Ch19: Unemployment and Inflation – HubbardOBrienEconomics.com Blog

Soft Landing, Hard Landing … or No Landing?

During the recovery from the Covid–19 pandemic, inflation as measured by the personal consumption expenditures (PCE) price index, first rose above the Federal Reserve’s target annual inflation rate of 2 percent in March 2021. Many economists inside and outside of the Fed believed the increase in inflation would be transitory because it was thought to be mainly the result of supply chain problems and an initial burst of spending as business lockdowns were ended or mitigated in most areas.

Accordingly, the Federal Open Market Committee (FOMC) kept its target for the federal funds rate at effectively zero (a range of 0 to 0.25 percent) until March 2022 and continued its quantitative easing (QE) program of buying long-term Treasury bonds and mortgage-backed securities (MBS) until that same month.

As the following figure shows, by March 2022 inflation had been well above the FOMC’s target for a year. The Fed responded by raising its target for the federal funds rate and switched from QE to quantitative tightening (QT). Although some supply chain problems were still contributing to the high inflation rate during the spring of 2022, the main driver appeared to be very expansionary monetary and fiscal policies. (This blog post from May 2021 has links to contributions to the debate over macro policy at the time. Glenn’s interview that month with the Financial Times can be found here. In November 2022, Glenn argued that overly expansionary fiscal policy was the main driver of inflation in this op-ed in the Financial Times (subscription or registration may be required).We discuss inconsistencies in the Fed’s forecasts of unemployment and inflation here. And in this post we discuss the question of whether the Fed made a mistake in not attempting to preempt inflation before it accelerated.)

Since March 2022, the FOMC has raised its target for the federal funds rate multiple times. In February 2023, the target was a range of 4.50 to 4.75 percent. Longer-term interest rates have also increased. In particular, the average interest rate on residential mortgage loans increased from 3 percent in March 2022 to 7 percent in November 2022, before falling back to around 6 percent in February 2023. In the fall of 2022, there was optimism among some economists that the Fed had succeeded in slowing the economy enough to put inflation on a path back to its 2 percent target. Although many economists had expected that inflation would only return to the target if the U.S. economy experienced a recession—labeled a hard landing—the probability that inflation could be reduced without a recession—labeled a soft landing—appeared to be increasing.

Economic data for January 2023 made a soft landing seem less likely. Consumer spending remained above its trend from before the pandemic, employment increases were unexpectedly high, and inflation reversed its downward trend. A continuation of low rates of unemployment and high rates of inflation wasn’t consistent with either a hard landing or a soft landing. Some observers, particularly in Wall Street financial firms, began describing the situation as no landing. But given the Fed’s strong commitment to returning to its 2 percent target, the no landing scenario couldn’t persist indefinitely.

Many investors had anticipated that the FOMC would end its increases in the federal funds target by mid-2023 and would have made one or more cuts to the target by the end of the year, but that outcome now seems unlikely. The FOMC had increased the federal funds target by only 0.25 percent at its February meeting but many economists now expected that it would announce a 0.50 percent increase at its next meeting on March 21 and 22. Unfortunately, the odds of a hard landing seem to be increasing.

A couple of notes: Although there are multiple ways of measuring inflation, the percentage increase in the PCE is the formal way in which the FOMC determines whether it is hitting its inflation target. To judge what the underlying inflation is—in other words, the inflation rate likely to persist in at least the near future—many economists look at core inflation. In the earlier figure we show movements in core inflation as measured by the PCE excluding prices of food and energy. Note that over the period shown PCE and core PCE follow the same pattern, although core PCE inflation begins to moderate earlier than does core PCE.

Some economists use other adjustments to PCE or to the consumer price index (CPI) in an attempt to better measure underlying inflation. For instance, housing rents and new and used car prices have been particularly volatile since early 2020, so some economists calculate PCE or CPI excluding those prices, as well as food and energy prices. As we discuss in this blog post from last September some economists prefer median CPI as the best measure of underlying inflation. (We discuss some of the alternative ways of measuring inflation in Macroeconomics, Chapter 15, Section 15.5 and Economics, Chapter 25, Section 25.5.) Nearly all these alternative measures of inflation indicated that the moderation in inflation that began in the summer of 2022 had ended in January 2023. So, choosing among measures of underlying inflation wasn’t critical to understanding the current path of inflation.

