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Olivier Blanchard on U.S. Pandemic-Era Inflation

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Olivier Blanchard discusses the direct and indirect effects of product-market and labor-market shocks on prices and nominal wages. Professor Blanchard suggests most of the inflation surge that began in 2021 was the result of shocks to prices given wages, including sharp increases in commodity prices and sectoral shortages. However, the effects of overheated labor markets on nominal wage growth and inflation are more persistent than the effects of product-market shocks.

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Image courtesy of interviewee. June 7, 2023

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This video discusses the unexpected rise in inflation, which has concerned various groups, including the general public and market policymakers. Initial beliefs underestimated the inflation's strength, affected by multiple factors such as oil prices, corporate greed, supply chain disruptions, and the effects of the COVID-19 pandemic.

The speaker and their collaborator argue that the fiscal responses to the pandemic, while necessary, were excessively generous, leading to inflation. They note a significant financial push in the U.S., which they believed would drive inflation higher due to insufficient production capacity to meet demand.

The analysis showed that while wage inflation was present, the main driver of overall inflation was the goods market, particularly due to commodity price increases resulting from supply chain issues and global events. Despite the spikes in inflation, inflation expectations remained anchored, reducing the likelihood of a wage-price spiral.

The speaker highlights the importance of recognizing both labor market dynamics and goods market pressures when analyzing inflation. Ultimately, they conclude that effective measures will be needed to bring inflation down, potentially requiring adjustments in employment levels, which may lead to a recession if not managed carefully. They stress that understanding inflation involves looking at aggregate demand, signaling that the current inflationary pressures, while concerning, may not indicate a fundamental failure of economic models or policies.

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Here are five key points from the video:

1. **Unanticipated Inflation:** The discussion highlights that inflation has recently surged to levels that were largely unexpected by most economists and policymakers, including those who predicted inflation. Various factors such as oil prices, corporate pricing strategies, and supply chain disruptions were cited as influences, but the speaker argues that high demand has played a fundamental role.

2. **Fiscal Stimulus and Economic Impact:** The speaker references significant fiscal interventions in the U.S. economy during the COVID-19 pandemic, totaling around $5 trillion. They suggest that the size of these stimulus measures was excessive relative to the economy's capacity to absorb them, contributing to inflationary pressures.

3. **Issues of Supply Chain and Market Dynamics:** The analysis distinguishes between the roles of the labor market and the goods market in driving inflation. It emphasizes that while labor market pressures have led to rising wages, the more significant driver of inflation has come from price increases in goods due to shortages and commodity price spikes.

4. **Inflation Expectations Management:** There is a critical focus on inflation expectations, particularly the difference between short-term and long-term expectations. The speaker notes that despite rising prices, inflation expectations have not significantly de-anchored, which is a positive sign in terms of longer-term inflation stability.

5. **Future Outlook and Economic Policy Implications:** The discussion concludes with an acknowledgment that high inflation resulting from past shocks might decrease in the future. However, to return to a target inflation rate (commonly 2%), the economy may need to undergo a period of slowed growth or a potential recession, particularly given the current signs of labor market overheating.

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Here are some key quotes from the video:

1. **On Inflation and Its Unexpected Nature:**
- "Inflation has been, you know, the obsession, uh, of many people,... but it was largely unexpected, uh, by most people."

2. **On Market Influences and Speculation:**
- "You hear about Saudis being responsible because of a price of oil... You hear about greed being a factor in firms moving prices without any reason except to increase profits."

3. **On the Fiscal Response to COVID-19:**
- "To me, it was absolutely obvious that the fiscal push that had come in the US was much too large."

4. **On Generosity of Fiscal Programs:**
- "The generosity of the programs became, I hesitate to use the word, but insane..."

5. **On Economic Capacity:**
- "No economy can come close to increasing production by 25%. It's just impossible."

6. **On Inflation Predictions:**
- "Inflation happened not the way I had predicted, which was mostly for the labor market, but for the goods market."

7. **On Expectations of Inflation:**
- "If you start saying, oh, the Fed will never get back to 2%, but we'll get back to four, then you start having a different way of thinking about the world."

8. **On the Role of Demand in Price Increases:**
- "Our inflation, the good news is most of the inflation was due to price shocks... which has not been understood by all the readers of our paper, uh, which is no, no, no, it was due to aggregate demand."

9. **On Future Inflation Trends:**
- "I think there's some question about food, which doesn't seem to be coming down the way it should... but for the moment it's a thing of the past."

