majority of the Senate disagreed, Raskin withdrew her nomination.
In April 2022, some members of Congress, including Senator Pat Toomey of Pennsylvania, questioned whether it was appropriate for President Neel Kashkari of the Federal Reserve Bank of Minneapolis to formally support the campaign to amend the Minnesota state constitution to include a provision stating that, “All children have a fundamental right to a quality public education …. It is a paramount duty of the state to ensure quality public schools that fulfill this fundamental right.”
The Bank defended its support for the amendment in a statement on its website: “The Federal Reserve Bank of Minneapolis’ support of the Page amendment is closely linked to the mission of the Federal Reserve. Congress assigned the Federal Reserve the dual goals of achieving (1) stable prices and (2) maximum employment, and one of the greatest determinants of success in the job market is education.”
Senator Toomey strongly disagreed, arguing in a letter of Bank President Kashkari that: “This amendment is highly political, as it wades into an ongoing debate about whether government-run school systems are preferable to parental choice in education.” Toomey asserted that: “These political lobbying efforts by you and other Minneapolis Fed officials … are well beyond the Federal Reserve’s mandate, violate Federal Reserve Bank policies, constitute a misuse of Minneapolis Fed resources, and ultimately undermine the Federal Reserve’s independence and credibility.”
It remains to be seen whether Congress will ultimately accept the arguments of Federal Reserve policymakers such as Kashkari and Raskin that the Fed needs to interpret its mandate from Congress more broadly, or whether Congress will decide to amend the Federal Reserve Act to more explicitly limit the boundaries of Fed action—or to reduce Fed independence in some other ways.
Sources: Sarah Bloom Raskin, “Why Is the Fed Spending So Much Money on a Dying Industry?” New York Times, May 28, 2020; Andrew Ackerman and Ken Thomas, “Sarah Bloom Raskin Withdraws as Biden’s Pick for Top Fed Banking Regulator,” Wall Street Journal, March 15, 2022; Michael S. Derby, “GOP Senator Criticizes Minneapolis Fed Over Education Issue,” Wall Street Journal, April 12, 2022; Federal Reserve Bank of Minneapolis, “Page Amendment: Every Child Deserves a Quality Public Education,” minneapolisfed.org; and Pat Toomey, “Letter to Neel Kashkari,” banking.senate. gov, April 11, 2022.
Authors Glenn Hubbard and Tony O’Brien reconsider the role of inflation in today’s economy. They discuss the Fed’s possible responses by considering responses to similar inflation threats in previous generations – notably the Fed’s response led by Paul Volcker that directly led to the early 1980’s recession. The markets are reflecting stark differences in our collective expectations about what will happen next. Listen to find out more about the Fed’s likely next steps.
It now seems clear that the new monetary policy strategy the Fed announced in August 2020 was a decisive break with the past in one respect: With the new strategy, the Fed abandoned the approach dating to the 1980s of preempting inflation. That is, the Fed would no longer begin raising its target for the federal funds rate when data on unemployment and real GDP growth indicated that inflation was likely to rise. Instead, the Fed would wait until inflation had already risen above its target inflation rate.
Since 2012, the Fed has had an explicit inflation target of 2 percent. As we discussed in a previous blog post, with the new monetary policy the Fed announced in August 2020, the Fed modified how it interpreted its inflation target: “[T]he Committee seeks to achieve inflation that averages 2 percent over time, and therefore judges that, following periods when inflation has been running persistently below 2 percent, appropriate monetary policy will likely aim to achieve inflation moderately above 2 percent for some time.”
The Fed’s new approach is sometimes referred to as average inflation targeting (AIT) because the Fed attempts to achieve its 2 percent target on average over a period of time. But as former Fed Vice Chair Richard Clarida discussed in a speech in November 2020, the Fed’s monetary policy strategy might be better called a flexible average inflation target (FAIT) approach rather than a strictly AIT approach. Clarida noted that the framework was asymmetric, meaning that inflation rates higher than 2 percent need not be offset with inflation rates lower than 2 percent: “The new framework is asymmetric. …[T]he goal of monetary policy … is to return inflation to its 2 percent longer-run goal, but not to push inflation below 2 percent.” And: “Our framework aims … for inflation to average 2 percent over time, but it does not make a … commitment to achieve … inflation outcomes that average 2 percent under any and all circumstances ….”
