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11/23/2024

Opinion | They Wouldn’t Know Inflation if It Bit Them in the Ballot© Mark Hertzberg/Zuma Press

You might have thought the Democrats’ biggest liability in the election was that the Biden-Harris administration and its advisers didn’t know what to do about inflation. Lately, however, a different and stranger question arises: Do these folks even know what inflation is?

Witness the Bidenomics rearguard action now under way. Economists within and around the departing administration are engaged in a revisionist attempt to cast the failures of the past four years in a less embarrassing light.

The policy disaster this crew must argue around is unprecedented spending. Highlights (or lowlights) included a $1.2 trillion infrastructure bill, the $280 billion Chips Act, an Inflation Reduction Act to which no one can attach an accurate price tag, and annual budgets featuring terrifyingly large peacetime deficits. Including the $3 trillion-plus pandemic relief passed under President Trump, federal debt held by the public grew more than $10 trillion between early 2020 and today, more than half of that after Mr. Biden took office and the pandemic emergency had abated, and it’s still growing.

The $1.9 trillion American Rescue Plan of March 2021 constitutes the biggest political liability. It passed on party-line votes in Congress when the economy already was recovering. Some liberal economists, such as Larry Summers, warned before its passage that it would be inflationary, and rising prices accelerated shortly after the bill was enacted. Voters appear to have intuited a connection.

Not so, say the revisionists. Representative of the genre is a recent Washington Post op-ed by Peter Orszag, CEO of Lazard and a director of the Office of Management and Budget in the Obama administration. He argues, based on research he conducted with economists from Lazard and the Brookings Institution, that supply-side problems such as supply-chain disruptions accounted for 79% (not 78% or 80%) of the inflation in 2021.

This is part of a growing academic literature attempting to decompose (yes, that’s really the jargon) inflation into its contributing factors, mostly reaching conclusions similar to Mr. Orszag’s. As he writes, the fiscal boost to demand played only “a modest role” in the Biden inflation.

Such studies have their uses. But if the overarching question is what caused the Biden inflation, you start to wonder if the eminent dismal scientists writing these papers remember what inflation actually is. We’re talking about a change in the general price level, which means one must examine supply and demand in tandem. The “price level,” after all, represents that matrix of prices for all goods and  services at which aggregate supply and aggregate demand reach balance

The Bidenomics rear guard is talking about something different: changes in relative prices, such as the jolt to prices for toys that might arise due to a Chinese pandemic lockdown, or the energy price shock after Russia’s 2022 invasion of Ukraine. In the process they beg the most important questions, in the true sense of that phrase—taking as a given the phenomenon one ought to be examining.

The obvious follow-up questions after an observation that snarling supply chains pushed up some prices would be: Why and how were consumers able to absorb those higher prices without offsetting declines in service prices? Why did temporary changes in relative prices for some things morph into a large and durable increase in the prices for everything? Mr. Orszag and his co-authors only mention cryptically in the last paragraph of their research note that the supply pressures they describe “inevitably have a demand component.”

There’s a lot of interesting economics to be done to understand the recent bout of inflation. For instance, what role did monetary policy play in all this? And how and why did a fiscal blowout like the American Rescue Plan stimulate rising consumption specifically? Why not, say, higher household saving or investment via 401(k)s and the like?

On the latter point, the revisionists note there’s no clear relationship between inflation and stimulus spending measured as a proportion of gross domestic product. But an alternative “fiscal theory of the price level,” championed by John Cochrane at the Hoover Institution among others, posits that the important link is between new government spending and the existing government debt level. When measured in this way, a robust relationship emerges between faster inflation on one hand and higher government spending relative to existing debt on the other hand.

The intuition is that as households and businesses collectively start to doubt the government’s long-term ability to repay a debt-fueled spending binge, incentives develop to consume rather than save and invest. Agree or disagree (I’ll profess agnosticism for now), this theory at least tackles the demand half of the inflation equation that the revisionists would rather ignore.

Sometimes conventional wisdom is wrong, especially in economics. But there isn’t much evidence the electorate got inflation wrong this time. If the goal is to rebuild trust in Democratic economic management, Bidenomics revisionism is an odd way to go about it.

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Remember – the American people did not vote these people into office in 2020. Don’t blame them.

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