Finally, the inflation, employment, and output measures that in January seemed to show that the U.S. economy was still in a strong expansion and that the inflation rate may have ticked up are all seasonally adjusted. Seasonal adjustment factors are applied to the raw (unadjusted) data to account for regular seasonal fluctuations in the series. For instance, unadjusted employment declined in January as measured by both the household and establishment series. Applying the seasonal adjustment factors to the data resulted in the actual decline in employment from December to January turning into an adjusted increase. In other words, employment declined by less than it typically does, so on a seasonally adjusted basis, the Bureau of Labor Statistics reported that it had increased. Seasonal adjustments for the holiday season may be distorted, however, because the 2020–2021 and 2021–2022 holiday seasons occurred during upsurges in Covid. Whether the reported data for January 2023 will be subject to significant revisions when the seasonal adjustments factors are subsequently revised remains to be seen. The latest BLS employment report, showing seasonally adjusted and not seasonally adjusted data, can be found here.

NEW! 2/19/23 Podcast – Authors Glenn Hubbard & Tony O’Brien discuss the Fed’s response to economic conditions and their ability to execute a soft-landing.

Join author Glenn Hubbard & Tony O’Brien in their first Sprint 2023 podcast where they revisit inflation as the major topic facing our country, our economy, and our classrooms. Glenn & Tony discuss the Federal Reserve response and the outlook for the economy. While rates have continued to move up, is a soft-landing still possible?

NEW! 11/17/22 Podcast – Authors Glenn Hubbard & Tony O’Brien discuss inflation, the Fed’s Response, FTX collapse, and also share thoughts on economics themes in holiday movies!

A Handy Way to Track Recession Indicators

The Bureau of Labor Statistics is housed in the U.S. Department of Labor. (Photo from don.gov site.)

In a blog post at the end of August, we noted that real GDP declined during the first two quarters of 2022. On September 29, the Bureau of Economic Analysis (BEA) slightly revised the real GDP data, but after the revisions the BEA’s estimates still showed real GDP declining during those quarters.

A popular definition of a recession is two consecutive quarters of declining real GDP. But, as we noted in the earlier blog post, most economists do not follow this definition. Instead, for most purposes, economists rely on the National Bureau of Economic Research’s business cycle dating, which is based on a number of macroeconomic data series. The NBER defines a recession as “a significant decline in activity spread across the economy, lasting more than a few months, visible in industrial production, employment, real income, and wholesale-retail trade.” The NBER discusses its approach to business cycle dating here.

The Federal Reserve Bank of St. Louis’s invaluable FRED economic data site has collected the data series that the NBER’s Business Cycle Dating Committee relies on when deciding when a recession began. The FRED page collecting these data can be found here.

Note that although the Business Cycle Dating Committee analyzes a variety of data series, “In recent decades, the two measures we have put the most weight on are real personal income less transfers and nonfarm payroll employment.” The following figures show movements in those two data series. These data series don’t give a strong indication that the economy was in recession during the first half of 2022. Real personal income minus transfer payments did decline by 0.4 percent between January and June 2022 (before increasing during July and August), but nonfarm payroll employment increased by 1.4 percent during the same period (and increased further in July and August).

As we noted in our earlier blog post, the message from most data series other than real GDP seems to be that the U.S. economy was not in a recession during the first half of 2022.

Should the Fed Be Looking at the Median CPI?

For years, all the products for sale in Dollar Tree stores had a price of $1.00 or less. But as inflation increased, the company had to raise its maxium prices to $1.25. (Thanks to Lena Buonanno for sending us the photo.)

There are multiple ways to measure inflation. Economists and policymakers use different measures of inflation depending on the use they intend to put the measure of inflation to. For example, as we discuss in Macroeconomics, Chapter 9, Section 9.4 (Economics, Chapter 19, Section 19.4), the Bureau of Labor Statistics (BLS) constructs the consumer price index (CPI) as measure of the cost of living of a typical urban household. So the BLS intends the percentage change in the CPI to measure inflation in the cost of living as experienced by the roughly 93 percent of the population that lives in an urban household. (We are referring here to what the BLS labels CPI–U. As we discuss in this blog post, the BLS also compiles a CPI for urban wage earners and clerical workers (or CPI–W).)

