The other day, Larry Summers threw a fit.
The former treasury secretary, perhaps the most famous face of Washington’s old-guard economic policy establishment, had spent weeks howling about the $1.9 trillion coronavirus relief plan that President Joe Biden signed into law earlier this month. Summers believes that the legislation could lead the economy to “overheat”—meaning that the massive dose of spending might cause a destabilizing burst of inflation. His criticisms kicked off a debate that gripped much of the economics world, and during an appearance on Bloomberg TV a couple weekends back, his doomsaying reached newly operatic heights, as he declared that the country had embarked on “the least responsible macroeconomic policies we’ve had in the last 40 years.
“I don’t really understand the logic of those who are serene right now,” Summers added later.
Few seem more serene at the moment than Jerome Powell, who has consistently argued that the risk of doing too little in responding to the economic calamity of the coronavirus crisis far outweighs the risk of doing too much. While testifying before Congress last Tuesday, the Federal Reserve chair was asked for his thoughts on whether Washington’s deficit spending spree might spark inflation. His response? Extremely relaxed.
“We do expect that inflation will move up over the course of this year,” Powell said, suggesting that as Americans are vaccinated and start to spend their stimulus checks, the prices of some goods might pop a bit due to production “bottlenecks.“ But, he explained, the Fed felt “the effect on inflation will be neither particularly large nor persistent.” The central bank still plans to hold off on rate hikes until inflation averages above 2 percent for a long while, a wait-and-see strategy it adopted after spending years of being unnecessarily skittish on monetary policy because it predicted inflation was around the bend, and then watched it fail to materialize.
Afterward, one anonymous econ wag complained about Powell’s performance to Politico, painting the Fed chair a bit like a blissed-out Cali surfer bro. “The fact that Powell is exuding all this utter serenity is [highly] problematic,” they carped. For obvious linguistic reasons, some assumed Summers was the source. At the very least, they were echoing him.
In monetary policy, people are usually considered hawks, meaning they tend to worry a lot about inflation, or doves, meaning they don’t. But this month, as the Great Overheating Debate unfolded, the econ field seemed to separate into two slightly different camps. There are now the Larrys, who are concerned that the U.S.’s COVID response may have charted a course for economic disaster. And there are the Jeromes, who are feeling more or less zen. Not everyone fits neatly on one side or the other—there’s really a Larry-to-Jerome spectrum—but the basic battle lines have formed around them.
What separates the camps isn’t just the question of whether inflation is a real and present danger, but whether our central bankers are capable of combating it without accidentally tanking the economy themselves.
Are You a Larry? (Or Do You Expect You Might Become One?)
In some ways, it’s ironic that Summers is now leading the chorus of would-be Cassandras. After all, back when the country was slogging through its slow recovery from the Great Recession, he famously championed the theory of “secular stagnation”—the idea that the world had sunk into an era of perpetually low interest rates and economic underperformance. Overcoming it, he argued, would likely require governments to run larger budget deficits, which is precisely what the United States is doing at the moment.
But Summers, a prickly gadfly at heart who has always enjoyed needling Democrats to his left, now says that the American Rescue Plan Act—and its massive, one-time money drop—may have gone too far. He has compared himself to someone who supports raising the minimum wage but thinks lifting it to $23 an hour for a couple years might be a bad idea. And while his rhetoric has been the most feverish on this issue by a far, he’s been backed in his concerns by influential fellow economists from the field’s moderate establishment, such as Olivier Blanchard, the former chief economist at the International Monetary Fund, and Harvard professor Greg Mankiw, a former George W. Bush administration adviser who may have written your textbook if you took macro in college.
So why exactly have Summers and co. been fretting?
One slightly confusing thing about the whole conversation is that there isn’t really a consensus definition of what it would mean for the economy to “overheat.” The New York Times’ Neil Irwin asked 10 different economists representing all sides of the fight and got roughly got 10 different answers.
What’s more, economists generally seem to expect that some prices are going to jump more than normal this year. Flights and hotel rooms will get more expensive as Americans rush to take a post-vax vacation. Big-ticket purchases like couches, fridges, and used cars could get another bump as families spend down their stimulus checks. Powell and his colleagues at the Fed have said they’ll be patient and won’t hike rates in response to those sorts of fleeting fluctuations.
