Why Fed and Biden stoned on inflation. Wsj report
According to the Wall Street Journal, the Biden administration applied old rules to a new crisis, making a mistake
In recent weeks, senior officials from the Biden administration and the Federal Reserve have publicly admitted that they have made mistakes in handling inflation.
Underlying their errors is a misreading of the economy.
President Biden's advisers and Fed officials feared that the Covid-19 pandemic and related restrictions would lead to consequences similar to those of the 2007-2009 financial crisis: weak demand, slow growth, long periods of high unemployment and too much inflation. low – writes the WSJ .
They then applied the latest manual to the new crisis. The Fed redistributed low interest rate policies it deemed effective and generally benevolent, and promised not to withdraw prematurely. Elected officials concluded they relied too heavily on the Fed earlier and decided to spend more aggressively this time, starting with President Donald Trump and ending with President Biden's $ 1.9 trillion stimulus.
In addition, many Democrats have seen control of the White House and Congress as a rare opportunity to shift Washington's priorities from Republican-favored tax cuts and to broad new social agendas.
But the economic pandemic turned out to be fundamentally different. While the financial crisis has mainly dented business and consumer demand, the pandemic has reduced supply, resulting in a persistent shortage of raw materials, container ships, workers, computer chips and more.
Unemployment fell and inflation rebounded faster than policy makers expected, but they remained true to the old manual. This exacerbated the imbalances between supply and demand and contributed to the rise in inflation, which reached 8.6% in May, the highest value in 40 years.
After the financial crisis of 2007-2009, total consumer, business and government spending, uncorrected for inflation, remained below the pre-crisis trend for years. In the first quarter of 2022, however, it jumped 5% above the pre-crisis trend of about $ 1 trillion year-on-year, thanks to the wave of federal stimulus.
Jason Furman, a Democrat who served as chairman of President Obama's Council of Economic Advisers from 2013-17, said the latest effort tackled the wrong crisis. "We fought the last war," he said.
"It was a complicated situation with little precedent," said Randal Quarles, Republican and Fed vice president for oversight from 2017 to late last year, last month. "People make mistakes."
Even private sector forecasters and Congressional evaluators failed to anticipate the magnitude and duration of the rise in inflation. There was also bad luck. The new variants of Covid, the invasion of Ukraine by Russia and the closures of China linked to Covid have made the situation worse. And high inflation is not just the result of US policy errors: according to forecasts by JP Morgan, inflation will stand at 7.2% in Germany at the end of the year, 8.8% in Great Britain. 6.1% in Canada and 6.8% in the United States.
Treasury Secretary Janet Yellen and other White House officials argued that the stimulus was worth it because it helped to quickly drop unemployment below 4%, avoiding the prolonged high unemployment rate of the previous decade.
"Our economy has recovered more rapidly than that of our peers around the world, with a historically strong and equitable labor market recovery and a historic reduction in the suffering population," said Brian Deese, director of the National Economic Council of the White House.
Officials acknowledged that inflation is unlikely to subside quickly. They are now trying to correct their previous miscalculations, a process that brings new risks of recession.
A year ago, Fed officials predicted that inflation, by their preferred measure, would drop to 2.1% by the end of this year. Now they see it double, and is unlikely to return to the 2% target before 2025. The Fed hiked short-term interest rates by three-quarters of a percentage point and is ready to raise them by another half-point in the meeting. of this week. The Fed is likely to continue to raise rates at least at this pace for upcoming meetings, the fastest adjustment in decades.
Officials are hoping for a "soft landing," a slowdown that will reduce inflation without causing a recession. They also recognize how difficult the task is – and regret not having started earlier.
"If you look back in hindsight, yes, it probably would have been better to raise rates earlier," Federal Reserve Chairman Jerome Powell said in an interview last month.
Yellen made headlines on June 1 when she acknowledged that she and other Biden administration officials had made a mistake in assuring the public a year earlier that the rise in inflation would be transitory. In Washington, where policymakers rarely admit mistakes, critics of the administration have lashed out against recognition. Inflation concerns have stalled Biden's legislative priorities and eroded his approval rating. Consumer confidence has collapsed, according to polls. Polls suggest Democrats could face heavy losses in next fall's midterm election.
