America’s Inflation Debate Is Fundamentally Confused

As America sweats through the dog days of summer, its economy is heating up. Last month, even as the Delta variant exploded, employers added 943,000 jobs to their payrolls. Sixteen months after the COVID recession officially ended, the unemployment rate has now fallen down to 5.4 percent; after the 2008 financial crisis, it took seven years for joblessness to fall that low. Meanwhile, wages are rising, the labor-force is expanding, and productivity growth is booming.

There’s little question that the economic recovery is proceeding nicely. What’s contested are the policy implications of that fact: Does the recovery’s strength validate Joe Biden’s high-priced stimulus and the Federal Reserve’s low interest rates? If so, does that mean that Congress should enact the rest of the president’s ambitious agenda for increasing public spending — and/or that the central bank should maintain a loose monetary policy — so we can keep the good times rolling? Or does it mean that public investment and monetary stimulus are no longer necessary, and we should now “normalize” interest rates, pare back the deficit, and let the private sector take things from there?

This is the central economic debate on Capitol Hill today. And the focal point of that debate is inflation. Those who counsel an end to high public spending and low interest rates generally do so in the name of price stability. In their view, monetary and fiscal tightening is necessary to avoid “overheating” the economy. They point to the unusually high growth in the consumer price-index (CPU) in recent months, and insist that the time to get serious about inflation is now.

Last week, America’s most powerful senator put one foot in this camp. On Thursday, Joe Manchin implored Federal Reserve Chairman Jerome Powell to taper the central bank’s stimulus policies, saying, “It’s time to ensure we don’t over prescribe the patient by further stimulating an already strong recovery.”

Others say that an economy in which millions remain involuntarily unemployed is still quite sick — and that further stimulus is just what the doctor ordered. Among this contingent is J.W. Mason, a professor at John Jay College and economist at the Roosevelt Institute. Mason believes that Manchin’s understanding of macroeconomics is fundamentally confused — as is the entire mainstream debate about inflation.

Intelligencer spoke with Mason last week about what the mainstream media gets wrong about inflation, how dubious abstractions disguise the anti-worker biases of orthodox economics, and why socialists should find encouragement in the first seven months of the Biden presidency, among other things.

What would you say are the biggest flaws in the way inflation is characterized in mainstream media coverage?
In some ways, the problem is actually the way of thinking that is behind the coverage. The problem is this notion that inflation — the change to the overall price level — is something more than, or distinct from, an average of particular price changes that we’re seeing for particular goods and services for particular reasons.

I think this is one of the fundamental sources of confusion. People have this idea in their head that somehow the overall change in the price level must be driven by a force other than the myriad things that are driving up particular prices. But that isn’t the case. Here is all that inflation is: You take all the prices that you can observe, and you average them in some way — and there’s debatable choices you have to make in averaging them, in designing your standard basket of goods and services — and that’s inflation.

Where does that mistaken idea about inflation — that it is something more than an average of various price movements for various goods — come from?
I think it comes from an old-fashioned vision of the economy, in which the amount of money in circulation is fixed by an external force. If you imagine that there’s a fixed amount of money in the economy, and that the stock of money determines overall spending, then particularities don’t matter much. Individual businesses and households may make particular choices about what to spend money on. But the overall spending level is not determined by their aggregate spending decisions. It’s determined by a larger force — the amount of money in circulation.

Today, even mainstream economists reject that picture of the economy. There is widespread recognition that there is no tight link between growth in the stock of money and inflation. The textbook view is now that inflation is caused by too much spending, not too much money. The distinction is important. More money is just more money. But spending is always spending on a particular thing.

In your recent essay on the inflation debate, you suggest that the “old-fashioned” view was not always wrong. Or at least, that there have been historical contexts in which excess currency production was indeed the key driver of inflation.
That’s right.

What’s distinguishes our contemporary context from those historical incidents?
If you look at historical hyperinflations, those really are cases where the basic machinery of taxing and spending has just profoundly broken down. The private financial system is profoundly broken down. And you really do have government spending financed by printing currency, more or less literally. Even then, there are always historically specific nuances. For instance, the hyperinflation in Germany [after World War I] was really about a political response to the French occupation of the Ruhr Valley. In any case, there is no correspondence between the economic problems of the Weimar Republic and those we face today.