10. **On Labor Market Challenges:**
- "But the bad news is, uh, going from in the US, four to two, um, may require say a slow down... if it's done slowly enough, maybe not. My guess is yes, there'll be something like a recession."

These quotes encapsulate many of the critical themes discussed in the video, including the nature of inflation, the effects of fiscal policy, the importance of understanding aggregate demand, and the challenges that lie ahead for the economy.

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Here are some articles that discuss similar topics, particularly focusing on inflation, economic policy, and the factors influencing economic conditions:

1. **"Understanding Inflation: The Economic Basics and Future Trends"**
- This article provides an overview of inflation, its causes, and expected trends in the global economy.

2. **"The Impact of Fiscal Policy on Inflation: Lessons from Recent Crises"**
- This piece explores how government spending during crises, such as the COVID-19 pandemic, can affect inflation rates.

3. **"Supply Chain Disruptions and Their Role in Current Inflation"**
- An analysis of how supply chain challenges have contributed to recent inflation rates and the broader economic implications.

4. **"Exploring the Phillips Curve: A Historical Perspective"**
- This article reviews the Phillips Curve and its relevance in understanding the relationship between inflation and unemployment.

5. **"The Role of Expectations in Inflation Dynamics"**
- A deep dive into how inflation expectations can influence actual inflation rates, including the concept of de-anchoring.

6. **"Demand-Pull Inflation: Causes and Consequences"**
- An examination of demand-pull inflation and how increases in aggregate demand can lead to higher price levels.

7. **"Energy Prices and Inflation: The Economic Chain Reaction"**
- This article discusses the correlation between rising energy prices and broader inflationary pressures in the economy.

8. **"Lessons from the Global Financial Crisis: Economic Policy and Inflation"**
- An exploration of the lessons learned from the financial crisis and how they inform current economic policy decisions regarding inflation.

9. **"Inflation Trends: Analyzing the Post-Pandemic Economy"**
- This piece analyzes post-pandemic inflation trends, discussing the balance between fiscal stimulus and inflation control.

10. **"High Inflation and Labor Market Dynamics: Implications for Future Policy"**
- An investigation into how high inflation impacts labor markets and what this means for policymakers aiming to control inflation while fostering job growth.

These articles collectively touch upon key themes of the original video, such as inflation factors, economic models, fiscal policy effects, and the relationship between labor markets and inflation dynamics.

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Inflation has been, you know, the obsession, of, of many people,

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people in the street, but people in the market, people in policy. Uh,

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so it was largely unexpected, by most people.

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Uh, it has been stronger,

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higher than even people like me who anticipated inflation thought it

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might go. Uh, so it seemed we,

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that it was ab and there was a, a lot of different explanations.

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There is a lot of different explanation. I mean, you hear about, you know,

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Saudis being responsible because of a price of oil. You sa you,

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you hear about greed,

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being a factor in firms moving prices without any reason except to increase

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profits. Uh, you hear about supply chain disruptions.

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Your ha you hear about Ukraine. And so Ben and I believe are,

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okay, let's hit down,

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let's think of a simple way of describing the data and try to allocate,

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you know, the inflation to the virus factors and try to understand why,

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it had not been anticipated to the degree that, that it was,

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it's true that some people, actually anticipated the inflation and, and got,

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a lot of flack for it when, when they said it. And,

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and one of them, and I suffers is another.

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So it makes two out of 6 billion people. Uh,

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but you know, to, to me,

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it was absolutely obvious that the fiscal push that

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had come in the US was much too large.

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So there was no question that given covid, given the lockdowns,

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there was a need to help firms and, and people, right?

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Firms would've gone bankrupt if they didn't have revenues. Uh,

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people had, lost their, not lost their job, but the job was no longer,

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active. So it was clear that there was a need to spend money. And, both,

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I think Larry and I were very much in favor of very generous programs,

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but the generosity of the programs became, I, if I,

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I hesitate to use the word, but insane, which is, you know,

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you had the car program, in March of 2020,

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which amounted to about 2 trillion.

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Then you had addi an additional, supplement at the end of a Trump,

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presidency of about nine, trillion.

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But these are, these are serious numbers. And then you had the, the Biden,

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program, in,

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in early 2021 at the tune of

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1.9 trillion. Now, the, some of this is 5 trillion.

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5 trillion is actually a big number. Uh,

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if you compare this to G D P, say 20 or 25 billion,

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depending on the year or depending on the year you, you use, you know, that's,

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that's close to a quarter of gdp. Uh,

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so it was fairly obvious to us that putting that money

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into the economy, was, was going to lead two palms.