When they decided to tackle the pandemic in 2020 and 2021, policymakers were motivated by the lessons of expansion after the 2007-2009 financial crisis, the slowest on record. It took six years for the unemployment rate to drop from 10% to 5%.
The initial blow of the pandemic and closures brought unemployment to 14.7%.
In 2020 Trump approved over $ 3 trillion in federal aid, approved with bipartisan majorities in Congress. The Fed, implementing the strategies it used after the financial crisis, pushed short-term interest rates close to zero, pledged to keep them, and began buying bonds to keep long-term rates low.
When Yellen, who was not involved in Biden's election campaign, informed him via videoconference in August 2020, she told him that after an initial wave of stimuli following the 2009 crisis, austerity slowed down. expansion, according to the people who participated in the call. With interest rates so low, he added, the government could avoid repeating that mistake by taking cheap loans.
“There is a huge amount of suffering out there,” she said in a September 2020 interview, and she said she was in favor of further stimulus.
The pandemic has caused lasting disruptions to global supplies of a range of goods and services, causing nagging shortages and upward pressure on prices that would likely have occurred even without stimulus. While the recovery in supply has been slow, the demand for goods and services has recovered rapidly.
By December 2020, the unemployment rate had dropped to 6.7%. After the 2007-2009 recession, it took three years to reach this level.
The politicians have not changed course. In May 2020, House Democrats passed a $ 3 trillion stimulus bill and continued to support that figure, citing Powell's support for targeted aid.
Fed officials and Biden advisors, many of whom worked under Obama or, like Yellen, at the Fed during the financial crisis, have been obsessed with the slow recovery of the 2010s and fears that new waves of Covid could derail the nascent recovery. Furthermore, inflation had remained below the Fed's target for over a decade. This has made them confident they have the leeway to take further action.
"We know from the previous expansion that it can take many years to reverse the damage" of prolonged high unemployment, Powell said in a 2021 speech.
Politics, not just economics, have influenced stimulus decisions. Many Democrats were angered that a decade earlier, Republicans in Congress had pressured Obama to accept fiscal austerity to reduce budget deficits, then increase deficits to cut taxes and increase military spending under Trump. This time around, Democrats saw the deficit-funded stimulus as a vehicle to promote the expansion of social programs, such as the child tax credit they hoped to make permanent. In progressive circles, some lawmakers have embraced the ideas of "modern monetary theory" that as long as inflation is low, there is no limit to how much Washington can borrow.
Biden compared his ambitions to those of Lyndon B. Johnson's Great Society in the 1960s. "This is the first time we've been able, since the Johnson administration and perhaps even before, to start changing the paradigm," he said after signing the stimulus bill in March.
In December 2020, after Trump lost the election to Biden but did not give up, he argued that millions of people need to be given an additional $ 2,000 check. Democratic candidates in the Georgia Senate ballot have accepted the appeal.
They won, giving the Democrats control of the Senate. Progressive lawmakers lobbied for swift stimulus action.
Days before the inauguration, Biden and his closest advisors agreed on the $ 1.9 trillion plan, which included $ 350 billion in aid for state and local governments, $ 300 a week in extra unemployment benefits until the first. week of September and, in keeping with the promises of Georgia's Democrats, $ 1,400 in support checks, in addition to the $ 600 approved by Congress in December.
Some economists have warned that all of this would lead to inflation, chief among them Lawrence Summers, former Secretary of the Treasury at Harvard University. He estimated that households' monthly income is about $ 25-30 billion less than what it would be in a normally functioning economy. He estimated that the stimulus was approaching $ 200 billion a month and that it would bridge this "output gap" many times over. Furman joined in with these criticisms.
Their criticisms have frustrated White House officials because they are both prominent Democrats who served under Obama. Ms. Yellen, new to Biden's team, was in a delicate position. When Biden completed the $ 1.9 trillion proposal in January, she did not attend the meeting, according to people familiar with the matter.
