Category Archives: Monetary Theory

Latest Producer Price Index Indicates Inflation Too High

This press release was originally posted on

The government’s latest numbers on average changes in prices, as measured by the Producer Price Index (PPI), are up at an annualized rate of 8.3 percent – higher than the Consumer Price Index’s latest reading of 5.4 percent.

CEI Senior Fellow Ryan Young says the discouraging numbers indicate Congress should change course.

“The PPI is often seen as a leading indicator of what is to come, and today’s high reading indicates inflation is much higher than the Fed’s longtime target inflation rate of about 2 percent. High inflation is bad news for the near future. While a return to 1970s-era stagflation remains unlikely because the only damper on an otherwise-sound economy is the pandemic, today’s inflation is still cause for concern because policymakers may not learn the right lessons.

“The main causes of today’s inflation are heavy deficit spending and a loose Federal Reserve policy. The Federal Reserve indicated it will dial things back a bit on its end starting next year, but since there is a midterm election coming up, it will likely face political pressure to keep interests low. On spending, both parties are proving hopeless.

“Today’s inflation is preventable. People are opening up to the extent they feel safe doing so. Congress’ ongoing spending binge will have little or no effect on people’s safety decisions. Policymakers should instead encourage prudence in dealing with COVID risks without risking backlash by being too heavy-handed about it. The most useful actions policymakers could take would be passing non-spending stimulus measures such as loosening regulations on occupational licensing, trade restrictions, and excessive permit and paperwork burdens.”

New Inflation Numbers: Still High, Still Fixable

July’s inflation numbers are out. The annualized Consumer Price Index came in at 5.4 percent, compared to a 2 percent target. The month-to-month increase was 0.5 percent, an improvement over June’s 0.9 percent. While a return to 1970s stagflation is almost certainly not in the cards, inflation is still too high. Congress and President Biden should act now to keep it in check.

This appears unlikely at the moment. As of this writing, their latest trillion-dollar spending bill is in the process of clearing the Senate, though it will likely face friction and delay in the House. Assuming the bill does pass, it will nudge inflation upwards in future months while doing little to help the economy. Fiscal discipline in Washington is currently about as popular as the plague, but that does not change the need to reduce deficit spending. Economic recovery depends on increasing vaccination rates, not more politically motivated spending.

Politicians also need to respect the Federal Reserve’s independence. Higher interest rates are necessary to keep inflation low—but they also make government debt more expensive. President Biden and other political officials should resist the urge to pressure the Fed to keep rates low, and should spend less instead. Political meddling in central banks is how inflationary debacles like in Argentina happen. While the Fed has its flaws, it can do a good job of keeping inflation low—if it’s allowed to.

Other price increases have nothing to do with inflation (see my recent post on what inflation is, and what it isn’t). These price increases also deserve attention.

Trade barriers from both the Trump and the Biden administrations are upsetting supply chains. Above and beyond inflation, protectionist trade policies are increasing prices for cars and houses, and are largely responsible for computer chip shortages. Occupational licenses are keeping honest people out of work. Excessive regulations and permit requirements are blocking new ideas and projects that could push product prices down. Financial regulations are keeping capital away from small businesses that could use to it grow and compete against bigger companies. Energy policy restrictions are raising prices across the economy.

It is not enough to do simply do something. It is important to do the right things. Today’s policy mistakes are likely not enough to topple the COVID-19 crisis recovery, but they will slow it down, for no good reason. Fortunately, there are lots of sound policies that can hold down inflation while boosting the COVID recovery. Many of them are in CEI’s most recent Agenda for Congress.

CPI Inflation Indicator Hits 5 Percent: Not Stagflation, But a Useful Warning

The Consumer Price Index (CPI) for May came out this morning. At 5 percent, it was higher than expected. CPI has its flaws as an indicator, but the fact that it is now the highest it has been since the 2008 financial crisis still says something useful. We’re not going back to 1970s stagflation, so nobody needs to freak out, but today’s numbers are a warning. Policy makers should listen.

Trillions of dollars of proposed new deficit spending would further increase inflation, and would mostly stimulate the politically connected. The Federal Reserve should resist political pressure to further flood the money supply in hopes of stimulating a faster COVID recovery.