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And I think we were aware of the fact that yeah,

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there was some room to increase output, but not a whole lot.

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And I think even us, even we on the,

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estimated, the importance of supply chain disruptions.

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So even if you ignored supply chain disruptions, this was much too large.

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No economy can come close to increasing,

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production by 25%. Uh, you know, even over one or two years,

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it's just impossible. But in addition, supply chain, issues came in and,

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and made it even worse. So I, I,

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I wouldn't take much credit for what we said,

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in, in, in, in early 21.

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It seemed to me that anybody who had any economic sense should have come to the

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same conclusion. So there's a fascinating issue of why is it that,

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that we were in the minority. Uh,

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I think there was a lot of wishful thinking. Uh,

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there was a sense that, well, you know, we have to help people and it's good.

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There was a sense that the opposite mistake had been made, in,

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in doing the, the global financial crisis, that that was not enough,

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and therefore the recovery was slow.

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So we're not going to make that mistake again. And if there was other,

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heating was not the end of the world, because, you know,

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that helps some people who would not have gotten into the labor market to

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actually get jobs, and they keep the job. So it's good.

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There was a sense that the Phillips curve was extremely flat. So yes,

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you could have other heating, but you know,

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it would not lead to a whole lot of inflation.

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So there were all these political, economic, ideological,

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hopeful, arguments,

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and they dominated the scene.

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Although I suspect that there was a bit of a Christmas tree aspect

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to at least the Biden, program, in which Biden said, you know,

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tell me what you want and I'll do it for you. Uh,

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so I think even people in the Biden administration thought was too big,

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but they were not in the majority, the administration. So that's what happened.

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It's one thing to say that if demand is much

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too high, there is going to be inflation. It's another thing to say why and how,

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and it could happen through the labor market. It could be,

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and that was, I think, the channel I had mostly in mind. And,

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and in that I was wrong. Um, that if you have overheating,

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the unemployment rate gets to very low levels. Uh, you know,

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it could have gone to, if people had spent more,

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they actually took time to spend. You know, there was this episode of,

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of excess saving, which is not over yet. I mean,

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the people are still basically,

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spending some of the saving they accumulated.

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But there was a sense that our unemploy would get very, very low.

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This would put a lot of pressure on wages,

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and this would lead to higher wage inflation,

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which would lead to more price inflation,

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which would lead to expectations being, de anchored to use the,

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the nerdy, technical jargon there. Uh,

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and that would lead to a lot of inflation. Uh, there was another channel,

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it could happen for the goods market, and by this I mean an increase in prices,

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not due to wages, but due to other things. Uh,

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and it's clear that some of it happened that way. And so the,

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the idea of them all with Ben was to say, okay,

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so some happen for the labor market, some happen for the goods market,

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supply chain disruption shortages, the price of oil.

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Uh, and let's try to get these elements in a,

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in a sample model. And then a lot of the dynamics,

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of inflation in a case like this, have to do with expectations of inflation,

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which is,

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if there's an increase in the price level or an increase in inflation,

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people may say, what's okay,

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it will go away because we trust that the Fed will do what's needed.

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And so expectations of inflation don't change, but it could be that people say,

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it's, the Fed will never have the guts to do it,

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and therefore we'll get more inflation. And then they start saying, okay,

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place more inflation. I want higher wage inflation. I want a higher wage.

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And then it starts, you know, what's known as a wage price spiral. Uh,

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and they get, they can get to very high inflation,

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even hyperinflation in some cases. Uh,

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so the more we had had a wage equation to understand the effect

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of the labor market on wages,

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it had a price equation reflecting the behavior of

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prices as a function of wages and other things.

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And then two expectation equations, because

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I think it's important to distinguish between what you expect inflation to be

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next year and what you expect inflation to be, say 10 years from now.

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It's completely normal if there was a lot of inflation this year,

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but you're going to think there's more inflation next year.

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That's just rational. That's normal.

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The important one is the long run expectation by even 10 years.

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Because if you start saying, the fed will never get back to 2%,

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but we'll get back to four,

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then you start having a different way of thinking about the world.

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So we had two expectation equations, one for the short run,

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one for the long run. We wrote down very simple more. I mean,

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actually I didn't feel guilty, but I, I felt a lot of,

09:10.130 --> 09:10.963

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admiration for people like Jim Tobin,

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you know, who wrote malls like this 30, 40 years ago.

