March 03, 2022
Earlier today, I was on a panel with Jason Furman and Joseph Stiglitz, discussing the recent surge in inflation and the prospects for the future. We took some questions from the audience, but there were a number for which we did not have time. I have picked some of these questions to answer myself, for anyone who may be interested.
Was the decision to go big with the Biden stimulus worth the cost in the form of higher inflation?
We can certainly look at the Biden stimulus and point to areas where we spent more than necessary. I would put the high reach of the $1,400 pandemic payments top on that list. If we had a phase out beginning at say, $50,000 a person, they would still reach the overwhelming majority of people who were hurt financially by the pandemic.
We also could have gotten by giving the states less money. Many now find themselves flush with cash and are giving out tax cuts to their residents.
But, we can’t design our policies retroactively. Also, there were political considerations behind the structuring of the package that can’t just be ignored.
To me, the basic question was whether it was worth the risk of going too big, as Biden did, or risk erring on the side of going too small, as was the case with the Obama stimulus in 2009. To my view, Biden made the right call.
We’ve gotten back the vast majority of jobs we lost during the pandemic. The economy is almost back to its pre-recession growth path. And, we shielded the bulk of the population from financial hardship from the pandemic.
This was really a great accomplishment and well worth the cost of say a 2.0 percentage point rise in the inflation rate. Just to be clear, we would have seen higher inflation with the reopening of the economy from the pandemic in any case. The robust stimulus of the Recovery Act added to this, but even countries without large stimulus packages had large upticks of inflation. So, the question is whether the benefits were worth the additional inflation, say going from 5.5 percent to 7.5 percent; we are not asking about the full increase to 7.5 percent.
How does the war in Ukraine affect your assessment of the prospects for the US economy?
This is hard to say at this point, since there is so much uncertainty about the longer-term effects. We can see the short-term jump in the price of oil and natural gas and many other commodities, which are clearly inflationary, but we don’t know how long these rises will be sustained, or if the prices will go higher.
These rises should push us to be more aggressive in our transition to clean energy. I would like to see us try to be innovative in reducing our reliance on fossil fuels, for example by paying people not to drive and offering free bus travel, but I realize there are serious political obstacles to going this route.
In any case, I think it would be a mistake for the Fed to aggressively raise interest rates to counteract this inflation. We need to move to clean energy as quickly as possible. A recession may slow inflation by throwing people out of work and putting downward pressure on wages, but it doesn’t help the transition to clean energy.
Do you think that the US economy has overheated, and needs to be slowed–even if it means reducing employment–in order to lower inflation?
I think there is a case that the stimulus increased demand at points in 2021 to levels that the economy could not meet. A big part of this story was that demand was so highly tilted towards goods, since people couldn’t buy a number of services due to the pandemic. Nonetheless, it was true that demand exceeded supply in wide areas of the economy.
But putting the past aside, the question is how best to deal with the inflation that resulted. I think there is a good case that inflation will largely fade as the backlogs in supply chains is resolved.
We have already seen this in a few areas. Television prices have fallen 6.3 percent in the last five months after rising 8.7 percent between March and August. Used car prices have fallen 1.5 percent in the first half of February, after rising almost 50 percent since the start of the pandemic. I expect that we will see this in many more areas in the months ahead.
In any case, I don’t think there is a serious case that the economy is overheating at present. The unemployment rate is still somewhat higher than before the pandemic. We have recently seen a modest rise in unemployment insurance claims, indicating that employers are comfortable laying off workers, rather than hoarding labor that they may not need. (I’m not happy to see people laid off, but this is an indication of a modest weakening in the labor market.)
I expect that, with cases of omicron dropping rapidly, we will get back to something closer to a normal economy. This should help to reduce inflationary pressure as businesses don’t have to continually adjust to workers missing days because of the pandemic.
How is inflation affecting the housing market? Who is winning? Who is losing?
The low mortgage rates during the pandemic, coupled with the various pandemic payments, have given many people the ability to pay more for housing. This has sent house prices soaring.
I expect the pressure on prices to be reduced in the months ahead for several reasons. First, interest rates have risen. The interest rate in 30-year fixed rate mortgages had been under 3.0 percent at various points during the pandemic. It is now near 4.0 percent.
The second reason is that we have seen a huge increase in the number of occupied housing units. The number of occupied housing units has risen by 3.5 million in the last two years. This is a context of very slow population growth. Many people had been living with family or friends now have their own places. But the number of people in that situation, who have the means to start their own household, is clearly declining.
It is also worth mentioning the eviction moratoriums that were in place during the pandemic. During a normal year there are roughly 1 million evictions. The number was almost certainly less than half as large in 2020 and 2021. The prospect of more people getting evicted is not a pretty one, but it does mean that more units will be available.
Third, there has been a sharp upturn in the rate of construction. We were building close to 1.4 million units a year before the pandemic. We are now up to 1.8 million. In addition, many stores and office buildings are being converted to residential housing. This should help to alleviate shortages over time.
It is also worth noting a big shift in population. We are seeing rapid rises in house prices and rents in many low-cost areas like Atlanta and Detroit, with little or no increases in high-prices areas like New York City and San Francisco.
This is a story where people who can now work remotely are taking advantage of lower cost housing. That is a good story for them and a good story for renters in high-priced cities. It also benefits homeowners in lower cost areas, who see a rise in their property values. It also benefits these low-cost areas by bringing in workers whose spending will support a variety of businesses. The losers are renters who will end up paying more for their apartments.
Is there anything that state and local governments can do or should do to help reduce inflation or the burden on American households?
There is a limit to what can be done at the state or local level. A simple measure would be to make it easier for people to buy lower cost drugs in other countries (assuming there is no action at the federal level). Utah’s public employee retirement program actually pays members to go to Canada or Mexico to buy drugs at lower prices.
Another measure these governments can do is to facilitate the transition of vacant retail and commercial space to residential housing. In many cases, this would just mean sharing best practices and removing regulatory obstacles. In other words, it doesn’t have to cost much money.
With many stores now empty, as a result of the pandemic-induced shift to online shopping, and many offices sitting vacant as people work remotely, we have lots of wasted space across the country. If these can be converted to housing, it could go a long way in alleviating the shortage of affordable housing.
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