The timing is also off. Most projects would not kick in until the economy is already mostly recovered anyway. While there is still a way to go, unemployment is already below 6 percent, GDP is working its way back to trend, and the return of in-person schooling this fall will allow more parents to reenter the workforce. Continued progress depends on vaccination rates, not new political projects.

Rather than producing more cash, Congress should enable more production of actual goods and services with a deregulatory stimulus, lowering of trade barriers, and incentives for more vaccinations. Almost a third of occupations now require some sort of license. These keep thousands of would-be small entrepreneurs out of the market, and make it harder for workers to find or change jobs. Financial regulations make it hard for startups and struggling businesses to find capital to grow or stay open—and higher inflation would worsen the problem. Endless permits and years-long environmental reviews are blocking infrastructure projects that could already be underway.

Tariffs left over from the Trump administration, along with new ones the Biden administration is proposing, are making cars and houses more expensive at a lousy time, and could hit billions of dollars of other goods this holiday shopping season.

Vaccination rates are the single most important factor for reopening the economy. People are itching to get back to normal, but first they need to feel safe. Remember, people didn’t wait for governors’ orders to lock down in the first place. Opening back up is also a decision people are making for themselves. Lifting government restrictions might have some impact at the margin. Politicians are not in the driver’s seat here, but there are still things they can do. Some states have tried incentive programs, like lottery drawings and free goods. These are already having a positive impact in communities, saving lives and letting people open back up. More of these would speed the process more than inflation would.

An inflationary boost is tempting for politicians because it is easy. It takes hard work to make substantive reforms to regulation and trade policy and to reach out to vaccine-hesitant people and ask them to do the right thing. But what is worthwhile is rarely easy. While today’s inflation news is not doom-and-gloom, it is cause for concern. We are at an inflection point. Will Congress and President Biden do the right thing?

For more, see my recent explainer on how inflation works, and my recent op-ed on how to stimulate the economy without new spending.

In the News: Inflation

About a week ago, I was quoted in another Center Square story on inflation.

What Inflation Is, and What It Isn’t

It looks like we’re in for a bit of inflation. After decades of stable 2 percent inflation, the latest indicators say it’s moving up to about 4 percent. While fears of Carter-era stagflation are overblown, even a modest jump in inflation would be harmful. The warning signs are clear, and policy makers should act to avoid it. They probably won’t. Even so, a lot of people need to chill out on their inflation fearmongering.

We’re not going to become Argentina or Zimbabwe. We’re not even going back to the 1970s, when inflation was in the double digits. Part of the confusion is that many people seem to be confused about what inflation is, and what it isn’t. This post will try to clarify that in plain English.

The late Nobel laureate economist Milton Friedman famously said that “inflation is always and everywhere a monetary phenomenon.” That means inflation has to do with money itself. When the money supply changes, but the amount of actual goods and services doesn’t, the price level changes. This can happen when the government prints more dollars, adjusts interest rates on loans, and engages in heavy deficit spending.

Other types of price changes are not inflation. The recent hike in gas prices following the Colonial Pipeline hack was not inflation. That was supply and demand. The supply of gas was cut off, so its price went up. Since this didn’t involve the supply of money itself, it wasn’t inflation.

Computers are another example of non-inflation price changes. Most people are familiar with Moore’s Law, which states that computing power at a given price doubles every two years or so. On paper, this continual price drop looks like deflation. It is not. The price is going down because of technological improvements. Money supply has nothing to do with it. Again, if a price change isn’t monetary, it isn’t inflation.

Some of this confusion is baked into the indicators we use to measure inflation, such as the Consumer Price Index) and the Personal Consumption Expenditures Price Index. These take a basket of common goods and track their prices over time. While this is good for tracking overall price changes, they can’t precisely suss out how much of those price changes are due to monetary factors like deficit spending or dollar printing, versus how much is caused by non-monetary factors, like broken pipelines or technological progress. These indicators are useful and can give us a general idea of what is happening. But they are not perfect, and most economists believe they overstate inflation.

Many people are worrying about gas price increases as a harbinger of inflation. There is a psychological reason for this—for a lot of people, the oil price shocks of the inflationary 1970s are within living memory. Today’s shocks are bringing back some bad memories, and it is natural to make that association. But if it isn’t monetary, it isn’t inflation. The recent price shock was a supply and demand shock.