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But I thought that was the right kind of mall. So we wrote that,

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and then we went to the data and we tried,

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I think partly the success of a paper is that we did not torture for data.

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We said, okay, this is the mall. Yes. I mean, the world is more complicated.

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There's more dynamics and so on and so on,

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but let's just estimate the equations, not try, you know,

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to get a good fit or whatever. Just see,

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and we did this and I think we were lucky. I mean, you know,

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the hope is that you could do this. Torture is never a good thing.

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So you always hope that you're going to go to the data and they're going to say,

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yes, you're so right. Uh, the reality of ER work,

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which is the strength for ER work, is you go to the data and they say,

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what do you think? Where is, where does this come from?

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That's not what we want to say. And then there are two attitudes,

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or maybe free. One is to say, well, let's work on something else. Uh,

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one is to say, okay, I'll respect you and I'll change my views.

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And then the third is to torture the data so that they on the torture tell you

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what you wanted them to say. Um,

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you can guess what it is that I prefer over free,

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but it has happened that I went to the data and they just did not cooperate.

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And I choose exit. I decided, okay, I don't understand the stuff.

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I'll come back to it one day. Um, and so we did this.

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And so this is what we did in terms of, you know,

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your question was largely about methodology, and that's what we did.

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The common cause is, again, high demand,

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high demand for goods, high demand for labor. But what we found is,

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so going back to the, to the previous discussion we had,

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there are two channels, right?

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So there's a labor market and there's a goods market.

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And we found that in the labor market, yes,

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there was actually over heating, and we can discuss this more,

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but, and that led to some pressure on wages and wage inflation.

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But the Phillips curve wage, Phillips curve is fairly flat.

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So there has been other heating now for maybe eight quarters,

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and this has led to some wage inflation,

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which has been reflected in price inflation, and that there,

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but most of the action kind of month to month for quarter to quarter,

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our estimation is quarterly. But you know,

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the discussion is typically every month some statistics come out, comes out,

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and the action was in the goods market. It was very much like given wages.

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The priced inflation was much stronger than wage inflation.

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And that came from the increase in the price of commodities, you know, energy,

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food, it came from shortages.

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And when you have shortages, you know,

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one way to get rid of a shortage is to have a very large price increase.

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What you typically get is a mix, which is the price increases a lot,

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but not enough to make people stay home and not buy. So you,

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we used an index of shortage, which worked very well. And,

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and what we found is that quarter to quarter,

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most of the action came from, goods market. Uh,

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so behind this, you had this slow movement up of wage inflation,

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but most of the action was somewhere else. So every month, you know,

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there would be some articles saying, but that's a, it's a price of energy,

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which do this. Or what we also found, which was good news,

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is that these very large movements in prices didn't lead to

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de anchoring of expectations.

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And that's important because you could have something which comes from the

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Saudis increasing know opac, increasing low price of oil,

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and people say, there's a lot of inflation. I want higher wages.

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And that just didn't happen. Uh, expectations did not. The anchor,

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they moved a bit, but not much. They moved away. They had before,

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no, relative to inflation. Uh,

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so it was very much kind of one shot every month, every quarter. Yeah,

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this quarter it's really energy of this quarter, it's food. Now,

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the interesting question that's a large point on this I think is

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some people say, so Biden was not responsible.

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It was not of a heating. It was the Saudis, it was, you know,

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global warming. Yeah. Leading to,

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to small coops and high prices. And, and we take a fairly strong stand here,

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but which has not been understood by all the readers of our paper,

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which is no, no, no, it was due to aggregate demand.

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And the way we do this is by looking at the whole set of commodity prices,

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right? And if you think about a market for a specific commodity, say lithium,

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what,

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what all these markets are going to be have in common is for general demand,

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aggregate demand,

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which is going to lead to an increase in the demand for lithium, for copper,

14:28.780 --> 14:33.080
for whatever you want. But on the supply side, you know,

14:33.100 --> 14:35.440
one is going to, in the lithium market,

14:35.620 --> 14:39.800
it may be that there's a big discovery of lithium somewhere,

14:40.010 --> 14:44.280
which will have an effect maybe that in the point of copper,

14:44.370 --> 14:48.040
maybe some new plant of mine is developed, right?

14:48.340 --> 14:52.240
But it's much more idiosyncratic. It's basically, it happens in every market.

14:52.300 --> 14:56.080
So if you look at the common component, what's common to all these prices,

14:56.560 --> 14:59.930
I think you get to something which is demand, right?