Inflation, right at this moment, is exactly two things. We’re seeing a big increase in the price of fossil fuels, gasoline, obviously, but also heating oil and so on. That’s one. And two, we’re seeing an increase in the price of automobiles, which is driven, I think, by some degree of supply chain issues plus pent-up demand. And that’s it. That is 100 percent of what we are calling inflation today. Neither of those phenomena has anything to do with the money supply. They have to do with factors specific to those particular two sectors of the economy. It doesn’t mean that they are not important, or that they don’t impose hardship on people who are paying those higher costs. But to think of this as somehow being related to something about money printing or the deficit, it’s just silly. And in any other context, we would recognize that whatever is setting the price of used cars, it’s not the Federal Reserve or the federal budget. It’s something specific to that industry.

It seems to me that there are clear policy implications here. If our conversation about price increases isn’t focused on specific goods — but rather, on the average price movements of all goods — then we’re liable to see a large increase in that average as a demand-side problem (“Inflation is going up, so we need to reduce spending and credit creation”). By contrast, if we look under the hood, and focus on which prices are actually rising, we’re more likely to see the same phenomenon as a set of discrete supply-side problems (“Car prices are rising because a shortage of semiconductors is slowing production, so we need to invest more in semiconductor manufacturing”).
That’s exactly right. We just think of inflation as this undifferentiated thing. Then we think, “Okay, there’s too much spending relative to the productive capacity of the economy. And so we have to have less spending.” Or else, “There’s too much money chasing the amount of stuff we have, so we need to have less money in circulation.” But that really has nothing to do with the problems that we’re facing now.

It would be like saying, “Rents are rising too quickly in New York City and that’s creating hardship on people. Let’s make subway service worse until we bring the number of people who want to live in New York into line with the number of people who can be accommodated in housing at reasonable rates.” I think anybody would agree that that would be a terrible way of managing a housing problem in a city. But we actually do precisely that when it comes to inflation. No one would say, “Look, we’re facing supply chain problems in the auto industry. So, let’s raise interest rates to make it harder for businesses to invest in increased capacity.” Or let’s say housing costs start to rise, and that pushes up inflation. Would it make any sense to say, “Housing costs are rising, so we need to raise interest rates, thereby making it more expensive to build new housing”? And yet, because we don’t talk about inflation in concrete terms — because we just talk about it in the abstract — we actually do approach it in that absurd way.

I feel like there are some less absurd — or at least, less obviously absurd — arguments for seeing inflation as a phenomenon distinct from the sum total of various price movements. In the discourse, I think “inflation” is often used as shorthand for demand conditions that produce self-reinforcing, accelerating increases in prices. One example is the “wage-push” inflation narrative: If consumer demand exceeds a certain threshold, then labor markets will grow so tight, workers will have the power to extract wage increases in excess of their productivity. Employers will then respond to higher labor costs by raising prices. Workers will respond to price increases by demanding still-higher wages, setting off a vicious inflationary cycle.
The textbook story, as you say, is the story of the Phillips Curve. It says low unemployment improves the bargaining position of workers who are in a position to demand higher wages. That’s a realistic account of things, as far as it goes. I don’t have any problem with that. I think it’s true.

The second part of the story says that higher wages increase firms’ overall costs. That too is often true. But then the story says that businesses raise prices exactly in line with the rise in wages. Which is really significant, because it implies that very tight labor markets are not actually good for workers: It may look like they are getting wage increases, but in real terms, they aren’t. Inflation will eat those gains. And then, as you say, the final part of the story is that there’s a feedback loop, in which workers who still have the bargaining power to demand higher wages do so to keep up with the cost of living.

I think there are three questions we should ask about all this. One is: Is it actually the case that labor markets are so tight, they’re generating very large wage increases? And that’s an empirical question. We can debate that. The second question is: Is unemployment unsustainably low, in the sense that we are trying to employ more people than the economy has available? And the answer is absolutely not.

