![](\"https:\/\/static01.nyt.com\/images\/2023\/08\/18\/opinion\/18krugman-newsletter\/18krugman-newsletter-articleLarge.jpg\")
\n
![](\"https:\/\/static01.nyt.com\/images\/2018\/04\/02\/opinion\/paul-krugman\/paul-krugman-thumbLarge.png\")
<\/p>\n
\n<\/p>\n
By <\/span>Paul Krugman<\/span><\/p>\n Opinion Columnist<\/p>\n What a difference a year makes.<\/p>\n Around this time last year there was a lot of debate, some of it ill tempered, about who deserved blame for soaring inflation. Now most of that is gone, replaced by a debate, some of it ill tempered, about who deserves credit for the rapid decline in inflation.<\/p>\n The one nice thing one might say about the current debate is that it doesn\u2019t seem to involve nearly as much partisanship. Unfortunately, the reason it\u2019s fairly nonpartisan is that many ardent Republicans appear to live in the Fox Cinematic Universe and either haven\u2019t noticed or refuse to acknowledge that inflation is, in fact, way down.<\/p>\n What remains is an argument between those who credit the Federal Reserve, which has certainly been trying to reduce inflation by rapidly increasing interest rates, and those who attribute disinflation to Long Transitory \u2014 a term I think I coined. That is, they argue that inflation is falling because the economy is finally unsnarling the kinks created by the Covid-19 pandemic and its aftereffects.<\/p>\n Here\u2019s the reason for the argument: As I documented the other day, as of late last year most economists expected Fed rate hikes \u2014 which have driven mortgage rates to a 21-year high \u2014 to reduce inflation. But they expected this disinflation to come at the cost of a substantial rise in unemployment. After all, that\u2019s how it works in standard economic models.<\/p>\n But while the disinflation came, the rise in unemployment hasn\u2019t, at least so far. And other measures of labor market strength, like the employed share of prime-age adults, have improved to levels not seen in decades. So how can we give credit to the Fed for disinflation when the mechanism through which monetary policy is supposed to reduce inflation doesn\u2019t seem to be operating?<\/p>\n One possible answer is that this mechanism actually is operating but is basically invisible in the fog of imperfect data. Lately quite a few economists have become converts to the idea of a nonlinear Phillips curve. What this means in something resembling plain English is that inflation isn\u2019t very sensitive to unemployment when the labor market isn\u2019t tight but becomes very sensitive when jobs are abundant and workers scarce. Since we\u2019ve had very tight labor markets recently, this view argues that the Fed wouldn\u2019t have to raise unemployment by much to get inflation down \u2014 and given the imprecision with which we measure unemployment, a small rise in true unemployment might get lost in the official data.<\/p>\n I have been sympathetic to this view but have become less so recently, for reasons I\u2019ll explain in a minute.<\/p>\n Some economists giving the Fed credit for lower inflation have been making a different argument, which I think of as \u201ccontactless\u201d monetary policy \u2014 the claim that monetary tightening can directly reduce inflation, without having to cause unemployment along the way. For example, Ricardo Reis of the London School of Economics argues that while inflation-reducing rate hikes may sometimes lead to higher unemployment, \u201cthat is a side effect, not the causal channel.\u201d<\/p>\n This argument provoked an acerbic response from Olivier Blanchard of the Peterson Institute for International Economics, who, you should know, isn\u2019t just one of the world\u2019s most respected macroeconomists but also normally a very even-tempered kind of guy:<\/p>\n I\u2019m with Blanchard here. It\u2019s always important to remember that economics is about what people do and that when you make an argument about the effects of economic policy, you should have at least some plausible story about how the policy affects the behavior of specific people.<\/p>\n In this context, I find it especially helpful to focus on small businesses, not out of any special affection for the little guys but because (a) we have regular surveys of small-business perceptions and intentions from the National Federation of Independent Business and (b) we can be reasonably sure that small-business owners aren\u2019t watching Fed press conferences and carefully parsing Jerome Powell\u2019s words to guide their pricing decisions.<\/p>\n Now, the N.F.I.B. survey doesn\u2019t directly ask respondents about the rate of inflation. Instead, it asks whether they are increasing or reducing prices and reports the resulting \u201cdiffusion index,\u201d the difference in number between those increasing and those reducing. Such diffusion indexes tend, however, to track economic data quite well. So here\u2019s the resulting inflation index:<\/p>\n As you can see, the N.F.I.B. survey looks a lot like official inflation data: It shows a sharp rise in 2021-22, then a steep fall that has brought us most, but not quite all, of the way back to prepandemic inflation.<\/p>\n This result is useful for several reasons. One is that it serves as a rebuttal to inflation truthers who claim that the government is faking the price numbers \u2014 yes, they\u2019re back. Well, here\u2019s a private survey that tells the same story as the government numbers. (And for what it\u2019s worth, small-business owners lean Republican.) Another reason is, as I\u2019ve already pointed out, small businesses are unlikely to be parsing Fed statements and making pricing decisions based on their perceptions of Fed credibility.<\/p>\n Finally, if you reject contactless disinflation but believe, nonetheless, that the Fed is driving inflation down by weakening the economy, albeit in ways that aren\u2019t showing in official data, well, that weakness isn\u2019t showing in business perceptions either. Here\u2019s how the N.F.I.B. puts it:<\/p>\n Waiting for Gadot: The long anticipated, predicted, recession is nowhere to be seen (almost). Recessions can start quickly (2020 shutdown) and end quickly (2020 reopening). Or they can start slowly, for example, due to opposing forces like expansionary fiscal policy vs. contractionary monetary policy. The Fed staff (not F.O.M.C.) has changed their recession forecast to a \u201cslowdown.\u201d There is more talk about a \u201csoft landing\u201d and less of a recession. The shifting outlook is often confusing but even less clear is, can the Fed reach its 2% inflation target (P.C.E. deflator) without a significant slowdown in economic activity (e.g., slower wage cost growth)? The manufacturing sector is clearly slowing, soft all year (I.S.M.) but services are doing well (I.S.M.). Business investment is solid (lots of government incentives), and housing is ignoring 7% mortgage rates.<\/p>\n OK, I don\u2019t think businesses are waiting for Wonder Woman. But typo aside, this really doesn\u2019t sound like an economy in which businesses are forgoing price hikes because of weak demand, in such a way that that we\u2019re currently sliding down the steep part of the Phillips curve. It sounds like an economy in which inflation is coming down because of improved supply, not reduced demand.<\/p>\n Does this mean that the Fed was wrong to raise rates? Not necessarily. If it hadn\u2019t raised rates, the economy might be running really, really hot. The Atlanta Fed\u2019s GDPNow tracker currently shows the economy growing at 5.8 percent (!!!), which isn\u2019t really plausible but does suggest a lot of heat; so the Fed may not have caused disinflation, but rate hikes may have been necessary to permit disinflation caused by other forces. Or, if you like, the Fed may have done the right thing for the wrong reasons.<\/p>\n In any case, I\u2019d urge economists to look up from their models now and then and remember that they\u2019re talking about people. Oh, and let\u2019s celebrate the good inflation news, whoever we think should get the credit.<\/p>\n Paul Krugman has been an Opinion columnist since 2000 and is also a distinguished professor at the City University of New York Graduate Center. He won the 2008 Nobel Memorial Prize in Economic Sciences for his work on international trade and economic geography. @<\/span>PaulKrugman <\/span><\/p>\nSite Index<\/h2>\n
Site Information Navigation<\/h2>\n