15:00.000 --> 15:04.610
Because that's really the only commonality, a across all these,

15:04.750 --> 15:07.610
all these commodities. And we found that, you know,

15:07.610 --> 15:10.410
with look very much aggregate demand.

15:11.030 --> 15:15.850
So I think the short of it is inflation happened not the

15:15.850 --> 15:19.370
way I had predicted, which was mostly for the labor market,

15:20.150 --> 15:24.430
but for the goods market. But the result is the same. Our inflation,

15:25.210 --> 15:29.950
the good news is most of the inflation was due to price shocks.

15:31.080 --> 15:34.100
And our reasons to think that it's not going to get worse,

15:34.560 --> 15:36.580
and our reasons to think it's going to get better.

15:36.660 --> 15:38.140
I think there's some question about food,

15:38.430 --> 15:40.820
which doesn't seem to be coming down the way it should.

15:41.400 --> 15:43.700
And so there we have to look, but in general,

15:44.120 --> 15:48.980
so this big shocks and therefore high inflation is a thing

15:48.980 --> 15:52.660
of the past until next time. But for the moment it's a thing of the past.

15:53.680 --> 15:54.900
So that's good news.

15:55.520 --> 15:59.860
It means that basically the underlying inflation is much lower than, you know,

15:59.860 --> 16:04.220
in the US V seven eight, and then in the UK more than 10. Uh,

16:04.400 --> 16:09.130
so that's a good news. The bad news is, well, now we are left with the rest,

16:09.340 --> 16:11.770
which is the labor market. We have a heating,

16:12.020 --> 16:16.690
which is more think for the US and for Europe, UK being in between maybe,

16:17.510 --> 16:22.010
and there it's too high. Basically the wage inflation we have,

16:22.010 --> 16:26.850
which reflects counter the heating and the slight de anchoring of

16:26.850 --> 16:31.650
expectations, they have moved a bit, a bit up, means that we have to,

16:32.110 --> 16:33.570
if we want to go back to target,

16:34.040 --> 16:38.370
then you may know that I'm not in favor of returning to two,

16:38.370 --> 16:41.770
but that's not my decision. If a fed wants to go back to two,

16:41.880 --> 16:46.570
then it really has to put the brakes and the palm is the Phillips

16:46.670 --> 16:49.010
Kvi splat, which was great news on the way up,

16:49.510 --> 16:51.970
but is very bad news on the way down.

16:52.550 --> 16:57.210
And so this means we have to go too high on employment for a while. And,

16:57.270 --> 17:02.130
people don't want to hear this, but I'm afraid that's where we are.

17:02.510 --> 17:06.590
So the good news is we got rid of most of it,

17:06.930 --> 17:11.430
and likely to stay. But the bad news is, going from in the US,

17:11.580 --> 17:13.870
four to two,

17:14.850 --> 17:19.270
may require say or slow down, whether it leads to a session, you know,

17:19.270 --> 17:23.230
if it's done slowly enough, maybe not. My guess is yes,

17:23.230 --> 17:26.430
there'll be something like a recession. Um,

17:26.610 --> 17:30.710
but something has to happen in the labor market, and we're not there yet.

17:31.100 --> 17:35.750
There's always a school of thought who says, everything we knew is wrong,

17:36.250 --> 17:39.270
we have to start from scratch. Um,

17:40.260 --> 17:42.300
I can see v p r angle in that,

17:42.310 --> 17:46.860
especially if starting from scratch means doing what the person is doing.

17:47.640 --> 17:48.473
Um, but

17:48.810 --> 17:52.480
This is not a case. Uh, there are cases, I mean, I think when I was, you know,

17:52.480 --> 17:56.360
you you referred to the imf, and,

17:57.080 --> 17:57.913
I think the,

17:58.100 --> 18:02.920
the global financial crisis was a case in which macro had gone seriously

18:02.920 --> 18:04.040
won. Uh,

18:04.040 --> 18:07.960
we really had under not understood the nature of financial market.

18:08.960 --> 18:11.380
Uh, we had a very mechanical view, which was wrong.

18:11.840 --> 18:14.780
So I think that was a case in which there was a lot of work to do,

18:14.800 --> 18:17.700
and lot of work has been done, and we understand it better.

18:18.810 --> 18:23.100
This is not a case of we being

18:23.760 --> 18:27.300
not having the right morals of the right way of thinking about it. Again,

18:27.320 --> 18:29.660
as I've said, you know, earlier in this interview,

18:30.600 --> 18:34.980
my MO could have been written by Tobin and was written by Tobin, right?