As we discuss in an Apply the Concept in Chapter 15, Section 15.5, because the Fed is charged by Congress with ensuring stability in the general price level, the Fed is interested in a broader measure of inflation than the CPI. So its preferred measure of inflation is the personal consumption expenditures (PCE) price index, which the Bureau of Economic Analysis (BEA) issues monthly. The PCE price index is a measure of the price level similar to the GDP deflator, except it includes only the prices of goods and services from the consumption category of GDP. Because the PCE price index includes more goods and services than the CPI, it is suits the Fed’s need for a broader measure of inflation. The Fed uses changes in the PCE to evaluate whether it’s meeting its target of a 2 percent annual inflation rate.

In using either the percentage change in the CPI or the percentage change in the PCE, we are looking at what inflation has been over the previous year. But economists and policymakers are also looking for indications of what inflation may be in the future. Prices of food and energy are particularly volatile, so the BLS issues data on the CPI excluding food and energy prices and the BEA does the same with respect to the PCE. These two measures help avoid the problem that, for example, a period of high gasoline prices might lead the inflation rate to temporarily increase. Note that inflation caclulated by excluding the prices of food and energy is called core inflation.

During the surge in inflation that began in the spring of 2021 and continued into the fall of 2022, some economists noted that supply chain problems and other effects of the pandemic on labor and product markets caused the prices of some goods and services to spike. For example, a shortage of computer chips led to a reduction in the supply of new cars and sharp increases in car prices. As with temporary spikes in prices of energy and food, spikes resulting from supply chain problems and other effects of the pandemic might lead the CPI and PCE—even excluding food and energy prices—to give a misleading measure of the underlying rate of inflation in the economy.

To correct for this problem, some economists have been more attention to the measure of inflation calculated using the median CPI, which is compiled monthly by economists at the Federal Reserve Bank of Cleveland. The median CPI is calculated by ranking the price changes of every good or service in the index from the largest price change to the smallest price change, and then choosing the price change in the middle. The idea is to eliminate the effect on measured inflation of any short-lived events that cause the prices of some goods and services to be particularly high or particularly low. Economists at the Cleveland Fed have conducted research that shows that, in their words, “the median CPI provides a better signal of the underlying inflation trend than either the all-items CPI or the CPI excluding food and energy. The median CPI is even better at forecasting PCE inflation in the near and longer term than the core PCE price index.”

The following figure shows the three measures of inflation using the CPI for each month since January 2019. The red line shows the unadjusted CPI, the green line shows the CPI excluding food and energy prices, and the blue line shows median CPI. To focus on the inflation rate in a particular month, in this figure we calculate inflation as the percentage change in the index at an annual rate. That is, we calculate the annual inflation rate assuming that the inflation rate in that month continued for a year.

Note that for most of the period since early 2021, during which the inflation rate accelerated, median inflation was well below inflation measured by changes in the unadjusted CPI. That difference reflects some of the distortions in measuring inflation arising from the effects of the pandemic.

But the last two values—for July and August 2022—tell a different story. In those months, inflation measured by changes in the CPI excluding food and energy prices or by changes in median CPI were well above inflation measured by changes in the unadjusted CPI. In August 2022, the unadjusted CPI shows a low rate of inflation—1.4 percent—whereas the CPI excluding food and energy prices shows an inflation rate of 7.0 percent and the median CPI shows an inflation rate of 9.2 percent.

We should always be cautious when interpreting any economic data for a period as short as two months. But data for inflation measured by the change in median CPI may be sending a signal that the slowdown in inflation that many economists and policymakers had been predicting would occur in the summer of 2022 isn’t actually occurring. We’ll have to await the release of future data to draw a firmer conclusion.

Sources: Michael S. Derby, “Inflation Data Scrambles Fed Rate Outlook Again,” Wall Street Journal, September 14, 2022; Federal Reserve Bank of Cleveland, “Median CPI,” clevelandfed.org; and Federal Reserve Bank of St. Louis.