But Team Larry has argued that the coronavirus bill could unleash a much more dangerous sort of economic chain reaction, triggering not just a bump in the cost of living but a sustained increase in inflation that might undo the success monetary policymakers have had keeping it in check over the past several decades.
To understand why, it helps to appreciate the central role that so-called inflation expectations play in the way mainstream economists think about monetary policy these days. The idea is pretty simple: If people expect inflation to jump in the future, workers and business owners will act accordingly, and it will probably jump. Employees will ask for bigger cost of living increases, stores will mark up their merchandise in anticipation of higher costs, and prices will start to rise. Likewise, if people expect inflation to stay low, then it will probably stay low. Either way, the public’s beliefs are supposed to be a self-fulfilling prophecy. (Partially, anyway. Expectations aren’t the only thing that matter.)
One way to think about this is that, in the dominant strain of monetary economics, inflation expectations function a bit like the Force in Star Wars—the powerful, quasi-mystical energy that central bankers must gain mastery over in order to bring order to the universe. A popular explanation for why inflation has stayed so low since the turn of the century is that the Federal Reserve has essentially trained Americans to believe it will come in at around its 2 percent target each year, no matter what. Policymakers have successfully “anchored” expectations, as the saying goes, by showing their willingness to smother inflation whenever it emerges.
But Team Larry is worried they could become unanchored thanks to Biden’s coronavirus bill and the Fed’s lax attitude. First, Summers and co. suspect that Washington is about to spend much more than necessary to fill the economic hole created by COVID. This splurge, they say, could spark an initial bout of inflation unlike any we have seen in years. There will simply be too much money chasing too few workers and goods, which will put pressure on businesses to hike wages and lead prices to rise. If the Fed sees inflation flare up and does nothing to quell it, Americans might begin to think that prices will rise faster in the future too. Expectations will become unglued, which in turn could become a self-fulfilling spiral.
Summers has specifically suggested we might witness a replay of the late 1960s, when the cost of living spiked amid Lyndon Johnson’s attempts to simultaneously fund the Vietnam War and his Great Society. Many economists believe that spark lit the fuse for stagflation in the 1970s—the painful combination of rising prices and high unemployment that defined much of the decade.
But even if the Federal Reserve does try to nip inflation early by raising interest rates, Summers argues that the economy could still wind up in trouble. “My reading of the historical experience is that almost every time inflation has accelerated, and the Fed has felt it necessary to step in … the result has been that the economy has gone into recession,” he said last month. “The Fed has had essentially no success in engineering soft landings.” Mankiw has similarly warned that “it would be a mistake to put too much faith in the prescience and skill of central bankers.” Team Larry’s view is not mere hawkishness, but rather a deep pessimism regarding the deftness of our economic institutions.
Are You a Jerome? (Or Are You Just Not Sweating It?)
To the members of Team Jerome, all of this seems a bit like needless hyperventilating. And, as of now, the optimists seem to have the larger, more influential squad. Along with Powell’s fellow Fed officials, who’ve essentially rolled their eyes at Summers, and the Biden administration (economic adviser Jared Bernstein got up on the White House podium and said Summers was “flat-out wrong” about the relief bill), the optimists include much of the economics commentariat that tends to dominate Twitter and center-left media. The New York Times columnist and Nobel Prize winner Paul Krugman has been acting as a point guard of sorts, waging a long debate with Summers. And yes, I count myself as a deep bench player on the roster.
What’s the case for chilling out, then?
First, the coronavirus bill might not create that much inflation to begin with. Many families will likely save rather than spend their checks, and states may take a while to deploy much of the aid they received, especially since they’re allowed to use it on infrastructure. Plus, the economy may have much more capacity to sop up new spending than the worrywarts think. Team Larry, and other skeptics, leaned heavily on estimates from the Congressional Budget Office on how fast the country can grow before inflation becomes a problem, which suggest the U.S. was already overheating in 2019. That’s unlikely, given the fact that inflation was nowhere to be seen; there’s just no real reason to think we’d reached our limits pre-plague.
