[Leading economists misdiagnosis of inflation in 2021-22 was the
latest episode in a long-running series of failures. Either mainstream
economists need to re-examine their core beliefs, or the profession
needs a new mainstream.]
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WHY MAINSTREAM ECONOMICS GOT INFLATION WRONG  
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James K. Galbraith
November 15, 2023
Project Syndicate
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_ Leading economists' misdiagnosis of inflation in 2021-22 was the
latest episode in a long-running series of failures. Either mainstream
economists need to re-examine their core beliefs, or the profession
needs a new mainstream. _

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AUSTIN – In his November 7, 2023 _New York Times _newsletter
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the economist Paul Krugman
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good, albeit belated, question: Why did so many economists get the
inflation outlook wrong? After all, the near-consensus among
mainstream economists in recent years was that inflation would persist
– and even accelerate – and that this justified substantial
interest-rate hikes by the US Federal Reserve. Yet the quasi-inflation
of 2021-22 proved transitory.

Krugman poses his question with impeccable diplomacy, professing
“respect” for three authors of a September 2022 paper
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by the Brookings Institution (which was then promoted
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Harvard University’s Jason Furman
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that it would take at least two years of unemployment at 6.5% to bring
inflation back to the Fed’s self-imposed 2% target. But inflation
had already peaked
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the Brookings paper appeared, and long before the Fed’s rate hikes
might have been felt. Over the next year, inflation petered out, even
as unemployment remained below 4%
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Transitory” – which once briefly included
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Secretary of the Treasury Janet L. Yellen
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endured two years of derision, but it was correct all along.

Krugman rightly focuses on the illogic of certain inflation
“pessimists,” who “came up with new, completely unrelated
justifications” for their contention that inflation would “remain
stubbornly high” long after the 2021 fiscal stimulus packages had
been absorbed. Since these pessimists encountered very little
mainstream dissent, their doomsaying continued to dominate the
discourse well into 2023.

Krugman tactfully avoids naming Lawrence H. Summers
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whose “justifications
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for inflation pessimism included supposedly excessive “savings,”
the Fed’s “debt purchases” and forecasts of “essentially zero
interest rates,” and “soaring stock and real estate prices.”
Yet, aside from his worries about fiscal stimulus, this was all
nonsense. As I pointed out
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the time, savings cannot cause inflation, and a technical forecast
has no causal power.

Adopting the persona of a naïf, Krugman then suggests that it was
“almost as if economists were looking for reasons to be
pessimistic.” A paragon of politesse, he declines to tell us what
those reasons might have been. But two always stood out. The first was
fear: if American workers retained a financial cushion from the
COVID-19 aid packages, they might be “harder to boss around.” The
second reason concerned power: high interest rates tend to support the
dollar internationally.

Since then, various Fed officials have acknowledged both motives many
times. For example, an obsession with wages permeates
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of Fed Chair Jerome Powell’s speeches, and he has openly stated
his commitment
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maintaining a strong dollar. It is no surprise that mainstream
economists endorse – indeed, craft – the same arguments.

But I, too, was being polite, because I omitted a third possibility:
namely, that some mainstream economists might call for high interest
rates to curry favor with bankers, who enjoy larger profit margins
when rates are high (especially now that the Fed pays interest on bank
reserves directly). A strong public stance on the matter could
generate hefty speaking fees, consulting contracts, or a path to high
public office. As Krugman concludes, “I’d like to see some hard
thinking about how so many of my colleagues got this story so wrong
and maybe even a bit of introspection about their motivations.”

That would be nice, but let’s not hold our breath. Instead, let’s
turn to a larger issue. Krugman notes that all the economists he
mentions “are very much part of the economics profession’s
mainstream.” He means this as a compliment; yet, as Hamlet says,
“there’s the rub.” Consider just how often mainstream economists
get things wrong – not only small things, but very big ones.
Remember their famous failure
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financial crisis, or the woefully ill-advised turn to austerity
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2010? What about the predictably perverse effect of sanctions
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Russia? The misdiagnosis of inflation
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2021-22 was merely the latest episode in a long-running series of
failures.

The question we should be asking, then, is whether there is something
wrong with mainstream economics. Mainstream economists should perhaps
re-examine their core beliefs, or maybe we need a new “mainstream”
altogether.

To be sure, Krugman notes that “one strand of argument involved
parallels with the inflation of the 1970s.” But this only grazes the
problem. The real issue is that most of today’s leading mainstream
economists were trained in the 1970s, and their worldview – not just
the facts, but the theory – was fixed back then. On macroeconomic
issues such as inflation, the influences of general equilibrium
theory, inflation-unemployment trade-offs, and monetarism remain
strong. The legacies of Kenneth Arrow
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Samuelson, Robert Solow, and Milton Friedman
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on.

That earlier generation’s project was partly scientific, partly
political. As “social scientists,” they believed in the power of
mathematics, which they borrowed from the celestial mechanics of
previous centuries. Politically, they sought to defend capitalism
against the Soviet challenge during the Cold War. By uniting these
objectives, they fashioned the market-oriented mathematical
straitjacket in which today’s mainstream economists were raised –
and from which they cannot escape. Yesterday’s _Wunderkinder_ –
including Summers and Krugman – are today’s tired old men.

Notably, Krugman’s reflection on disinflation makes no mention of
the economists who did not misdiagnose things, including
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M. Weber
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University of Massachusetts Amherst, and L. Randall Wray
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Nersisyan
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Levy Institute. They correctly predicted
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disinflation back in March 2022.

But economists with better ideas never get citations by name, let
alone job offers from so-called top departments, mainly because so
many members of the old guard want to preserve the academic,
political, and media monopolies they have held since the 1970s. That
means purging new ideas and belittling
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people who advance them. By offering such a polite, gentle critique of
his “colleagues” after their latest failure, Krugman is being
diplomatic to a fault.

_JAMES K. GALBRAITH, Professor of Government and Chair in
Government/Business Relations at the University of Texas at Austin, is
a former staff economist for the House Banking Committee and a former
executive director of the Joint Economic Committee of Congress. From
1993-97, he served as chief technical adviser for macroeconomic reform
to China’s State Planning Commission. He is the author
of Inequality: What Everyone Needs to Know
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University Press, 2016) and Welcome to the Poisoned Chalice: The
Destruction of Greece and the Future of Europe
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University Press, 2016)._

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* inflation
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* economists
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* federal reserve
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* strong dollar
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* wages
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* profits
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