18:35.420 --> 18:39.860
I mean, maybe it's not the same Greek symbols. Um, so I,

18:39.980 --> 18:44.100
I don't think that there's something fundamental, that we have to learn,

18:44.800 --> 18:49.020
but what we've learned is that high demand can happen through the goods market,

18:50.080 --> 18:51.660
and has happened in this case.

18:51.680 --> 18:55.580
So I think we have to be more aware of the fact that when we think about

18:56.610 --> 18:58.460
overheating in general,

18:58.460 --> 19:02.820
we have to look both at the labor market and the wage Phillips curve, but also,

19:03.200 --> 19:07.700
as you know, at the community prices, at other prices which,

19:08.480 --> 19:11.700
which which are relevant. So I think that's, that's a lesson.

19:11.850 --> 19:15.160
It's not the dramatic lesson. Um,

19:16.390 --> 19:19.330
but that's, that's a lesson I think from that episode.

00:06 - Inflation has been, you know, the obsession, of, of many people, people in the street, but people in the market, people in policy. so it was largely unexpected, by most people. it has been stronger, higher than even people like me who anticipated inflation thought it might go. so it seemed we,

00:32 - that it was ab and there was a, a lot of different explanations. There is a lot of different explanation. I mean, you hear about, you know, Saudis being responsible because of a price of oil. You sa you, you hear about greed, being a factor in firms moving prices without any reason except to increase profits. you hear about supply chain disruptions. Your ha you hear about Ukraine. And so Ben and I believe are, okay, let's hit down, let's think of a simple way of describing the data and try to allocate, you know, the inflation to the virus factors and try to understand why,

01:12 - it had not been anticipated to the degree that, that it was, it's true that some people, actually anticipated the inflation and, and got, a lot of flack for it when, when they said it. And, and one of them, and I suffers is another. So it makes two out of 6 billion people. but you know, to, to me, it was absolutely obvious that the fiscal push that had come in the US was much too large. So there was no question that given covid, given the lockdowns, there was a need to help firms and, and people, right?

01:50 - Firms would've gone bankrupt if they didn't have revenues. people had, lost their, not lost their job, but the job was no longer, active. So it was clear that there was a need to spend money. And, both, I think Larry and I were very much in favor of very generous programs, but the generosity of the programs became, I, if I, I hesitate to use the word, but insane, which is, you know, you had the car program, in March of 2020, which amounted to about 2 trillion. Then you had addi an additional, supplement at the end of a Trump, presidency of about nine, trillion.

02:36 - But these are, these are serious numbers. And then you had the, the Biden, program, in, in early 2021 at the tune of 1.9 trillion. Now, the, some of this is 5 trillion. 5 trillion is actually a big number. if you compare this to G D P, say 20 or 25 billion, depending on the year or depending on the year you, you use, you know, that's, that's close to a quarter of gdp. so it was fairly obvious to us that putting that money into the economy, was, was going to lead two palms.

03:16 - And I think we were aware of the fact that yeah, there was some room to increase output, but not a whole lot. And I think even us, even we on the, estimated, the importance of supply chain disruptions. So even if you ignored supply chain disruptions, this was much too large. No economy can come close to increasing, production by 25%. you know, even over one or two years, it's just impossible. But in addition, supply chain, issues came in and, and made it even worse. So I, I, I wouldn't take much credit for what we said,

04:00 - in, in, in, in early 21. It seemed to me that anybody who had any economic sense should have come to the same conclusion. So there's a fascinating issue of why is it that, that we were in the minority. I think there was a lot of wishful thinking. there was a sense that, well, you know, we have to help people and it's good. There was a sense that the opposite mistake had been made, in, in doing the, the global financial crisis, that that was not enough, and therefore the recovery was slow. So we're not going to make that mistake again. And if there was other,

04:41 - heating was not the end of the world, because, you know, that helps some people who would not have gotten into the labor market to actually get jobs, and they keep the job. So it's good. There was a sense that the Phillips curve was extremely flat. So yes, you could have other heating, but you know, it would not lead to a whole lot of inflation. So there were all these political, economic, ideological, hopeful, arguments, and they dominated the scene. Although I suspect that there was a bit of a Christmas tree aspect

05:19 - to at least the Biden, program, in which Biden said, you know, tell me what you want and I'll do it for you. so I think even people in the Biden administration thought was too big, but they were not in the majority, the administration. So that's what happened. It's one thing to say that if demand is much too high, there is going to be inflation. It's another thing to say why and how, and it could happen through the labor market. It could be, and that was, I think, the channel I had mostly in mind. And, and in that I was wrong. that if you have overheating, the unemployment rate gets to very low levels. you know,