Podcasts Back for Fall 2022! – 9/9/22 Podcast – Authors Glenn Hubbard & Tony O’Brien discuss inflation, the Fed’s Response, cryptocurrency, and also briefly touch on labor markets.

Solved Problem: How Can Total Employment and the Unemployment Rate Both Increase?

Supports: Macroeconomics, Chapter 9, Section 9.1, Economics Chapter 19, Section 19.1, and Essentials of Economics, Chapter 13, Section 13.1.

As it does on the first Friday of each month, on September 2, 2022, the U.S. Bureau of Labor Statistics (BLS) released its “Employment Situation” report for August 2022. According to the household survey data in the report, total employment in the U.S. economy increased in August by 442,000 compared with July. The unemployment rate rose from 3.5 percent in July to 3.7 percent in August. According to the establishment survey, the total number of workers on payrolls increased in August by 315,000 compared with July.

How are the data in the household survey collected? How are the data in the establishment survey collected?
Why are the estimated increases in employment from July to August 2022 in the two surveys different?
Briefly explain how it is possible for the household survey to report in a given month that both total employment and the unemployment rate increased.

Solving the Problem

Step 1: Review the chapter material. This problem is about how the BLS reports data on employment and unemployment, so you may want to review Chapter 9, Section 9.1, “Measuring the Unemployment Rate, the Labor Force Participation Rate, and the Employment–Population Ratio.”

Step 2: Answer part a. by explaining how the data from the two surveys are collected. As discussed in Section 9.1, the data in the household survey is from interviews with a sample of 60,000 households, chosen to represent the U.S. population. The data in the establishment survey—sometimes called the payroll survey in media stories—is from a sample of 300,000 establishments (factories, stores, and offices).

Step 3: Answer part b. by explaining why the estimated increase in employment is different in the two surveys. First note that the BLS intends the surveys to estimate two different measures of employment. The household survey includes people working at jobs of all types, including people who are self-employed or who are unpaid family workers, whereas the establishment survey includes only people who appear on a non-agricultural firm’s payroll, so the self-employed, farm workers, and unpaid family workers aren’t counted. Second, the data are collected from surveys and so—like all estimates that rely on surveys—will have some measurement error. That is, the actual increase in employment—either total employment in the household survey or payroll employment in the establishment survey—is likely to be larger or smaller than the reported estimates. The estimates in the establishment survey are revised in later months as the BLS receives additional data on payroll employment. In contrast, the estimates in household survey are ordinarily not revised because they are based only on a survey conducted once per month.

Step 4: Answer part c. by explaining how in a given month the household survey may report an increase in both employment and the unemployment rate. The BLS’s estimate of the unemployment is calculated from responses to the household survey. (The establishment survey doesn’t report an estimate of the unemployment rate.) The unemployment rate equals the total number of people unemployed divided by the labor force, multiplied by 100. The labor force equals the sum of the employed and the unemployed. If the number of people employed increases—thereby increasing the denominator in the unemployment rate equation—while the number of people unemployed remains the same or falls, as a matter of arithmetic the unemployment rate will have to fall.

The BLS reported that the unemployment rate in August 2022 rose even though total employment increased. That outcome is possible only if the number of people who are unemployed also increased, resulting in a proportionally larger increase in the numerator in the unemployment equation relative to the denominator. In fact, the BLS estimated that the number of people unemployed increased by 344,000 from July to August 2022. Employment and unemployment both increasing during a month happens fairly often during an economic expansion as some people who had been out of the labor force—and, therefore, not counted by the BLS as being unemployed—begin to search for work during the month but don’t find jobs.

Source: U.S. Bureau of Labor Statistics, “The Employment Situation—August 2022,” bls.gov, September 2, 2022.

Why Might Good News for the Job Market Be Bad News for the Stock Market?

On Tuesday, August 30, 2022, the U.S. Bureau of Labor Statistics (BLS) released its Job Openings and Labor Turnover Survey (JOLTS) report for July 2022. The report indicated that the U.S. labor market remained very strong, even though, according to the Bureau of Economic Analysis (BEA), real gross domestic product (GDP) had declined during the first half of 2022. (In this blog post, we discuss the possibility that during this period the real GDP data may have been a misleading indicator of the actual state of the economy.)