Inflation began to increase rapidly in mid-2021. The following figure shows three measure of inflation, each calculated as the percentage change in the series from the same month in the previous year: the consumer price index (CPI), the personal consumption expenditure (PCE) price index, and the core PCE—which excludes the prices of food and energy. Inflation as measured by the CPI is sometimes called headline inflation because it’s the measure of inflation that most often appears in media stories about the economy. The PCE is a broader measure of the price level in that it includes the prices of more consumer goods and services than does the CPI. The Fed’s target for the inflation rate is stated in terms of the PCE. Because prices of food and inflation fluctuate more than do the prices of other goods and services, members of the Fed’s Federal Open Market Committee (FOMC) generally consider changes in the core PCE to be the best measure of the underlying rate of inflation.
The figure shows that for most of the period from 2002 through early 2021, inflation as measured by the PCE was below the Fed’s 2 percent target. Since that time, inflation has been running well above the Fed’s target. In February 2022, PCE inflation was 6.4 percent. (Core PCE inflation was 5.4 percent and CPI inflation was 7.9 percent.) At its March 2022 meeting the FOMC begin raising its target for the federal funds rate—well after the increase in inflation had begun. The Fed increased its target for the federal funds rate by 0.25 percent, which raised the target from 0 to 0.25 percent to 0.25 to 0.50 percent.
Should the Fed have taken action to reduce inflation earlier? To answer that question, it’s first worth briefly reviewing Fed policy during the Great Inflation of 1968 to 1982. In the late 1960s, total federal spending grew rapidly as a result of the Great Society social programs and the war in Vietnam. At the same time, the Fed increased the rate of growth of the money supply. The result was an end to the price stability of the 1952-1967 period during which the annual inflation rate had averaged only 1.6 percent.
The 1973 and 1979 oil price shocks also contributed to accelerating inflation. Between January 1974 and June 1982, the annual inflation rate averaged 9.3 percent. This was the first episode of sustained inflation outside of wartime in U.S. history—until now. Although the oil price shocks and expansionary fiscal policy contributed to the Great Inflation, most economists, inside and outside of the Fed, eventually concluded that Fed policy failures were primarily responsible for inflation becoming so severe.
The key errors are usually attributed to Arthur Burns, who was Fed Chair from January 1970 to March 1978. Burns, who was 66 at the time of his appointment, had made his reputation for his work on business cycles, mostly conducted prior to World War II at the National Bureau of Economic Research. Burns was skeptical that monetary policy could have much effect on inflation. He was convinced that inflation was mainly the result of structural factors such as the power of unions to push up wages or the pricing power of large firms in concentrated industries.
Accordingly, Burns was reluctant to raise interest rates, believing that doing so hurt the housing industry without reducing inflation. Burns testified to Congress that inflation “poses a problem that traditional monetary and fiscal remedies cannot solve as quickly as the national interest demands.” Instead of fighting inflation with monetary policy he recommended “effective controls over many, but by no means all, wage bargains and prices.” (A collection Burns’s speeches can be found here.)
Few economists shared Burns’s enthusiasm for wage and price controls, believing that controls can’t end inflation, they can only temporarily reduce it while causing distortions in the economy. (A recent overview of the economics of price controls can be found here.) In analyzing this period, economists inside and outside the Fed concluded that to bring the inflation rate down, Burns should have increased the Fed’s target for the federal funds rate until it was higher than the inflation rate. In other words, the real interest rate, which equals the nominal—or stated—interest rate minus the inflation rate, needed to be positive. When the real interest rate is negative, a business may, for example, pay 6% on a bond when the inflation rate is 10%, so they’re borrowing funds at a real rate of −4%. In that situation, we would expect borrowing to increase, which can lead to a boom in spending. The higher spending worsens inflation.