But the third question is: what actually happens when you have accelerating wage increases? The assumption of the textbook story is that 100 percent of workers’ wage gains get passed on into prices. The idea being that prices move up and down in lockstep with wages. And there’s absolutely no reason to think that that’s true. In fact, there’s overwhelming evidence that it is not true. The textbook story just assumes that the division of income between wages and profits can never change.

In other words, it assumes that wage increases never come at the expense of profits (and thus, owners); they always come at the expense of consumers.
Yes. The story is: When wages go up, prices rise faster. If wages rise more slowly, prices rise more slowly. So, nothing ever happens to real wages. But in the real world, when the economy is booming, wages do rise, and prices don’t; or they don’t rise by as much. And in periods of stagnation, wages stagnate, or fall, and prices do not. In the real world, we’ve seen big movements in the share of national income going to workers, as opposed to owners, over the past generation. Mostly down, but also up, during short periods of tight labor markets and low unemployment. So the idea that every change in wages gets passed on one-for-one to prices is refuted the moment we look up from the textbook to the world around us.

It’s clear then that tight labor markets can enable workers to secure real wage growth; that wages in that context can rise faster than prices. Therefore, if you say that policymakers must never tolerate accelerating wage growth – or allow wages to rise faster than productivity – what you’re really saying is we can’t have an increase in labor’s  share of national income. We can’t ever have a situation where the share of the pie going to workers is getting bigger. That’s what the target actually means in practice. And there are some people who like that. And that’s maybe why we have it as an implicit policy goal. But plainly stated, it is not a platform that people are going to consent to in a remotely democratic political system.

The ultimate conclusion of your critique of the inflation discourse is that “anti-inflation policy should aim at identifying supply constraints as much as, or more than, restraining demand.” What would an inflation policy that prioritized the identification of supply constraints look like? Or, more to the point: Once policymakers identify existing supply constraints, what precisely should they do?
The first step is always to admit you have a problem. And the thing that I want to convince people of right now is that raising interest rates is absolutely not the appropriate response here. It’s very destructive, and it doesn’t even address the real problem. But the point is there’s a lot of prices, they rise for different reasons, and there’s not going to be one set of tools. If fossil fuel prices are rising very rapidly, we’re in luck, because we definitely know how to fix that problem: We need to become less reliant on fossil fuels. And we’ve got a lot of tools in place to try to move in that direction. We just need to deploy them faster.

What I fear is that people will see this inflation and say, “Oh, well, I guess we’ve got to scale back our plans for investment in decarbonization,” – when what the price data is actually showing us is that we need to transition faster away from fossil fuels! Because, aside from destroying the Earth, which is the fundamental thing, it also introduces a lot of instability into the economic system, because the price of these fuels is extremely volatile.

In your writing, you emphasize that mainstream economists know that the “Econ 101 textbook” view of things is wrong. They know that there is no tight link between the money supply and inflation, or that economic booms have historically produced real wage gains. And yet, these obsolete paradigms still inform their policy conclusions, and cause them to look past massive logical flaws in their positions. These mainstream economists are generally intelligent people. What do you think sustains the dissonance between their theoretical premises and policy prescriptions?
Political convenience is obviously a factor. If you admitted that tight labor markets actually are effective at redistributing income from profits to wages — and that slack labor markets redistribute from wages to profits — you would bring the question of income distribution into the political arena. And I think that one of the successes of what we might call the “neoliberal” model of politics was to move those questions offstage. I suppose the people who see that as a positive thing would say that these are such disruptive questions, they’re hard to negotiate, and would lead to a much more zero-sum, adversarial kind of politics. So, better to take them off the table.

Separately, I think a lot of economists are drawn to an abstract, formal kind of reasoning where there are questions that you can find a unique, optimal answer to, and you don’t have to think too much about history or institutions. And so if you say, “100 percent of wage changes get passed on to price changes,” that’s very simple. If you say, “Well, it’s actually divided up in a complex fashion depending on a variety of conditions,” that model of the world doesn’t give you simple, timeless answers. It doesn’t lend itself to a neat formalization. I think within the economics profession that’s certainly a factor. But it’s a little bit of a puzzle to be honest, because as you say, once you actually start thinking about this stuff, the logical problems with the orthodox story are pretty glaring.