As the following figure shows, the rate of job openings remained very high, even in comparison with the strong labor market of 2019 and early 2020 before the Covid-19 pandemic began disrupting the U.S. economy. The BLS defines a job opening as a full-time or part-time job that a firm is advertising and that will start within 30 days. The rate of job openings is the number of job openings divided by the number of job openings plus the number of employed workers, multiplied by 100.

In the following figure, we compare the total number of job openings to the total number of people unemployed. The figure shows that in July 2022 there were almost two jobs available for each person who was unemployed.

Typically, a strong job market with high rates of job openings indicates that firms are expanding and that they expect their profits to be increasing. As we discuss in Macroeconomics, Chapter 6, Section 6.2 (Microeconomics and Economics, Chapter 8, Section 8.2) the price of a stock is determined by investors’ expectations of the future profitability of the firm issuing the stock. So, we might have expected that on the day the BLS released the July JOLTS report containing good news about the labor market, the stock market indexes like the Dow Jones Industrial Average, the S&P 500, and the Nasdaq Composite Index would rise. In fact, though the indexes fell, with the Dow Jones Industrial Average declining a substantial 300 points. As a column in the Wall Street Journal put it: “A surprisingly tight U.S. labor market is rotten news for stock investors.” Why did good news about the labor market could cause stock prices to decline? The answer is found in investors’ expectations of the effect the news would have on monetary policy.

In August 2022, Fed Chair Jerome Powell and the other members of the Federal Reserve Open Market Committee (FOMC) were in the process of tightening monetary policy to reduce the very high inflation rates the U.S. economy was experiencing. In July 2022, inflation as measured by the percentage change in the consumer price index (CPI) was 8.5 percent. Inflation as measured by the percentage change in the personal consumption expenditures (PCE) price index—which is the measure of inflation that the Fed uses when evaluating whether it is hitting its target of 2 percent annual inflation—was 6.3 percent. (For a discussion of the Fed’s choice of inflation measure, see the Apply the Concept “Should the Fed Worry about the Prices of Food and Gasoline,” in Macroeconomics, chapter 15, Section 15.5 and in Economics, Chapter 25, Section 25.5.)

To slow inflation, the FOMC was increasing its target for the federal funds rate—the interest rate that banks charge each other on overnight loans—which in turn was leading to increases in other interest rates, such as the interest rate on residential mortgage loans. Higher interest rates would slow increases in aggregate demand, thereby slowing price increases. How high would the FOMC increase its target for the federal funds rate? Fed Chair Powell had made clear that the FOMC would monitor economic data for indications that economic activity was slowing. Members of the FOMC were concerned that unless the inflation rate was brought down quickly, the U.S. economy might enter a wage-price spiral in which high inflation rates would lead workers to push for higher wages, which, in turn, would increase firms’ labor costs, leading them to raise prices further, in response to which workers would push for even higher wages, and so on. (We discuss the concept of a wage-price spiral in this earlier blog post.)

In this context, investors interpretated data showing unexpected strength in the economy—particularly in the labor market—as making it likely that the FOMC would need to make larger increases in its target for the federal fund rate. The higher interest rates go, the more likely that the U.S. economy will enter an economic recession. During recessions, as production, income, and employment decline, firms typically experience lower profits or even suffer losses. So, a good JOLTS report could send stock prices falling because news that the labor market was stronger than expected increased the likelihood that the FOMC’s actions would push the economy into a recession, reducing profits. Or as the Wall Street Journal column quoted earlier put it:

“So Tuesday’s [JOLTS] report was good news for workers, but not such good news for stock investors. It made another 0.75-percentage-point rate increase [in the target for the federal funds rate] from the Fed when policy makers meet next month seem increasingly likely, while also strengthening the case that the Fed will keep raising rates well into next year. Stocks sold off sharply following the report’s release.”

