In a recent interview, SF Fed President Mary Daly listed 4 factors that caused inflation to exceed her expectations. The first three are supply issues, while the fourth relates to demand:
4. Unexpectedly high consumer demand
The final factor that Daly says she underestimated was consumer demand. “The American consumer has been incredibly resilient and incredibly interested in purchasing things when they couldn’t purchase services,” she said. At some point, she believed that Americans had “purchased as many Pelotons as we can possibly use.” And yet, the demand seems insatiable.
In February, overall retail sales increased 0.3% from January and were up 17.6% year-over-year, according to U.S. Census Bureau. And that’s set to continue. The National Retail Federation predicts that sales will grow between 6% and 8% this year.
I have several problems with this claim. First, it’s pretty obvious that most people have effectively “insatiable” preferences for a higher living standard. Even if at some point people have all the Pelotons they want (and I for one do not), they would simply begin to desire other goods. I find it a bit worrisome that a top Fed official would view consumer satiation as a reason not to worry too much about inflation.
Second, it makes more sense to focus on total aggregate demand rather than just consumer demand. In some cases, excessive aggregate demand shows up in rapid growth in investment spending, which can be just as inflationary as rapid growth in consumption.
Third, there is no mention of the role of monetary policy in creating the inflation. Fed policy was clearly too expansionary last year, and as a result aggregate demand (M*V) rose at an excessive rate. Fast growth in nominal spending will lead to high inflation regardless of whether consumers have enough Pelotons or not. If the consumer saving rate rises because their garages are packed with expensive toys, then fast growth in nominal spending would lead to higher investment spending. Or perhaps government spending increases. One way or another, a monetary policy that leads to excessive growth in nominal spending is almost certain to lead to excessive inflation.
When I hear Fed officials talk about inflation, it often seems as if they regard it as some sort of mysterious problem that befell our economy. Excessive inflation is a product of excessively expansionary monetary policy. Demand is a nominal concept; don’t talk about it like it’s a real concept. Aggregate demand rose by more than 100 billion-fold in Germany during the early 1920s, and it wasn’t because Germans suddenly had an insatiable demand for exercise equipment.
That does not mean that all inflation above 2% is excessive. The Fed has a flexible average inflation target, and when there are supply shocks it is appropriate to allow above 2% inflation for a brief period in order to better achieve the Fed’s dual mandate. But when inflation is excessive even from a dual mandate perspective (as it clearly is today), that’s a failure of monetary policy. It’s that simple. Fed officials are perfectly justified in talking about supply problems, which do provide justification for temporarily allowing above 2% inflation. But instead of talking about mysterious increases in “demand”, I wish they’d simply say that monetary policy in 2021 was too expansionary. Why is that so hard to do?
Arsonists don’t need to fix the house burning problems; they need to stop burning down houses. The Fed doesn’t need to “fix” the inflation problem; it needs to stop creating inflation.
READER COMMENTS
Airman Spry Shark
Mar 29 2022 at 3:22pm
Giving Daly a lot of benefit of the doubt, couldn’t her statement be interpreted as “V was a lot larger than expected, so M was too high”?
Scott Sumner
Mar 29 2022 at 7:04pm
Perhaps, but I would still have written essentially the same post. Having all the Pelotons we need is not a good reason to expect a low V.
Kenneth Duda
Mar 29 2022 at 7:16pm
Yes! This is the most frustrating thing. I mean, you can kind of understand a Fed bank president dodging blame. But Scott, check out this “Vox explainer”:
https://www.vox.com/the-goods/22994731/inflation-rate-russia-gas-prices-jerome-powell
The Vox ignorance is astonishing. They go through a million factors that might shift the equilibrium interest rate without ever mentioning that it’s the FOMC’s entire job to offset those factors. It’s like, imagine a bus driver screwed up and drove off a mountain road. Vox would go through all the reasons roads have curves and how it’s really hard to build perfectly straight roads, never once mentioning that the bus has a driver, and the driver has a steering wheel, and the bus driver can use the steering wheel to — wait for it — keep the bus on the road!!
Where’s Matty Yglesias when you need him?
It must be nice to be a fed official. So much power, so little accountability.
-Ken
Scott Sumner
Mar 30 2022 at 12:11pm
Thanks, I’ll do a post on that article.
Thomas Lee Hutcheson
Mar 30 2022 at 6:28am
The proper way to defend the Fed is that it just misjudged the supply shocks (increases in international petroleum prices work like supply shocks). I think that misjudgment even makes sense up to September when TIPS took off.
The “consumer satiation” argument might be construed as a one time structural shift in demand from restaurant meals (services) to Pelotons (goods) that, given sticky prices of services requires a higher average price level (inflation to get there). The question is did it require inflation of more than 2% PCE?