The rapid gas price increase also comes after people had gotten used to enjoying a year of low gas prices due to the pandemic. Coming up from a lower baseline makes a sharp increase feel even sharper. But again, this price change wasn’t monetary. People weren’t driving as much during lockdowns, so demand for gas was down. Money supply had nothing to do with it.

People shouldn’t be so jumpy, though it’s understandable that they would be. While 4 percent inflation is not cause for alarm, it will still cause harm. Inflation is a regressive tax that hits everyone, but especially the poor. When your dollars buy less for reasons having nothing to do with supply and demand, that is unfair—especially if you are already having trouble making ends meet.

Inflation also causes long-term harm. Prices are information signals. Even if people had no idea the Colonial Pipeline had been hacked, seeing a $16 per gallon price told them to buy less gas, and save supply for people who really need it. The hoarders the Internet has been making fun of are the exception, not the rule. Some of the images are also fakes.

Inflation messes with those signals. When a fake price signal tells people to buy one good instead of another, businesses will shift resources to meet that fake demand. That leaves everyone worse off—consumers and businesses alike. When people make long-term investment decisions based on faulty signals, the result is malinvestment—and fewer resources available for good investments.

How can policy makers keep inflation in check? One way is to spend less. When government engages in deficit spending, it increases the money supply. Part of the cost of the trillions of dollars of stimulus and infrastructure spending will be extra inflation—not enough to bring back bellbottom jeans, but enough to cause some harm.

Unfortunately, neither party is interested in spending restraint. Fortunately, even a $2 trillion infrastructure bill, if spread out over 10 years, will not have a major inflationary effect on an economy that is expected to produce more than $200 trillion over that time. It might be enough to add 1/10th of a percentage point or two to inflation, depending on how other factors play out. But it is not enough to cripple the price system.

Another way to keep inflation in check is through the Federal Reserve. The best policy for the Fed would be to adopt a strict rule like the Taylor rule or Nominal GDP targeting. These work by giving the Fed set instructions on how to respond to economic conditions. A simplified version of how these rules work is that if the economy grows by a certain amount, the Fed increases money supply by a certain matching amount specified by the rule.

This would accomplish two things. First, it would keep the level of inflation relatively low. All else being equal, a lower inflation rate is better than a higher one.

Second, sticking to a rule would keep inflation predictable. That is more important. If inflation is stable, it can’t do very much harm, even if it is relatively high. People can plan around steady inflation by factoring it into interest rates and cost-of-living pay increases. But if inflation is jumping all over the place, how can a small business taking out a 10-year loan calculate a fair interest rate?

While the Fed is unlikely to adopt a formal rule, it can at least resist political pressure to mess with inflation levels on election-minded politicians’ changing whims.

The recent news about inflation is not good, but it is also not apocalyptic. While inflation and monetary policy are a lot more detailed than described here, even a little bit of knowledge can show that while people should keep an eye on the new inflation, they also do not need to panic.

In the News: Inflation

I was recently quoted in a Center Square article about the recent uptick in inflation. Also quoted in the article is George Selgin, who unlike me is one of the top monetary economists in the country.

Read the whole thing here.

Keynes – The General Theory of Employment, Interest, and Money

Keynes – The General Theory of Employment, Interest, and Money

My undergrad macroeconomics teacher was an avowed Keynesian. Most of what he taught was in this book, except in the forms of Marshallian geometric analysis and Samuelsonian algebra. I could have saved 19-year old me a great deal of time and anguish by simply reading Keynes’ original, mostly verbal explanations of his ideas. In fact, that pedagogical experience was one reason I switched my undergrad major from economics to history, despite my much greater enthusiasm for economics. Depending on who teaches intro classes, economic ideas are sometimes taught more clearly outside of economics departments.

People often forget that Keynes worked from the same quantity theory of money framework his rivals Friedman and Hayek relied on—an insight I was never taught in undergrad, thanks in part to poor standard pedagogical practices.