Sources: U.S. Bureau of Labor Statistics, “Job Openings and Labor Turnover–July 2022,” bls.gov, August 30, 2022; Justin Lahart, “Why Stocks Got Jolted,” Wall Street Journal, August 30, 2022; Jerome H. Powell, “Monetary Policy and Price Stability,” speech at “Reassessing Constraints on the Economy and Policy,” an economic policy symposium sponsored by the Federal Reserve Bank of Kansas City, Jackson Hole, Wyoming, August 26, 2022; and Federal Reserve Bank of St. Louis.

How Should We Measure Inflation?

In the textbook, we discuss several measures of inflation. In Macroeconomics, Chapter 8, Section 8.4 (Economics, Chapter 18, Section 18.4) we discuss the GDP deflator as a measure of the price level and the percentage change in the GDP deflator as a measure of inflation. In Chapter 9, Section 9.4, we discuss the consumer price index (CPI) as a measure of the price level and the percentage change in the CPI as the most widely used measure of inflation.

In Chapter 15, Section 15.5 we examine the reasons that the Federal Reserve often looks at the core inflation rate—the inflation rate excluding the prices of food and energy—as a better measure of the underlying rate of inflation. Finally, in that section we note that the Fed uses the percentage change in the personal consumption expenditures (PCE) price index to assess of whether it’s achieving its goal of a 2 percent inflation rate.

In this blog post, we’ll discuss two other aspects of measuring inflation that we don’t cover in the textbook. First, the Bureau of Labor Statistics (BLS) publishes two versions of the CPI: (1) The familiar CPI for all urban consumers (or CPI–U), which includes prices of goods and services purchased by households in urban areas, and (2) the less familiar CPI for urban wage earners and clerical workers (or CPI–W), which includes the same prices included in the CPI–U. The two versions of the CPI give slightly different measures of the inflation rate—despite including the same prices—because each version applies different weights to the prices when constructing the index.

As we explain in Chapter 9, Section 9.4, the weights in the CPI–U (the only version of the CPI we discuss in the chapter) are determined by a survey of 36,000 households nationwide on their spending habits. The more the households surveyed spend on a good or service, the larger the weight the price of the good or service receives in the CPI–U. To calculate the weights in the CPI–W the BLS uses only expenditures by households in which at least half of the household’s income comes from a clerical or wage occupation and in which at least one member of the household has worked 37 or more weeks during the previous year. The BLS estimates that the sample of households used in calculating the CPI–U includes about 93 percent of the population of the United States, while the households included in the CPI–W include only about 29 percent of the population.

Because the percentage of the population covered by the CPI–U is so much larger than the percentage of the population covered by the CPI–W, it’s not surprising that most media coverage of inflation focuses on the CPI–U. As the following figure shows, the measures of inflation from the two versions of the CPI aren’t greatly different, although inflation as measured by the CPI–W—the red line—tends to be higher during economic expansions and lower during economic recessions than inflation measured by the CPI–U—the blue line.

One important use of the CPI–W is in calculating cost-of-living adjustments (COLAs) applied to Social Security payments retired and disabled people receive. Each year, the federal government’s Social Security Administration (SSA) calculates the average for the CPI–W during June, July, and August in the current year and in the previous year and then measures the inflation rate as the percentage increase between the two averages. The SSA then increases Social Security payments by that inflation rate. Because the increase in CPI–W is often—although not always—larger than the increase in CPI–U, using CPI–W to calculate Social Security COLAs increases the payments recipients of Social Security receive.

A second aspect of measuring inflation that we don’t mention in the textbook was the subject of discussion following the release of the July 2022 CPI data. In June 2022, the value for the CPI–U was 295.3. In July 2022, the value for the CPI–U was also 295.3. So, was there no inflation during July—an inflation rate of 0 percent? You can certainly make that argument, but typically, as we note in the textbook (for instance, see our display of the inflation rate in Chapter 10, Figure 10.7) we measure the inflation rate in a particular month as the percentage change in the CPI from the same month in the previous year. Using that approach to measuring inflation, the inflation rate in July 2022 was the percentage change in the CPI from its value in July 2021, or 8.5 percent. Note that you could calculate an annual inflation rate using the increase in the CPI from one month to the next by compounding that rate over 12 months. In this case, because the CPI was unchanged from June to July 2022, the inflation rate calculated as a compound annual rate would be 0 percent.

