Why, politically, do we insist our only economic tool must be a bludgeon? Why ignore a whole array of more precise, more effective alternative instruments? I’m talking about simple effectiveness here, not my personal politics. But politics are exactly why we are left clubbing ourselves with a bludgeon while the toolbox stays shut…
Olivier Blanchard – moderately right-winged pillar of the mainstream Economics establishment – recently set off an Econ twitter explosion. How? He observed that inflation has (gasp) a political dimension (“Distributional conflict” below = politics).
Obvious, right? Judging from the reaction… no. A lot of people do not want to talk about the elephant in the room.
1/8. A point which is often lost in discussions of inflation and central bank policy. Inflation is fundamentally the outcome of the distributional conflict, between firms, workers, and taxpayers. It stops only when the various players are forced to accept the outcome.
— Olivier Blanchard (@ojblanchard1) December 30, 2022
The most vehement objections came from those with the nominally “apolitical” agenda – the technocratic, Fed-centric, Monetary-mechanics. They want economic policy “kept away from those useless, corrupt politicians.” Let the experts in the ivory tower of the Fed handle it. From this flows the “its all the Fed and out of our hands” narrative of Team Monetary.
Why is this a problem? Because the Fed can only bludgeon the economy with an incredibly limited, often-ineffective toolkit.
Look at 2022. The housing and auto sector have come to a screeching halt. Asset markets have tanked. The rest of the Real Economy has sailed along largely indifferent. Eventually the bludgeoning will have some long-lagged impact; as bludgeoning does. The Fed itself doesn’t pretend or aspire to much more precision than that.
The Fed’s limitations are pretty obvious if you see inflation’s sources and causes in the Real Economy (supply chains and labor markets and all that supply/demand stuff).
Outside of the housing and auto finance markets, the Fed has remarkably little agency in the real economy. Basically they raise rates and wait for the famous long-lagged effects to pop up somewhere. But the Fed Funds rate only raises some rates in some places with a whole lot of weird counter-balancing effects mixed in.
Even large-scale corporate capital investment decisions are remarkably unaffected by Fed-driven changes in interest rates. Companies invest because they need or want to. The cost of capital is a factor, but (unsurprisingly) far below “is this a good idea?” on their decision list.
What if we had a scalpel? A tool that could act with more speed, certainty, and precision? What if we used – gasp – the Government’s taxation and spending tools to, like, directly affect the economy?
The 2022 scenario below is a counter-factual, but the mirror image of the 2020 stimulus. The 2020 scenario is very very real – a “factual.”
- The 2022 alternative scenario: Inflation explodes. Some sort of “automatic stabilizer” kicks in and raises taxes – preferably consumption taxes. Inflation skids to a halt in the face of lower spending. As a super-beneficial side effect, inflation expectations never really gets going because “everyone” will know that tax hike will snuff it out…
- The 2020 Actual Real World Scenario (in future): The economy weakens. Some sort of “automatic stabilizer” kicks in and sends out checks – preferably to the people most likely to spend the money immediately. The economy perks up, savings accounts aren’t ravaged, and we have a swift and speedy recovery to pre-slump trend. The average American still experiences ups and downs, but the downside damage isn’t quite so systemically damaging.
The 2020 stimulus had an unexpectedly massive economic impact. Its effectiveness and impact surprised nearly everyone – even the super lefty Economics crowd. The US recovered from 2020 at light speed compared to the post 2008 recovery.
We bounced back so hard, we kindled inflation. So why not use the same tool to bring inflation down (hard)?
It is about here that you’ll shake your head and say; OK in theory, but it is politically impossible…. A true statement, but a political statement.
The scalpel stays in the drawer. The bludgeon is all we get. Why? Because of politics. Not because of sensible economics. Or technocratic wisdom. Just greedy, self-dealing politics. That “distributional conflict” of which Mr. Blanchard dared speak…
So whose politics? Who would use a bludgeon when they had a scalpel in the drawer? Who’s narrative leaves no space for political (ie. non-Fed) action? Who is so deeply wedded to that anti-government narrative that they will gladly impoverish the nation to sustain it? Why build this technocratic smokescreen to conceal what political agenda?
Hmmmm…