Nearly all economists, regardless of ideology, agree that tinkering with the money supply can induce temporary booms and busts. Where they differ is that for monetarists and other free-market types, the fact that policymakers can mess with the price system does not imply that they should. There are tradeoffs a boom now comes at the price of a bust later. Picking up one part of the economy comes at the cost of dragging down other parts. Moreover, unintended consequences can be unpredictable, and harder to manage than the original problems.

Keynes and many of the economists he has influenced instead work with idealized models of economics and government. Economists, using increasingly sophisticated techniques, are increasingly able to foresee and adapt to changing circumstances and unintended consequences to maintain economic stability. Fiscal and monetary policies will never be perfect, but with careful management they can outperform unmanaged markets. Also in this model, politicians actually listen to economists. Even more fantastically, politicians use their boom-and-bust power in the public interest. They do not use it to influence their electoral prospects, or give favors to rent-seekers.

On the positive side, Keynes’ remarks about animal spirits remain insightful, though underappreciated. Here Keynes shared important common ground with economists from Adam Smith on down to his rough contemporaries such as Philip Wicksteed, Frank Knight, and F.A. Hayek, who all emphasized human psychology in their works over formal modeling.

Keynes’ followers pursued a different path after Paul Samuelson, preferring instead to confine themselves to quantifiable models, and to study Homo economicus rather than Homo sapiens. The old joke about Keynesians being more Keynesian than Keynes ever was is often true. Fortunately, the behavioral economics movement has done much to revive animal spirits in the wake of MIT-Harvard-Princeton’s sterilizing the profession, though many of them forget that human frailties also apply to policymakers and the policies they make.

This is not Keynes’ fault. But his unintentional legacy has harmed economics as a discipline, which has missed out on important insights and discoveries by largely walling itself off from other, less quantitative disciplines for several decades. Keynesian models have also acted as enablers for policymakers eager to hear justifications for things they want to do anyway, and for excuses to forget that can does not always imply ought.

CEI Press Release on 4.1 Percent GDP Growth in Q2 2018

Cross-posted from The short version: this week’s growth report is good news, but the long-term outlook is less rosy.

The Department of Commerce announced Friday morning the U.S. economy grew by 4.1 percent in the second quarter of 2018.

CEI Vice President for Strategy Iain Murray said:

“Today’s growth numbers are yet more proof that supply-side policies work. Freeing up labor and capital by reducing the burden of government regulation and taxation will lead to high growth, more opportunity, more innovation, and lower unemployment. This rising tide will lift all boats, so it is important both that these policies continue and no new policies, like trade barriers, contradict them.”

CEI Fellow Ryan Young said:

“Four percent economic growth is wonderful news. An economy can double in size in just 18 years at that pace. While President Trump deserves much of the criticism he gets for his economic policies, his slowing of regulatory growth and some short-term benefits from his income tax cut probably helped boost growth.

“The long-term outlook is less sanguine. The extra debt from the tax cut will have to be repaid, dampening growth. And as the economic effects from his tariffs begin to be felt, growth could noticeably slow as soon as this year. Most troubling are Trump’s rumblings about exercising more control over the Federal Reserve, which is supposed to be politically independent. If there is anything economists across the political spectrum hold sacred, it is the price system. Politicians toy with it at our peril, as Herbert Hoover and Richard Nixon found out.

“If President Trump restrains his impulses, the near future will be as bright as today’s report. If not, rough economic times are ahead.”

Raise, Don’t Level: New CEI Papers on Inequality and Poverty Relief

Economic inequality is one of today’s defining issues. How to address it? Iain Murray and I offer an unconventional approach in a new two-part CEI study, released today. The first part frames the issue. The title sums it up well enough: People, Not Ratios: Why the Debate over Income Inequality Asks the Wrong Questions. The second part,The Rising Tide: Answering the Right Questions in the Inequality Debate, outlines a concrete policy agenda to make the poor better off.

Anti-poverty activists routinely fret about the ratio between a CEO’s salary and her lowest-paid employee’s, or how the top one percent’s ratio of national income compares to the bottom one percent’s. Instead of mathematical ratios, we encourage activists to focus on human beings. Again, we plead: focus on people, not ratios.

Ratio-obsessed activists from Thomas Piketty to Naomi Klein ignore some obvious questions due to their monomania:

  • How are the poor actually doing?
  • Is their economic situation improving over time?
  • What policies can make the global poor better off over time?