06:03 - it could have gone to, if people had spent more, they actually took time to spend. You know, there was this episode of, of excess saving, which is not over yet. I mean, the people are still basically, spending some of the saving they accumulated. But there was a sense that our unemploy would get very, very low. This would put a lot of pressure on wages, and this would lead to higher wage inflation, which would lead to more price inflation, which would lead to expectations being, de anchored to use the,

06:36 - the nerdy, technical jargon there. and that would lead to a lot of inflation. there was another channel, it could happen for the goods market, and by this I mean an increase in prices, not due to wages, but due to other things. and it's clear that some of it happened that way. And so the, the idea of them all with Ben was to say, okay, so some happen for the labor market, some happen for the goods market, supply chain disruption shortages, the price of oil. and let's try to get these elements in a, in a sample model. And then a lot of the dynamics,

07:20 - of inflation in a case like this, have to do with expectations of inflation, which is, if there's an increase in the price level or an increase in inflation, people may say, what's okay, it will go away because we trust that the Fed will do what's needed. And so expectations of inflation don't change, but it could be that people say, it's, the Fed will never have the guts to do it, and therefore we'll get more inflation. And then they start saying, okay, place more inflation. I want higher wage inflation. I want a higher wage. And then it starts, you know, what's known as a wage price spiral.

07:58 - and they get, they can get to very high inflation, even hyperinflation in some cases. so the more we had had a wage equation to understand the effect of the labor market on wages, it had a price equation reflecting the behavior of prices as a function of wages and other things. And then two expectation equations, because I think it's important to distinguish between what you expect inflation to be next year and what you expect inflation to be, say 10 years from now. It's completely normal if there was a lot of inflation this year,

08:38 - but you're going to think there's more inflation next year. That's just rational. That's normal. The important one is the long run expectation by even 10 years. Because if you start saying, the fed will never get back to 2%, but we'll get back to four, then you start having a different way of thinking about the world. So we had two expectation equations, one for the short run, one for the long run. We wrote down very simple more. I mean, actually I didn't feel guilty, but I, I felt a lot of,

09:12 - admiration for people like Jim Tobin, you know, who wrote malls like this 30, 40 years ago. But I thought that was the right kind of mall. So we wrote that, and then we went to the data and we tried, I think partly the success of a paper is that we did not torture for data. We said, okay, this is the mall. Yes. I mean, the world is more complicated. There's more dynamics and so on and so on, but let's just estimate the equations, not try, you know, to get a good fit or whatever. Just see, and we did this and I think we were lucky. I mean, you know,

09:52 - the hope is that you could do this. Torture is never a good thing. So you always hope that you're going to go to the data and they're going to say, yes, you're so right. the reality of work, which is the strength for work, is you go to the data and they say, what do you think? Where is, where does this come from? That's not what we want to say. And then there are two attitudes, or maybe free. One is to say, well, let's work on something else. one is to say, okay, I'll respect you and I'll change my views. And then the third is to torture the data so that they on the torture tell you what you wanted them to say.

10:32 - you can guess what it is that I prefer over free, but it has happened that I went to the data and they just did not cooperate. And I choose exit. I decided, okay, I don't understand the stuff. I'll come back to it one day. and so we did this. And so this is what we did in terms of, you know, your question was largely about methodology, and that's what we did. The common cause is, again, high demand, high demand for goods, high demand for labor. But what we found is, so going back to the, to the previous discussion we had, there are two channels, right?

11:12 - So there's a labor market and there's a goods market. And we found that in the labor market, yes, there was actually over heating, and we can discuss this more, but, and that led to some pressure on wages and wage inflation. But the Phillips curve wage, Phillips curve is fairly flat. So there has been other heating now for maybe eight quarters, and this has led to some wage inflation, which has been reflected in price inflation, and that there, but most of the action kind of month to month for quarter to quarter, our estimation is quarterly. But you know,

11:49 - the discussion is typically every month some statistics come out, comes out, and the action was in the goods market. It was very much like given wages. The priced inflation was much stronger than wage inflation. And that came from the increase in the price of commodities, you know, energy, food, it came from shortages. And when you have shortages, you know, one way to get rid of a shortage is to have a very large price increase. What you typically get is a mix, which is the price increases a lot, but not enough to make people stay home and not buy. So you, we used an index of shortage, which worked very well. And,