Speaking of problems with the orthodox story: You and Mike Konczal recently published a report for the Roosevelt Institute arguing that the Congressional Budget Office’s estimate of the size of America’s potential labor-force – the number of workers available to the economy, given optimal policy and conditions – is off by 28 million. Which has major implications for inflation. If our labor supply is much larger than we realize, then the amount of demand our economy can absorb without suffering high inflation is much larger too. So, how did you arrive at that enormous figure?
Yes, this concept of potential employment is fundamental to a lot of our macroeconomic debates. “How fast can we grow?” in many ways comes down to “How many jobs can we add?” How many people are there potentially available for work? What is full employment? The way we conventionally measure that is to look at how many people were working at some recent high-water mark. You pick a year – let’s say 2005 – look at how many people were working that year, and declare that full employment. Then typically you make some adjustment based on the aging of the population, since we know older people are less likely to be employed. And that’s kind of where you stop.

The problem with that approach is that it assumes our recent best is the best we could ever possibly do. It presumes that we have not been systematically falling short of full employment.

If you want to at least be open to the idea that potential employment is significantly greater than what we’ve seen in recent history, you need a different approach. One natural thing you could do would be to look at other countries. But we thought it would be interesting to try something a little different, which is to look at different groups within the United States. Employment rates vary a lot by various demographic categories, and in ways that are hard to attribute to a different willingness or capacity to be engaged in paid work. And these demographic disparities vary systematically with the state of demand in the economy: When demand is high, the gap between the employment rates of favored groups and disfavored groups narrows.

Now, we’re talking here about potential. If you want to know how fast a car can go you don’t look at how fast it goes on average when driving in traffic. You look at the fastest speed you’ve actually seen it sustain on the open highway. So if we want to know what fraction of people in a given age group can be expected to work, we should look over an extended period and see, “Well, how much have people in that age group worked at various times in the past?” As it happens, older people, and this may or may not be a good thing, but older people today in the United States are working at higher rates than they’ve ever worked. But younger people are working at much lower rates than they have in the past.

It seems to us that, first of all, if you want to know our economy’s potential employment, you shouldn’t just assume that the decline in employment among younger people is irrevocable. It can’t be all just because they’re playing video games in their parents’ basements or wherever.

What about the rising rate of college attendance? Couldn’t that reduce employment among young people, relative to the past, in a permanent way?
There is some of that. But a lot of people in college do work. And if you look at the people who aren’t in college, there’s fewer of them working too. So clearly, there’s something else going on.

Then, there are big gaps by gender and by race in employment. I think it would be hard to defend the notion that the reason so many fewer Black Americans are employed than white people of a similar age is because Black people are not as willing to work or because they have no capacity to do paid work. On the other hand, we have overwhelming evidence from micro-surveys and controlled studies that employers have a strong preference for white candidates over black candidates with similar credentials. So it’s natural to conclude that when you have a slack labor market with more job applicants than jobs, employers are unfortunately just going to hire the white workers. Black people are at the back of the line for hiring.

If we want to think about full employment, then, we can ask, “What would it look like if you had sufficiently full employment that employers reached the ‘back of the line,’ and people who are disfavored because of their race started getting hired at the same rate as white people?” And then you can do the same analysis with gender. Education status is more complicated because in some cases, educational attainment is really germane to employability. But the employment gap between people with only a high school degree and college graduates has varied a lot over time. It was much lower around the year 2000 than it is today. And again, we have evidence at a micro-level that employers, when they have the opportunity to do so, will prefer college graduates, even for jobs that – under other circumstances – they’d be perfectly happy to hire high school graduates for. Those requirements shift a lot depending on how tight labor markets are.

So, let’s not say that high school graduates will ever be employed at the same exact rate as college graduates; let’s just say that the gap between those groups shrinks to what it was in the year 2000. So, you make those adjustments, and you end up concluding that there’s an enormous amount of additional labor out there.

