Was the recent excess inflation an aggregate supply or an aggregate demand shock?  Tyler Cowen weighs in on the issue:

A year or so ago I recall telling Bari Weiss in a podcast that the inflation was perhaps half real shocks, half an aggregate demand problem.  Don’t let the revisionists talk you into the hardcore RBC view!

I didn’t know that hardcore RBC types had a view on this question, but today I’m more interested in Tyler’s comment on aggregate demand.

Back in 2022, I also thought it was reasonable to talk about high inflation representing a roughly equal mix of supply and demand factors.  As of today, supply problems have eased and almost all of the cumulative excess inflation since 2019 is demand driven—as NGDP has overshot its trend by roughly the same amount as prices have overshot their 2% inflation target path.  These facts support Tyler’s claims about the excess demand.  So why don’t all economists see things in this way?

Here’s where things seem to get weird.  As far as I can tell, economists do not actually have any substantive debate about the existence or non-existence of a recent aggregate demand shock.  There is pretty general agreement as to what has happened; the debate seems to be over the meaning of the specific term “aggregate demand”.  Thus if I point to very rapid growth in nominal spending, those who disagree with me won’t deny that NGDP rose sharply, they’ll typically say that NGDP is not aggregate demand.

Others point to modest growth in real spending (which has been close to trend since 2019), as evidence that there was no big aggregate demand surge.  I respond that real GDP is not aggregate demand, as a rise in aggregate supply also causes real GDP to increase.

In this imaginary debate, we aren’t disagreeing as to whether some well-defined concept like “aggregate demand” increased or did not increase, we are disagreeing over how to define AD.  It’s merely a debate over semantics.  But when I see these debates on the internet, I see little or no awareness that it’s merely a debate about semantics, not substance.

To be clear, I’m not saying the issue is purely subjective—“Just a matter of opinion.”  We have dozens of economics textbooks with AS/AD diagrams.  In that model, a sharp rise in NGDP is evidence of a rightward shift in AD.  In contrast, a sharp rise in RGDP is not evidence of an increase in AD (rising AS also boosts output).  So there really is reason to prefer NGDP over RGDP as a proxy for aggregate demand.

I suspect that most economists use neither NGDP nor RGDP as a proxy for AD.  Instead, they have some sort of model of factors that they believe should make aggregate demand go up.  If that model says AD should have gone up, then they assume that it did increase.

But that makes economics seem more akin to religion than science.  Instead of just accepting as a matter of faith that certain fiscal and monetary policy stances ought to boost AD, why not look at actual empirical data and see if the model is correct?  Did AD increase in response to stimulative policies?  What does the data show?  But this just puts us back in the original dilemma—how do we measure aggregate demand?  How do we test whether fiscal and monetary policy boosted AD, if we cannot measure AD?  And if we can measure it, then what’s the debate all about?  Just look at the data to see if AD increased.

It is clear that if economists disagree as to whether there has been a big surge in AD, then they must, ipso facto, disagree as how best to define AD.  One economist has a model showing a big rise in AD, while another has a different model showing no unusual surge in demand.  In this case, each model represents a different definition of aggregate demand.  Again, the debate is merely over semantics.

I believe the Bible says something to the effect:

Wherefore by their fruits ye shall know them.

Economists seem to believe we determine what happened to AD by its effects, but they cannot seem to agree as to what these effects would be.  In that case, they don’t agree as to what AD actually is.

I suspect that Tyler would argue the real issue is not the role played by aggregate demand, rather the important issue is the role played by stimulative monetary and fiscal policy.

At first glance, that seems like a more tractable approach.  We all accept the fact that NGDP rose sharply in 2021-23, but we don’t know if that increase was due to fiscal stimulus, monetary stimulus or a rise in animal spirits (say due to revenge spending after Covid.)

Unfortunately, that doesn’t actually help at all.  I wrote an entire book explaining that economists frequently refer to the stance of monetary policy being “easy” or “tight” without having any sort of coherent definition of what they mean by “monetary policy”.  All you’ve done is to replace a meaningless semantic debate over aggregate demand with a meaningless semantic debate over monetary policy.

I wish we lived in a world where all economists agreed that aggregate demand was nominal GDP, but we do not.  I wish we lived in a world where all economists defined the stance of monetary policy in terms of whether the expected growth rate of NGDP was above or below the central banks implicit target, but we do not.

Most of all, I wish we lived in a world where economists showed some awareness that their debates over things like “aggregate demand” and “monetary policy” are actually largely a debate over semantics, but we do not.

Here are some debates that would actually be useful:

1. Was the rapid 2019-2023 growth in NGDP appropriate, or undesirably fast?

2. If NGDP growth was excessive, was there some alternative fiscal and monetary policy path that would have delivered appropriate NGDP growth?

3.  If Congress was determined to do an excessively large fiscal stimulus, was there an alternative monetary policy path that would have offset this stimulus, delivering appropriate NGDP growth?

4. If there was a monetary policy path that would have prevented excess NGDP growth, should the Fed have adopted that policy in 2021?

Those are relatively clear and interesting questions with meaningful policy implications.  In contrast, the entire “Was is supply or demand?” debate is so poorly defined as to be almost meaningless.

In my new book, I basically argued that, “The emperor has no clothes”.  I called out the economics profession for making “monetary policy” a key part of macroeconomics, without ever offering a coherent definition of monetary policy.  I could write another book offering a similar critique of “aggregate demand”.

I suspect that most economists would regard my new book as boringly pedantic.  But the current very depressing debate over the role of aggregate demand in inflation shows that there’s never been a greater need to clearly define our core macroeconomic concepts.  Until we do so, we’ll continue talking past each other.  And non-economists will be justifiably scornful of a profession that cannot even answer a question as basic as “Was the recent inflation demand or supply-side?”

If the supply and demand model cannot answer a question that basic, then of what use is the supply and demand model?  What is its purpose?