12:32 - and what we found is that quarter to quarter, most of the action came from, goods market. so behind this, you had this slow movement up of wage inflation, but most of the action was somewhere else. So every month, you know, there would be some articles saying, but that's a, it's a price of energy, which do this. Or what we also found, which was good news, is that these very large movements in prices didn't lead to de anchoring of expectations. And that's important because you could have something which comes from the Saudis increasing know opac, increasing low price of oil,

13:12 - and people say, there's a lot of inflation. I want higher wages. And that just didn't happen. expectations did not. The anchor, they moved a bit, but not much. They moved away. They had before, no, relative to inflation. so it was very much kind of one shot every month, every quarter. Yeah, this quarter it's really energy of this quarter, it's food. Now, the interesting question that's a large point on this I think is some people say, so Biden was not responsible. It was not of a heating. It was the Saudis, it was, you know, global warming. Yeah. Leading to,

13:56 - to small coops and high prices. And, and we take a fairly strong stand here, but which has not been understood by all the readers of our paper, which is no, no, no, it was due to aggregate demand. And the way we do this is by looking at the whole set of commodity prices, right? And if you think about a market for a specific commodity, say lithium, what, what all these markets are going to be have in common is for general demand, aggregate demand, which is going to lead to an increase in the demand for lithium, for copper, for whatever you want. But on the supply side, you know,

14:33 - one is going to, in the lithium market, it may be that there's a big discovery of lithium somewhere, which will have an effect maybe that in the point of copper, maybe some new plant of mine is developed, right? But it's much more idiosyncratic. It's basically, it happens in every market. So if you look at the common component, what's common to all these prices, I think you get to something which is demand, right? Because that's really the only commonality, a across all these, all these commodities. And we found that, you know, with look very much aggregate demand.

15:11 - So I think the short of it is inflation happened not the way I had predicted, which was mostly for the labor market, but for the goods market. But the result is the same. Our inflation, the good news is most of the inflation was due to price shocks. And our reasons to think that it's not going to get worse, and our reasons to think it's going to get better. I think there's some question about food, which doesn't seem to be coming down the way it should. And so there we have to look, but in general, so this big shocks and therefore high inflation is a thing

15:48 - of the past until next time. But for the moment it's a thing of the past. So that's good news. It means that basically the underlying inflation is much lower than, you know, in the US V seven eight, and then in the UK more than 10. so that's a good news. The bad news is, well, now we are left with the rest, which is the labor market. We have a heating, which is more think for the US and for Europe, UK being in between maybe, and there it's too high. Basically the wage inflation we have, which reflects counter the heating and the slight de anchoring of expectations, they have moved a bit, a bit up, means that we have to,

16:32 - if we want to go back to target, then you may know that I'm not in favor of returning to two, but that's not my decision. If a fed wants to go back to two, then it really has to put the brakes and the palm is the Phillips Kvi splat, which was great news on the way up, but is very bad news on the way down. And so this means we have to go too high on employment for a while. And, people don't want to hear this, but I'm afraid that's where we are. So the good news is we got rid of most of it, and likely to stay. But the bad news is, going from in the US,

17:11 - four to two, may require say or slow down, whether it leads to a session, you know, if it's done slowly enough, maybe not. My guess is yes, there'll be something like a recession. but something has to happen in the labor market, and we're not there yet. There's always a school of thought who says, everything we knew is wrong, we have to start from scratch. I can see v p r angle in that, especially if starting from scratch means doing what the person is doing. but

17:48 - This is not a case. there are cases, I mean, I think when I was, you know, you you referred to the imf, and, I think the, the global financial crisis was a case in which macro had gone seriously won. we really had under not understood the nature of financial market. we had a very mechanical view, which was wrong. So I think that was a case in which there was a lot of work to do, and lot of work has been done, and we understand it better. This is not a case of we being

18:23 - not having the right morals of the right way of thinking about it. Again, as I've said, you know, earlier in this interview, my MO could have been written by Tobin and was written by Tobin, right? I mean, maybe it's not the same Greek symbols. so I, I don't think that there's something fundamental, that we have to learn, but what we've learned is that high demand can happen through the goods market, and has happened in this case. So I think we have to be more aware of the fact that when we think about overheating in general, we have to look both at the labor market and the wage Phillips curve, but also,

19:03 - as you know, at the community prices, at other prices which, which which are relevant. So I think that's, that's a lesson. It's not the dramatic lesson. but that's, that's a lesson I think from that episode.

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