Was Friedman Wrong?

Dr. Alan Blinder urges us to remain unconcerned about inflation in a Wall Street Journal op-ed:

Much of this year’s inflationary surge can be traced to two transitory factors: bounceback from the anomalous negative inflation readings of early 2020 and bottlenecks as the economy reopens unevenly.

One simple way to assess the importance of special factors is to consult the trimmed mean inflation series maintained by two of the Federal Reserve banks. These measures ignore the prices with the highest and lowest inflation rates and focus on the rest.

It turns out that the Dallas Fed’s trimmed mean PCE inflation rate over the past 12 months is 1.9%, and the Cleveland Fed’s trimmed mean CPI inflation rate is 2.6%. Not very scary. The high-inflation outliers—such as prices for used cars and energy—aren’t illusions, but they won’t persist.

A second inflation worry is that the U.S. economy, powered by pent-up consumer demand and huge government expenditures, will soon soar into the inflationary zone. Could be. But there are three counterarguments.

First, this worry reflects Phillips curve thinking, which hypothesizes that low unemployment rates make the inflation rate rise. But inflation wasn’t rising before the pandemic despite a 3.5% unemployment rate.

Second, the bond market isn’t buying the argument. Inflation forecasts embedded in bond yields remain consistent with the Fed’s low target.

Third, much of the extreme fiscal stimulus that has been driving spending is transitory. Most pandemic relief spending will be ending soon, and I don’t think Congress will approve much more spending this year that isn’t paid for.

The big question is how pent-up consumer demand will play out. American households socked away about $2 trillion in bank accounts as the pandemic raged. If that money gushes out, we’re likely in for some classic demand-side inflation. But if it gets spent gradually, American businesses will meet demand easily.

The third inflation worry is more subtle. Most of the supply-side bottlenecks, such as the shortage of computer chips, are global. Yet inflation is running higher in the U.S. than in other advanced economies. Is this evidence that we’ve used up the slack and are already “running hot”?

Milton Friedman famously remarked that “inflation is always and everywhere a monetary phenomenon” and I don’t think the astonishing increase in the money supply over the last year should be ignored. A question that Dr. Blinder does not address: does he think that the additional fiscal stimulus that the Biden Administration advocates is called for? No one can seriously maintain that it will not require creating additional money. And even advocates of Modern Monetary Theory do not argue that production can be extended beyond potential production using borrowed money. What if the additional potential short term production is zero?