Because Burns and the FOMC responded only slowly to rising inflation, workers, firms, and investors gradually increased their expectations of inflation. Once higher expectation inflation became embedded, or entrenched, in the U.S. economy it was difficult to reduce the actual inflation rate without increasing the target for the federal funds rate enough to cause a significant slowdown in the growth of real GDP and a rise in the unemployment rate. As we discuss in Macroeconomics, Chapter 17, Sections 17.2 and 17.3 (Economics, Chapter 27, Sections 27.2 and 27.3), the process of the expected inflation rate rising over time to equal the actual inflation rate was first described in research conducted separately by Nobel Laureates Milton Friedman and Edmund Phelps during the 1960s.
An implication of Friedman and Phelps’s work is that because a change in monetary policy takes more than a year to have its full effect on the economy, if the Fed waits until inflation has already increased, it will be too late to keep the higher inflation rate from becoming embedded in interest rates and long-term labor and raw material contracts.
Paul Volcker, appointed Fed chair by Jimmy Carter in 1979, showed that, contrary to Burns’s contention, monetary policy could, in fact, deal with inflation. By the time Volcker became chair, inflation was above 11%. By raising the target for the federal funds rate to 22%—it was 7% when Burns left office—Volcker brought the inflation rate down to below 4%, but only at the cost of a severe recession during 1981–1982, during which the unemployment rate rose above 10 percent for the first time since the Great Depression of the 1930s. Note that whereas Burns had largely failed to increase the target for the federal funds as rapidly as inflation had increased—resulting in a negative real federal funds rate—Volcker had raised the target for the federal funds rate above the inflation rate—resulting in a positive real federal funds rate.
Because the 1981–1982 recession was so severe, the inflation rate declined from above 11 percent to below 4 percent. In Chapter 17, Figure 17.10 (reproduced below), we plot the course of the inflation and unemployment rates from 1979 to 1989.
Caption: Under Chair Paul Volcker, the Fed began fighting inflation in 1979 by reducing the growth of the money supply, thereby raising interest rates. By 1982, the unemployment rate had risen to 10 percent, and the inflation rate had fallen to 6 percent. As workers and firms lowered their expectations of future inflation, the short-run Phillips curve shifted down. The adjustment in expectations allowed the Fed to switch to an expansionary monetary policy, which by 1987 brought unemployment back to the natural rate of unemployment, with an inflation rate of about 4 percent. The orange line shows the actual combinations of unemployment and inflation for each year from 1979 to 1989.
The Fed chairs who followed Volcker accepted the lesson of the 1970s that it was important to head off potential increases in inflation before the increases became embedded in the economy. For instance, in 2015, then Fed Chair Janet Yellen in explaining why the FOMC was likely to raise to soon its target for the federal funds rate noted that: “A substantial body of theory, informed by considerable historical evidence, suggests that inflation will eventually begin to rise as resource utilization continues to tighten. It is largely for this reason that a significant pickup in incoming readings on core inflation will not be a precondition for me to judge that an initial increase in the federal funds rate would be warranted.”
Between 2015 and 2018, the FOMC increased its target for the federal funds rate nine times, raising the target from a range of 0 to 0.25 percent to a range of 2.25 to 2.50 percent. In 2018, Raphael Bostic, president of the Federal Reserve Bank of Atlanta justified these rate increases by noting that “… we shouldn’t forget that [the Fed’s] credibility [with respect to keeping inflation low] was hard won. Inflation expectations are reasonably stable for now, but we know little about how far the scales can tip before it is no longer so.”
He used the following figure to illustrate his point.
Bostic interpreted the figure as follows:
“[The red areas in the figure are] periods of time when the actual unemployment rate fell below what the U.S. Congressional Budget Office now estimates as the so-called natural rate of unemployment. I refer to these episodes as “high-pressure” periods. Here is the punchline. Dating back to 1960, every high-pressure period ended in a recession. And all but one recession was preceded by a high-pressure period….
I think a risk management approach requires that we at least consider the possibility that unemployment rates that are lower than normal for an extended period are symptoms of an overheated economy. One potential consequence of overheating is that inflationary pressures inevitably build up, leading the central bank to take a much more “muscular” stance of policy at the end of these high-pressure periods to combat rising nominal pressures. Economic weakness follows [resulting typically, as indicated in the figure by the gray band, in a recession].”