Michael Rulle
Mar 30 2022 at 10:06am
There is a saying in business that a point has to be repeated 7 times for it to be really heard. When it comes to monetary policy, it is more likely 70 times. So, when you say monetary policy is too expansionary it would be helpful if you always said explicitly in a few sentences what explicitly makes it too expansionary in today’s context.
I am likely not the the only person who wishes you would do this—-It just does not embarrass me to admit it would be helpful to me if you did. Please do not play the role of the irritated Professor with lazy students——this is a blog——not a course. I would certainly appreciate if you did what I suggest.
Thanks!
Scott Sumner
Mar 30 2022 at 12:09pm
Too much NGDP
Michael Rulle
Apr 12 2022 at 9:15am
Perfect— thanks!
Capt. J Parker
Mar 30 2022 at 10:29am
So true and so strange. It’s maddening when all the inflation articles in the press talk about inflation like that but you’d think Fed insiders know better. I’m tempted to assume that Fed officials close ranks and speak in anodyne ways about inflation in order to minimize political interference. With Summers, Krugman, Taylor and of course Dr. Sumner all saying that monetary policy is too expansionary the Fed must be thinking the same thing. Right?
With all that said, my own personal experience right now is that there are still big supply problems. I work in medical device manufacturing and the number of fires we are currently fighting because of inability to obtain components and suddenly increased lead times has never been this extreme. Not all the fires are supply chain issues per se. Some of our suppliers as telling us the their lead times jumped up because they cant find workers.
I’m not saying current inflation is all a negative supply shock or that Fed policy is appropriate under current conditions but I am saying there really is a supply shock and it has not yet ended. Does this explain Fed slowness in responding?
Scott Sumner
Mar 30 2022 at 12:11pm
One reason they cannot find workers is that there is too much demand.
Thomas Lee Hutcheson
Mar 30 2022 at 5:13pm
But that is circular. If they could find the workers, the demand would not be too much.
Scott Sumner
Mar 31 2022 at 10:46am
Actually, it’s not “circular” at all. There might be other reasons why firms could not find workers.
Capt. J Parker
Mar 31 2022 at 3:47pm
I swear on a stack of newly printed thousand dollar bills that this is not a trollish comment. I’m just trying to get my head around Dr. Sumner’s model. Whenever I think I have grasped it, that turns to be a complete delusion on may part.
Dr. Sumner said:
I see nothing to disagree with in the above statement. Dr. Sumner also said in the comments:
I’m tempted to think there is something to this. Like, oh yeah, they can’t find workers because they all went to make more Pelotons. But, boy-oh-boy, isn’t that talking about demand as if it were a real concept?
Dr. Sumner has also said in the past the nominal GDP moves with real GDP. So, I might infer that too much nominal spending could result in more desire for real goods and hence lead to a shortage of workers. But, this reasoning is exactly wrong according to the example of 1920s Germany excess demand example.
Is it really that Mary Daly’s sin is one of getting causality wrong? Increased demand (a nominal concept) can cause real effects but agents in the economy suddenly desiring more of everything isn’t going to increase aggregate demand?
Can any Dr. Sumner mind readers clear this up for me?
Mark Burk
Mar 30 2022 at 11:57am
Re. Mary Daly’s omission of any role played by central banking for inflation, all the better for the Federal Reserve so that as time goes by and individuals seek someone to blame for the spiraling inflation, the finger will point at business, if not the free-market system itself (which, because of central banking and other government interventionist behaviors we do not even remotely have) as opposed to the real culprit.
Jeff
Mar 30 2022 at 1:57pm
It’s difficult to avoid the impression that a lot of this misdirection is political in nature. Over the past few years an alliance of moneyed interests and progressive activists converged on the view that a “hot” economy promotes social justice and is the medicine America needs. This “loose money messianism” seems to have reached its apotheosis at the San Francisco Fed. Articles like this one <a href=”https://splashpad.org/2021/05/neighbor-mary-c-daly-uses-escape-velocity-to-increase-economic-mobility/“>https://splashpad.org/2021/05/neighbor-mary-c-daly-uses-escape-velocity-to-increase-economic-mobility/</a> suggest an environment that is dripping with political overtones, led by the individuals at the top. The FRBSF president firmly insisted in a November interview that “There are no politics at the Fed!”, but it had a definite “lady doth protest too much” feel.
Chris Blatchly
Mar 30 2022 at 4:36pm
Your post motivated me to look at Mary Daly’s biography. Despite being a research scholar for the Federal Reserve Bank for 25 years, she has spent very little time thinking about monetary policy. I looked at her list of publications on Google Scholar and out of 276 publications cited, perhaps 6 were about monetary policy or inflation.