During periods of moderate inflation rates—which includes most of the decades prior to 2021—the difference between inflation calculated in these two ways was typically much smaller. Focusing on just the change in the CPI for one month has the advantage that you are using only the most recent data. But if the CPI in that month turns out to be untypical of what is happening to inflation over a longer period, then focusing on that month can be misleading. Note also that inflation rate calculated as the compound annual change in the CPI each month results in very large fluctuations in the inflation rate, as shown in the following figure.

Sources: Anne Tergesen, “Social Security Benefits Are Heading for the Biggest Increase in 40 Years,” Wall Street Journal, August 10, 2022; Neil Irwin, “Inflation Drops to Zero in July Due to Falling Gas Prices,” axios.com, August 10, 2022; “Consumer Price Index Frequently Asked Questions,” bls.gov, March 23, 2022; Stephen B. Reed and Kenneth J. Stewart, “Why Does BLS Provide Both the CPI–W and CPI–U?” U.S. Bureau of Labor Statistics, Beyond the Numbers, Vol. 3, No. 5, February 2014; “Latest Cost of Living Adjustment,” ssa.gov; and Federal Reserve Bank of St. Louis.

Senator Elizabeth Warren vs. Economist Lawrence Summers on Monetary Policy

Senator Elizabeth Warren (Photo from the Associated Press)

Lawrence Summers (Photo from harvardmagazine.com)

As we’ve discussed in several previous blog posts, in early 2021 Lawrence Summers, professor of economics at Harvard and secretary of the treasury in the Clinton administration, argued that the Biden administration’s $1.9 trillion American Rescue Plan, enacted in March, was likely to cause a sharp acceleration in inflation. When inflation began to rapidly increase, Summers urged the Federal Reserve to raise its target for the federal funds rate in order to slow the increase in aggregate demand, but the Fed was slow to do so. Some members of the Federal Open Market Committee (FOMC) argued that much of the inflation during 2021 was transitory in that it had been caused by lingering supply chain problems initially caused by the Covid–19 pandemic.

At the beginning of 2022, most members of the FOMC became convinced that in fact increases in aggregate demand were playing an important role in causing high inflation rates. Accordingly, the FOMC began increasing its target for the federal funds rate in March 2022. After two more rate increases, on the eve of the FOMC’s meeting on July 26–27, the federal funds rate target was a range of 1.50 percent to 1.75 percent. The FOMC was expected to raise its target by at least 0.75 percent at the meeting. The following figure shows movements in the effective federal funds rate—which can differ somewhat from the target rate—from January 1, 2015 to July 21, 2022.

In an opinion column in the Wall Street Journal, Massachusetts Senator Elizabeth Warren argued that the FOMC was making a mistake by increasing its target for the federal funds rate. She also criticized Summers for supporting the increases. Warren worried that the rate increases were likely to cause a recession and argued that Congress and President Biden should adopt alternative measures to contain inflation. Warren argued that a better approach to dealing with inflation would be to, among other steps, increase the federal government’s support for child care to enable more parents to work, provide support for strengthening supply chains, and lower prescription drug prices by allowing Medicare to negotiate the prices with pharmaceutical firms. She also urged a “crack down on price gouging by large corporations.” (We discussed the argument that monopoly power is responsible for inflation in this blog post.)

Summers responded to Warren in a Twitter thread. He noted that: “In the 18 months since the massive stimulus policies & easy money that [Senator Warren] has favored & I have opposed, the inflation rate has risen from below 2 to above 9 percent & workers purchasing power has, as a consequence, declined more rapidly than in any year in the last 50.” And “[Senator Warren] opposes restrictive monetary policy or any other measure to cool off total demand. Why does she think at a time when there are twice as many vacancies as jobs that inflation will come down without some drop in total demand?”

Clearly, economists and policymakers continue to hotly debate monetary policy.

Source: Elizabeth Warren, “Jerome Powell’s Fed Pursues a Painful and Ineffective Inflation Cure,” Wall Street Journal, July 24, 2022.