By July 2019, a majority of the members of the FOMC, including Chair Powell, had come to believe that with no sign of inflation accelerating, they could safely cut the federal funds rate. But they had not yet explicitly abandoned the view that the FOMC should act to preempt increases in inflation. The formal change came in August 2020 when, as discussed earlier, the FOMC announced the new FAIT.
At the time the FOMC adopted its new monetary policy strategy, most members expected that any increase in inflation owing to problems caused by the Covid-19 pandemic—particularly the disruptions in supply chains—would be transitory. Because inflation has proven to be more persistent than Fed policymakers and many economists expected, two aspects of the FAIT approach to monetary policy have been widely discussed: First, the FOMC did not explicitly state by how much inflation can exceed the 2 percent target or for how long it needs to stay there before the Fed will react. The failure to elaborate on this aspect of the policy has made it more difficult for workers, firms, and investors to gauge the Fed’s likely reaction to the acceleration in inflation that began in the spring of 2021. Second, the FOMC’s decision to abandon the decades-long policy of preempting inflation may have made it more difficult to bring inflation down to the 2 percent target without causing a recession.
Federal Reserve Governor Lael Brainard recently remarked that “it is of paramount importance to get inflation down” and some Fed policymakers believe that the FOMC will have to begin increasing its target for the federal funds rate more aggressively. (The speech in which Governor Brainard discusses her current thinking on monetary policy can be found here.) For instance James Bullard, president of the Federal Reserve Bank of St. Louis, has argued in favor of raising the target to above 3 percent this year. With the Fed’s preferred measure of inflation running above 5 percent, it would take substantial increases int the target to achieve a positive real federal funds rate.
It is an open question whether Jerome Powell finds himself in a position similar to that of Paul Volcker in 1979: Rapid increases in interest rates may be necessary to keep inflation from accelerating, but doing so risks causing a recession. In a recent speech (found here), Powell pledged that: “We will take the necessary steps to ensure a return to price stability. In particular, if we conclude that it is appropriate to move more aggressively by raising the federal funds rate by more than 25 basis points at a meeting or meetings, we will do so.”
But Powell argued that the FOMC could achieve “a soft landing, with inflation coming down and unemployment holding steady” even if it is forced to rapidly increase its target for the federal funds rate:
“Some have argued that history stacks the odds against achieving a soft landing, and point to the 1994 episode as the only successful soft landing in the postwar period. I believe that the historical record provides some grounds for optimism: Soft, or at least softish, landings have been relatively common in U.S. monetary history. In three episodes—in 1965, 1984, and 1994—the Fed raised the federal funds rate significantly in response to perceived overheating without precipitating a recession.”
Some economists have been skeptical that a soft landing is likely. Harvard economist and former Treasury Secretary Lawrence Summers has been particularly critical of Fed policy, as in this Twitter thread. Summers concludes that: “I am apprehensive that we will be disappointed in the years ahead by unemployment levels, inflation levels, or both.” (Summers and Harvard economist Alex Domash provide an extended discussion in a National Bureau of Economic Research Working Paper found here.)
Clearly, we are in a period of great macroeconomic uncertainty.
Photo of Russian President Vladimir Putin from the Wall Street Journal.
On February 24, when Russian President Vladimir Putin launched an assault on Ukraine he apparently expected within a few days to achieve his main objectives, including occupying the Ukrainian capital of Kyiv and replacing the Ukrainian government. After three weeks, the fierce resistance of the Ukrainian armed forces have resulted in his failing to achieve these objectives. Although the Russian military had expected to experience few casualties or losses of equipment, in fact Russia has already lost more military personnel killed than the United States has since 2001 in Afghanistan and Iraq combined, as well as experiencing the destruction of many tanks, planes, and other equipment.
The United States, the European Union, and other countries have imposed economic sanctions on Russia that have reduced the country’s ability to import or export most goods, other than oil and natural gas. The sanctions have the potential to reduce the standard of living of the average Russian citizen.
Most importantly, the war has killed thousands of Ukrainians and inflicted horrendous damage on many Ukrainian cities.