According to people familiar with her ideas at the time, Ms. Yellen believed that Mr. Summers might have a valid point of view in her analysis. But based on her experience in the latest expansion, Ms. Yellen believed and repeatedly advised Biden that doing too little was more of a risk than doing too much, these people said. "The best thing we can do is act big," he told lawmakers. His views on inflation had particular weight: He chaired the Fed from 2014 to 2018 and over the course of two decades has earned a reputation as a shrewd forecaster.
The Fed's response was similarly anchored to a reading from the previous decade, when the main concern was not high inflation, but low inflation and stagnation, as Japan had suffered. In August 2020, officials presented a policy framework that aimed to push inflation modestly above the 2% target, so as to make up for previous shortcomings.
To follow up on the new strategy, they signaled that they would keep rates at zero until the economy reached what Fed officials have called "maximum employment," the maximum that can be sustained without causing inflation. Such commitments were another feature of the post-crisis manual devised by former Fed chairman Ben Bernanke and Ms. Yellen.
Maximum employment is difficult to estimate in normal times and was even more so when the pandemic subsided. When inflation began to rise in June, Fed officials thought this was a transitory phenomenon, partly because unemployment was still 5.9%; it had dropped to 3.5% in 2019 without inflation rising. Rather than focusing on inflation, they have chosen to stick to their new commitment to bringing unemployment down further before raising rates.
Until November 2021, the Fed will add further stimulus by purchasing $ 120 billion a month of Treasury and mortgage-backed bonds. These purchases aim to contain long-term interest rates. Officials said they would "cut" monthly purchases to zero before starting to raise rates.
Powell was cautious because he feared a repeat of the 2013 “taper tantrum”, when investors, worried about the Fed's end of bond purchases after the crisis, pushed long-term Treasury yields up sharply. In early 2021, Powell urged his colleagues to delay any public discussion of tapering, according to reports from people familiar with the deliberations. Once inflation began to rise, it began communicating the reduction plans, but did so gradually, spreading the debate over several policy meetings last summer.
“Tapering is the element that really put us in trouble. We couldn't get off the ground until we were done, ”Fed Governor Christopher Waller said. "We didn't start fast enough and we weren't fast enough at the start."
Quarles said that, in hindsight, the Fed should have started reducing bond purchases last September; it phased out them between November and March.
Prior to the pandemic, Summers warned of a chronic shortage of demand and low inflation, a combination dubbed "secular stagnation." But after the approval of Biden's stimulus in March 2021, his concerns shifted to excess demand and inflation. The Fed's job is to take away the cup of punch just when the party starts, a former president said. Summers likened the Fed's new picture to waiting "to see a bunch of drunks staggering."
Summers was in the minority. Many professional economists, using models similar to those used by Powell and Yellen, agreed with them that the surge in inflation would be transient. In July 2021, private forecasters surveyed by the Wall Street Journal predicted that inflation would drop to 2.4% by the end of 2022. They now forecast 4.8% by the end of the year.
“We used econometric models estimated on the basis of the last two decades or so of data. At that time, inflation was close to 2%, ”said St. Louis Fed Chairman James Bullard. “Then they tried to use that model when there was a giant pandemic shock; it was not the right model to use ”. Eventually, he said, the Fed had to "throw the entire manual away."
Other central banks also admit that inflation is wrong and are rushing to raise interest rates. The Reserve Bank of Australia, which had planned to keep rates close to zero until 2024 until last fall because it predicted inflation would remain low, has just raised them. “It's embarrassing. We should have foreseen it better. We didn't, ”Governor Philip Lowe said.
Biden hasn't gotten much credit for the strength of the job market, because rising inflation has dented household payrolls and because many assets are harder to buy. As consumer confidence declined, Biden's approval rating settled at around 40%, according to polls.
"In some ways, history may have guided the Fed a little bit wrong, as well as fiscal policy," Bernanke said at a public event last month. "Fiscal policymakers seem to have learned too well the austerity lessons of the post-financial crisis."
(Extract from the press review of eprcomunicazione)
This is a machine translation from Italian language of a post published on Start Magazine at the URL https://www.startmag.it/economia/stati-uniti-inflazione-fed-biden/ on Sun, 19 Jun 2022 05:58:07 +0000.