We seek to fill these disappointing gaps. According to nearly all available data, poor people are better off than ever before in human history—keep at it, then! There is still lots to do, but ignoring the accomplishments people have already made, and what can make more accomplishments possible, only hurts the poor.

Over the course of the 20th century, infant mortality went down by more than 90 percent—just think of how many parents’ broken hearts have stayed whole thanks to modern technology and sanitary practices.

Life expectancy improved by 30 years during the 20th century. And that’s not the only type of length modernity has improved: from 1900 to 1950, the average American became three inches taller, thanks to better nutrition, food security, and health care. The process has only continued since then.

Even if it was only the top one percent that enjoyed zero infant mortality, lived a hundred years, and were all seven feet tall, their best efforts could not bias society-wide statistics nearly that much, despite their most conspiratorial plutocratic efforts. This is what mass prosperity looks like.

According to the Swedish economist Max Roser, since 1960 the number of people living in absolute poverty has declined from nearly two billion to about 700 million—a two-thirds decline. And this happened as total world population more than doubled! This is good news. Today’s most important task is to keep this great enrichment going, and to eliminate absolute poverty altogether.

The poor will never have as much as the rich—every curve has a bottom and a top ten percent, and always will. No changing that. But only the hardest heads deny that most poor people today live better lives than their parents or grandparents did—and that future generations can expect this wonderful trajectory to continue, if they’re allowed to.

This is both a reason to celebrate, and a reason to double down. Now that we haveasked the right questions about inequality, the second part of our study, The Rising Tide, seeks to answer them: what policies can continue to make the world’s poor better off?

There are a lot of answers. We don’t pretend to have all of them, but we offer a few. One is an honest price system: runaway-inflation countries such as Zimbabwe and Venezuela are universally poor. Keeping inflation in check and making sure prices convey honest information will help consumers and entrepreneurs make wise decisions that create value for people.

Affordable energy is another answer, allowing everything from clean home heating (natural gas is somewhat cleaner than dung and logs, especially indoors) to more and better transportation choices, which expands employment options.

Any aspiring entrepreneur needs access to capital—Dodd-Frank-style financial regulations openly insult every person trying to escape poverty. So do many governments’ resistance to granting formal property rights to their people.

Another answer—there really are a lot of them, and no single panacea—is occupational licensing reform. There is no legitimate reason for an interior decorator or a hair-braider to undergo hundreds of hours of training in something they already know how to do, in order to do for pay something they can do for free. Nearly a third of American workers require government permission to begin their day’s work. That is ethically wrong, and should be immediately reformed.

Inequality is a complicated issue. Properly addressing it requires both asking and answering the right questions. Ask how real-world people are doing, not abstract income ratios. And ask about policies that can help people escape poverty. The answers are numerous, and Iain’s and my papers do not pretend to have all of them.

But, we humbly submit, a general ethos of not stamping down on impoverished hands would be a good start. It would also be quite a change from current policy in the U.S. and many other countries.

For more, see our papers, People, Not Ratios: Why the Debate over Income Inequality Asks the Wrong Questions, and The Rising Tide: Answering the Right Questions in the Inequality Debate.

The Improvisational Fed, and Unpredictable Regulations

Improvisation can be a wonderful thing when performed by talented hands—Charlie Parker, Miles Davis, and the like. The Federal Reserve, especially for the past several weeks, has fancied itself an improvisational talent on that level. But like most humans, Janet Yellen is no Charlie Parker. They should consider a return to the Paul Volcker/early Alan Greenspan adherence to a defined rule. But that isn’t the end of the story—any substantive Fed reforms will fail unless they are coupled with a thorough program of regulatory reform reaching through the entire executive branch. This post will examine a few worthwhile Federal Reserve reforms, then some regulatory reforms, most of which have already passed the House.

The rest of the executive branch has a similar lesson to learn—more complexity and an ever-increasing stock of rules means less predictability and more uncertainty for businesses, investors, and consumers. Agencies’ increasing tendency to regulating through non-transparent “dark matter” means only makes the problem worse.