Despite all this, is Putin’s persistence in the invasion rational or if he were acting rationally would he instead withdraw his troops or accept a political comprise (at this writing, negotiations between representatives of Russia and Ukraine are continuing)? First, recall the economic definition of rationality: People are rational when they take actions that are appropriate to achieve their goals given the information available to them. (We discuss rationality in Microeconomics, Chapter 10, Section 10.4, and in Economics, Chapter 10, Section 10.4.) Note that rationality does not deal with whether a person’s goals are good or bad. In this discussion, we are considering whether Putin is acting rationally in attempting to achieve the—immoral—goal of subjugating a foreign country.
Peter Coy, a columnist for the New York Times, discusses three reasons Putin may continue his attack on Ukraine even though, “The bloody invasion of Ukraine has been a disaster” for Putin. The first reason, Coy recognizes, involves an economic concept. His other two reasons can also be understood within the economic framework we employ in Microeconomics.
First, Coy argues that Putin may have fallen into one of the pitfalls to decision making we discuss in Chapter 10: A failure to ignore sunk costs. Coy notes that Putin may want to continue the attack to justify the death and destruction that has already occurred. However, those costs are sunk because no subsequent action Putin takes can reduce them. If Putin is continuing the attack for this reason, then Coy is correct that Putin is not acting rationally because he is failing to ignore sunk costs in making his decision.
There is a subtle point, though, that Coy may be overlooking: Putin is effectively a dictator, but he may still believe he needs to avoid Russian public opinion turning too sharply against him. In that case, even if recognizes that he should ignore sunk costs he may believe that the Russian public may not be willing to ignore the costs of the death and destruction that has already occurred. In that case, his refusal to ignore this sunk cost be rational.
Coy’s second reason why Putin may continue the attack is that he may believe “just another few weeks of fighting will be enough to subdue Ukraine.” Although Coy doesn’t discuss the point in these terms, it would be rational for Putin to continue the attack if he believes that the marginal benefit of doing so exceeds the marginal cost. (We discuss this point directly in Chapter 1, Section 1.1 “Optimal Decisions Are Made at the Margin,” and provided many examples throughout the text.) The marginal cost includes the additional Russian military casualties and losses of equipment from prolonging the war and the cost of economic sanctions to the Russian economy. (It seems unlikely that Putin is taking into account the additional loss of life among Ukrainians and the additional devastation to Ukrainian cities from prolonging the war.)
The marginal benefit from continuing the attack would be either winning the war or obtaining a more favorable peace settlement in negotiations with the Ukrainian government. If Putin believes that the marginal benefit is greater than the marginal cost, he is acting rationally in continuing to attack.
Coy’s final reason why Putin may continue the attack is that “he has little to lose by fighting on.” Although Coy doesn’t discuss the point in these terms, Russia may be suffering from a principal-agent problem. As we discuss in Microeconomics, Chapter 8, Section 8.1 (also Economics, Chapter 8, Section 8.1 and Macroeconomics, Chapter 6, Section 6.1) the principal-agent problem arises when an agent pursues the agent’s interst rather than the interests of the principal in whose behalf the agent is supposed to act. In this case, Putin is the agent and the Russian people are the principal. Putin’s own interest may be in prolonging the war indefinitely in the hopes of ultimately winning, despite the additional Russian soldiers who will be wounded or killed and despite the economic suffering of the Russian people resulting from the sanctions.
Although as president of Russia, Putin should be acting in the best interests of the Russian people, as a dictator, he can largely disregard their interests. Unlike his soldiers, Putin isn’t exposed to the personal dangers of being in battle. And unlike the average Russian, Putin will not suffer a decline in his standard of living because of economic sanctions.
Appalling as the consequences will be, Putin’s continuing his attack on Ukraine may be rational.
Sources: Peter Coy, “Here Are Three Reasons Putin Might Fight On,” New York Times, March 14, 2022; Alan Cullison, “Talks to End Ukraine War Pause as Russia’s Offensive Intensifies,” Wall Street Journal, March 14, 2022; and Thomas Grove, “Russia’s Military Chief Promised Quick Victory in Ukraine, but Now Faces a Potential Quagmire,” Wall Street Journal, March 6, 2022.
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