Inflation: True and False
By David Henderson
With the recent report that the Consumer Price Index (CPI) rose by 4.2 percent in the twelve-month period from April 2020 to April 2021, many people have started to worry that worse is to come. Many have used the feared C-word: Carter. Recall that during the Carter administration, in the forty-eight months between his inauguration on January 20, 1977, and Ronald Reagan’s inauguration on January 20, 1981, inflation measured by the CPI averaged 10.4 percent annually. There are lags, of course: Carter can hardly be blamed for the first few months of inflation in 1977, just as Reagan can hardly be blamed for the first few months of inflation in 1981. Still, the 10.4 percent estimate gives a reasonable take on Carter-era inflation. Running the numbers from June 1977 to June 1981 gives a similar average annual inflation rate: 10.5 percent.
Is the fear of Carter-era inflation justified? Is the increase in gasoline prices a sign of higher inflation? Is the fear of hyperinflation justified? With President Biden implementing and proposing various policies that will hurt economic growth, is there much danger in the short run of a return to stagflation? My answers: somewhat, no, no, and no.
These are the opening two paragraphs of “Inflation: True and False,” my latest article at Defining Ideas, May 20, 2021.
Some observers have suggested that we should fear hyperinflation. They have no idea what hyperinflation is. Hyperinflation is not just high inflation. Hyperinflation is inflation of 50 percent per month or more. The most extreme hyperinflations in history were in Germany from 1921 to 1923, Hungary from August 1945 to July 1946, and Zimbabwe from March 2007 to November 2008. We’re not even close to 1 percent per month, let alone 50 percent per month. The United States did have extremely high inflation during the Revolutionary War—have you ever heard the expression “not worth a Continental”?—and in the Confederacy during the Civil War. Other than that, the highest US inflation rate in our history was in 1918, when the government used the newly created Federal Reserve to fund its participation in World War I. Even then, the price level between April 1917, when America entered the war, and November 1918, when the war ended, increased by 27 percent. That’s 16.3 percent on an annual basis. Bad? Yes. But hyperinflation? Still not close.
Why am I so confident? Because we are set to have very high growth in real GDP this year. The reason is not that President Biden’s economic policies are so good. They’re actually pretty bad. The $300 federal addition to the weekly unemployment benefit, which was part of his $1.9 trillion bill in March, will actually cause real GDP to grow more slowly than otherwise because it discourages millions of lower-wage people from taking jobs. My criticism is not partisan. I criticized a similar, though worse, plan after President Trump, back in March 2020, signed the CARES Act, which added a whopping $600 per week to weekly unemployment benefits. That’s the nice thing about economics: we can talk about effects of policies without knowing whether the initiator of the bad policies has an R or a D after his name.
Still, even with this growth-destroying policy, with possibly more to come, real GDP will rise a lot this year. To see why, imagine a hose hooked to a water spigot with the spigot turned on but an elephant standing on the hose. Not much water comes out the other end. But if the elephant gets off the hose, then, even if the water spigot is turned down slightly, a lot of water will come out the other end.
Governments are that elephant. The federal government, to some extent, but mainly the majority of state governments are standing with various weights on that hose by enforcing lockdowns. Once they get off, real GDP will increase.
My prediction: we will have at least 4 percent inflation during the next twelve months and real GDP growth of at least 5 percent on an annualized basis. If the feds get off the hose in September by not renewing the $300 per month federal addition to unemployment benefits, we will have even higher growth.
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