You argued earlier that orthodoxy serves to suppress zero-sum political conflict. But I actually think an overriding implication of your work is that there are immense opportunities for non-zero-sum gains in the U.S. economy. You argue that America’s labor force – and thus, its productive capacity – is far greater than mainstream models presume. And you suggest that America can realize its full productive capacity through the (supposedly, politically easy) task of giving ordinary people more spending power: Rather than exhausting a fixed supply of resources, high demand can actually increase the labor supply. So, there’s this politically painless way to make all Americans much wealthier. And yet, for decade after decade, we’ve been choosing not to do it. Why do you suppose that is?
I have three answers to this. The first is that if you subscribe to the orthodoxy, then you simply don’t believe that there is all of this additional productive potential that’s going unused. And in that case, distributional questions really do become a zero-sum.

Answer two is the one that [Polish economist] Michał Kalecki gave a long time ago, and that various people on the left have picked up since, which is that for business owners and their political allies, status and authority are ultimately more important than the volume of profits. And it isn’t just that they prefer a bigger slice of a smaller pie. They want to be in charge of the pie. In a very tight labor market, employers might on a dollar-and-cents basis benefit more from greater sales and they lose to higher wages. But they would also be losing authority in the workplace if people were no longer afraid of losing their jobs.

Answer three, is just that it requires doing things differently and political institutions have a lot of inertia and people aren’t comfortable being told that the thing they believed for a long time isn’t actually true. And we’ve had this sort of scarcity mindset for a long time and it’s familiar to people. I think that we do have the potential for vastly higher employment, vastly higher levels of production, and vastly higher material living standards for people than we have today. But that requires a lot more spending, a lot more demand in the economy. And it doesn’t require only that. It also requires reorganizing the way we do various things. We may need to adjust workplace hierarchies. We may need more centralized decisions about how investment gets made. Which people aren’t necessarily comfortable with. Housing scarcity in the U.S. is one headwind to growth. And of course, if you build more housing, we all know that there’s always people who find that very threatening. So I think there’s just the element of inertia that we shouldn’t underestimate here. In a way, the pandemic and the climate crisis offer an advantage for reform. Those are forces big enough to potentially break us out of some of that inertia.

Months ago, in the wake of the American Rescue Plan’s passage, you wrote that the stimulus bill struck you as a decisive break with neoliberalism, and that “It really does seem that on the big macroeconomic questions, our side is winning.” Have you grown more or less confident in that assessment since March? 
Obviously, there’s been a lot of back and forth. And there’s a lot of things one would wish had been done better. But what’s already been done is extraordinarily positive. I think there is a real problem on the left of not giving sufficient recognition to how much better the response to this crisis has been than our responses to past crises were. I think some people are still looking at it through the lens of 2009, which really did fall short in profound and fundamental ways. Back then, the focus was on rescuing the banks. Nothing was done to maintain incomes and employment for working people. Nothing at the necessary scale. I think this has just been night-and-day compared with that. And I think that really has to be acknowledged — not to be fair, or to give credit where it’s due (they’re big boys, they don’t need our credit) — but so that we can actually build on this and do more of it. We can’t build on something until we acknowledge that it’s a foundation. The big challenge is to make programs like the pandemic employment insurance permanent.

The key thing about the neoliberal turn, its critical victory, was not changing people’s minds about what was desirable. It was changing people’s minds about what was possible. That was the whole thing: there is no alternative. It doesn’t matter whether you think the government ought to do certain things. It just can’t. This pandemic experience has really disproven that. It’s proven that actually, government can do a lot more than we thought. And actually, it can do it pretty well. We don’t actually have to have mass impoverishment, eviction, and hunger every time the economy enters recession. We can actually maintain people’s access to the necessities of life. We didn’t do it perfectly. But we did it so much better than we’ve done it in the past. And that sets a new benchmark for what can be done in the future.

Operation Warp Speed did the same thing. Obviously, it’s not good that the vaccines it yielded are protected by private patents. They should not be the private property of some business. But nonetheless, it’s very clear that there was a public commitment to do this, public resources were invested, and it really worked. Once you open the door — and show that these things are possible — it’s very hard to go back and convince people that they didn’t see what they just saw. The cat is out of the bag. Our government can actually solve problems. I don’t know. Maybe I’m just being optimistic. But I think that it’s very hard to turn the clock back.