She is probably a very good economist, but having her be a Federal Reserve president is like having a pediatrician be in charge of the cardiac department at a hospital.
Scott Sumner
Mar 31 2022 at 10:47am
I’ve argued that all of the FOMC voters should be specialists in monetary policy.
steve
Mar 30 2022 at 8:26pm
“The Fed has a flexible average inflation target, and when there are supply shocks it is appropriate to allow above 2% inflation for a brief period”
This is helpful. It has certainly seemed like there could be times when supply shocks could drive things for a while.
Steve
C8to
Mar 30 2022 at 9:55pm
Hmm this kind of crystallizes for me the first part of your elsewhere referenced « if the fed was even serious about inflation , it would look different «
it’s surprising that the controllers of the money supply are surprised by inflation running hot – but they have to look in the rear view mirror targeting inflation.
the part I’m fuzzy on is if the fed said seriously we will not let inflation next year be above 2 percent – what happens in the market before concrete steps of monetary policy to make inflation move closer to the target . What is it that firms or banks do if they heard those words from the fed and they were credible – how do they anticipate and effectuate (even partially) what the fed would do with money levers
Scott you may have a post on this I’ve missed …
Scott Sumner
Mar 31 2022 at 10:50am
Asset prices would respond immediately to that promise, if credible. Interest rates might rise. The prices of stocks, commodities and real estate might fall. Firms would be more resistant to raising nominal wages.
steve
Mar 31 2022 at 2:22pm
Why is the inflation rate so widely different for services vs goods? When that happens do interventions need to be aimed more specifically at areas with much higher inflation?
Steve
Manfred
Mar 31 2022 at 11:00am
Guys (and gals),
Please cut the lady (Mary Daly) some slack (and I am not saying this because she is a fellow Illini). She has a cushy job as Fed regional bank president, *and she probably wants to keep her job as such*.
Thus, is she going to criticize her overlords at the Fed Board sitting in Washington, D.C.? Of course not. Thus, Mary publicly repeats the party line. Maybe with nuances, but still the party line.
Her PhD is from Syracuse. I am very sure that at the Econ Dept in Syracuse they heard about Friedman and Sargent and other monetary literature. And I am sure our good friend Mary had to read it at some point.
But now, she is a high powered Fed President. And she wants to keep her job.
Beau Martin
Apr 2 2022 at 3:41am
Macro isn’t my focus but it seems that this is as much a fiscal train wreck as a monetary one.
If I had to guess, prime drivers were as follows:
1. Eager to show he was responsible for the recovery, or eager to introduce MMT, Biden and the Democrats in Congress over stimulated the economy in March 2021, just three months after the second Trump stimulus. The third stimulus was almost as large as the first two combined.
2. Prohibitions against evictions led to non-payment of rent, moving owners investment funds into their tennant’s consumption.
3. Last year’s baseline low energy costs, when the spot price of oil went negative, and the capping of supply that entailed caused a huge run-up in prices, both real, due to capped supply, and as a percent increase, due to low baselines.
3. Reserve requirements have been set to 0%, down from 10% pre-COVID. As a result, banks can write loans without limitation. Setting them to even 1% would constrain lending (this is on the Fed).
4. Rates remained accommodative, stimulating demand for those loans.
5. Demand for service was delayed due to social distancing. When it returned, there was insufficient supply available, much like conditions following a natural disaster.
6. The run-ups in financial assets were strong due to low rates, creating demand while reducing the labor supply both due to retirements and to a lesser extent reddit windfalls to the younger more connected speculators in various alternative forms of money and in GameStop options and the like.
7. Companies with COVID losses, driven by the same forces at the same time sought collectively to recoup those losses by being more agressive regarding prices. A fraction of the increases passed along were due to higher costs like masking or barriers but most were due to a desire to recapture lost earnings.
8. The closure of competiors reduced competition in the marketplace, and in many cases supply as well leading to a less elastic response to price changes.
I’m sure there are other reasons the economy is awash in money, but the Fed matters mostly if their strategies are more extreme than those the market would normally adopt. Rates were rising last year independent of the Fed, so while they’re listed here I suspect their rate setting was less important than some or even most of the other factors shown here. The one thing that’s clear in my mind is that the vast majority of the blame for the destruction of the world’s currencies lies with the governments of those countries and the US is no different. Was it opportunistic to destroy their mounting debts? It was probably that too.
Spencer Bradley Hall
Apr 4 2022 at 12:56pm
Unless you close the gap between short-term and long-term money flows, the volume and velocity of money, you get higher prices regardless of a deceleration in long-term money flows. US Factory Orders fell by 5% mom in Feb. increasing the gap.
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