Policy

This is partly why the Fed is getting more and more hawkish.

You’ve got measures of the natural rate (older LB-W, more recent LM data). The real rate (fed funds – expected inflation) is still way below those estimates and getting lower because expected inflation is rising.

Which you can view in nominal terms.

And this works well enough, to capture the idea of why the Fed “feels it is playing catch up” and getting more and more hawkish. You can formalise the below relationship with a simple OLS, but your eyeballs can do it just as well. NGDP and FFR are related, but presently the gap is enormous, and the idea is that NGDP comes down a lot and FFR up a lot.

In fairness to the Fed though, look at the post 2010 period. Real rates well below estimates of natural, but no evidence of overheating, indeed, a jobless recovery that took a decade to reach prior peaks. No sign of inflation overheating. So it isn’t a slam dunk to go r < r*.

Hence why some clever economists say they are “not sure of anything about R*, or anything * in general”. We had austerity over the ’10’s, post the GFC, as contractionary fiscal policy set in, which appears to have made a big difference.

Hence why some clever people say “you need monetary policy to work hand in hand with fiscal to produce these sorts of effects”. No big inflation boom without both.

Does one enable the other, more fulsomely perhaps, unlocks it perhaps, has synergies, perhaps; that’s the idea, and we are absolutely sure they do.

Lastly, you can point to the necessary combination of “animal spirits” (repressed COVID demand unleashed) AND a burgeoning supply shock (RUS-UKR).

Wrapping it all up together it seems very clear that to have a sizeable bust of inflation (like that which we are seeing, of this magnitude) you need a framework only fractionally more complex than simply pointing to interest rates relative to natural rates.

You need fiscal. You need a consumer preference shift that occurs simultaneously. You need a supply shock.

I suppose the point is that you wouldn’t look at the first two graphs, and make a material prognostication of inflation / deflation.

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