As far as the Fed goes, the point is not so much which rule a central bank should adopt, but that it must have a rule in the first place, and follow it consistently. Here are three possibilities.

One is a Taylor rule, which the U.S. Federal Reserve followed for the better part of the 1980s and 1990s, with good results. A Taylor rule raises interest rates when growth and inflation are high, and lowers interest rates when growth and inflation are low. In other words, if the economy looks like it might be overheating, the Fed automatically touches the brakes a little bit. And if it looks sluggish, the Fed pushes the gas pedal a little bit, by predictable, predefined amounts.

The Taylor rule can even be summarized in a single equation, making it easy for central bankers to know how they should react to a given set of economic conditions. The Taylor rule worked pretty well when the Fed was following it, but its attempts at managing the business cycle rub this analyst the wrong way—hubris at worst, spitting into the wind at best.

Another possibility that doesn’t have those problems is NGDP targeting, most famously advocated for by Scott Sumner. Instead of interest rates, NGDP targeting directly targets the money supply itself. If Nominal Gross Domestic Product (NGDP) goes up by 5 percent, then so does the money supply, in lockstep. It attempts to keep each dollar describing the same amount of wealth, which should result in stable, predictable prices. Some central bankers prefer having, say, a 2 percent inflation rate in perpetuity. Why someone would prefer such a thing is beyond me, but the NGDP targeting equation can easily be modified to build in a small inflation or deflation as bankers wish. The important thing, again, is not so much what the inflation level is, but that it is steady, and the Fed sticks to principle, even during a crisis.

There are also significant measurement problems with finding out exactly what GDP is at any given time, but an NGDP targeting rule is still far preferable to the Fed’s whim on any given day.

A third possibility is the Friedman rule, named for Milton Friedman. A Friedman rule deflates the currency at the same rate as the prevailing interest rate on government bonds. The goal is to make people indifferent about keeping money in their wallet, versus a savings account. This means people will make those allocation decisions based on economic efficiency, not the vagaries of inflation. Deflation is unsustainable in the long run, and central bankers are hyper-wary of deflation in general, ironically because of Friedman’s own work. He, along with Anna J. Schwartz, convincingly argued that rapid deflation was the Great Depression’s single largest cause.

Each of these rules—and there are others—has its own advantages and drawbacks. The larger point is that the Fed needs to follow some kind of rule, and stick to it. Its inept free-jazz improvisational approach makes entrepreneurs and investors skittish, and results in far less long-term investment.

Regulatory agencies have similar problems. Would you invest in a 30-year project if you had no idea if the EPA would confiscate your land, or if some other agency finds some obscure rule to kill your project? That’s why regulations to be simple and predictable.

Fortunately, a number of reforms are now winding their way through Congress. The REINS Act, as regular readers know, would require Congress to vote on all executive branch regulations with annual costs of more than $100 million.

The SCRUB Act could save nearly $300 billion per year if it works as planned. It would set up an independent commission to comb through all federal regulations, and send Congress a repeal package for an up-or-down vote, with the goal of trimming at least 15 percent from annual compliance costs, currently estimated at $1.9 trillion.

The ALERT Act would establish a one-in, one-out rule similar to what Canada has had for several years. If an agency wants to issue a new rule, it must first get rid of a similar dollar amount of old rules.

The Sunshine Act would rein in a practice called sue-and-settle, under which activist groups sue agencies for missing deadlines or not enforcing rules strictly enough. Since the agencies are often on the same side, and may in some cases be collaborating behind the scenes, they are only too happy to reach a settlement expanding the agency’s power and authority.

Other options include a regulatory budget, similar to the spending budget the federal government is supposed to issue each year. Each agency would have a “budget” of regulatory costs it is allowed to impose, and must prioritize its rule enforcement so it doesn’t exceed its cap. Finally, automatic sunsets for new regulations would automatically scrub old rules from the books unless Congress sees fit to renew them. This would prevent obsolete or harmful rules from becoming immortal.

The Fed’s improvisational approach does no favors to entrepreneurs, investors, or consumers. Nor does the increasingly arbitrary and capricious approach many regulatory agencies are turning towards. Just as the Fed should bind itself to a predictable and stable rule, so should agencies embrace reform to keep their regulations as simple and predictable as possible.