Second, there’s the matter of expectations. Powell’s view is that the Fed can let some temporary inflation come and go without worrying about it spiraling, because people know the central bank will move mountains to keep inflation around 2 percent in the long term. “There was a time when inflation went up, it would stay up. And that time is not now,” he said during a March 17 press conference. “Having inflation expectations anchored at 2 percent is the key to it all.”
It’s possible Powell is overconfident. But the reality is that inflation has been very low for a very long time now, to the point where it’s barely been a factor in most Americans’ conscious lives. The Fed has struggled even to push inflation up to that 2 percent annual target since the Great Recession—which is why it now plans to hold off on any rate hikes until inflation actually emerges. And while it’s always possible we’re becoming complacent and ignoring the lessons of the past, it’s just a bit hard to believe that the public is going to radically change its views about inflation overnight. It certainly hasn’t happened yet: While some measures of inflation expectations are rising at the moment, they’re all still within their completely normal ranges by the standards of recent years.
Things might be different if Democrats were getting ready to pass $1.9 trillion deficit-financed spending packages each session of Congress, but they’re not—the party’s leaders are already busy talking about what tax hikes they might use to fund their infrastructure plans.
History doesn’t necessarily support the idea that it’s particularly easy for inflation to rage out of control, either. In the 1970s, it took the combination of a global spike in food prices, two separate oil crises caused by the creation of OPEC and the Iranian revolution, the end of price controls, the dissolution of the Bretton-Woods international monetary system, and Richard Nixon strong-arming the Fed into loosening up monetary policy for the sake of his reelection campaign—among other potential factors—to produce the stagflation now seared into the minds of older economists. Charles Evans, the president of Federal Reserve Bank of Chicago, put it simply last week. “I kind of remember the ’70s, too,” he said. “This isn’t the ’70s. We’ve had trouble getting inflation up.“
If inflation does somehow spike, can the Fed squelch it without plunging us into recession? The clues of the past are mixed, to be honest. The central bank’s most famous inflation-fighting efforts, like Paul Volcker’s campaign in the 1980s, triggered deep downturns. But the Fed has certainly raised interest rates in the past without triggering an immediate recession, and its most recent leaders have shown their ability to read data and adjust their strategy to avert disaster. The Fed hiked rates in 2017 and 2018, for instance, before cutting them back down in 2019 when it realized it needed a looser approach. It may not be wise to put all your faith in central bankers, but today’s bunch are reasonably nimble.
Some people might wonder why this argument matters now, given that the coronavirus bill already passed and the Fed seems set in its path for now. And to some extent, a lot of what’s going on is academics and journalists marking off intellectual territory so they can claim credit down the line if their predictions come true. But it’s important for politicians and readers following along at home to understand the different stories each side is telling so they can tell which narrative better fits the facts if we see stirrings of inflation later on. Whether people think it’s just a momentary bump or the sign of something more ominous could impact the extent to which the Biden administration and Congress feel comfortable deficit-financing some of their priorities down the line, too. It could also affect how much pressure politicians try to put on the Fed to react, which could prove important; the central bank might be independent, but its leaders are human, after all.
A final, important thing to keep in mind about this whole debate is that, to one extent or another, everyone involved is working on gut instinct, rather than a carefully calibrated model. In part, that’s because the economy is in a strange place, and in part it’s because nobody is entirely clear on how inflation works in general anymore. Summers has said he thinks there is a one-third chance we’ll see an inflationary spiral, a one-third chance the Fed will throttle the economy, and a one-third chance everything will work out fine—which is a long, faux-precise way to say he’s nervous about the economy but realizes his anxieties could be misplaced.
The question is how the sides are choosing to embrace the uncertainty. After years of watching inflation stay stubbornly low, Team Jerome has concluded the least risky thing to do is spend aggressively on the economy to prevent a prolonged slump and not get worked up if prices bump up a bit. Team Larry believes bold action risks ruin. “I think in environments which you don’t understand very well, it’s a good idea to take small careful steps, unless there’s a compelling reason to do something else,” he said back in February. Of course, the Jeromes would say COVID was a very compelling reason to do something else.