Ramesh Ponnuru and David Beckworth recently took to the New York Times op/ed page to clip the wings of inflation hawks. I certainly have no problem with ruffling the feathers of the perma-hawks -- I've spent much of the past two decades talking people down from various inflation scares -- but the case that inflation risks are rising is stronger than it's been in a long time (with the possible exception of 2009, when I was briefly hawkish, and when we did see a brief inflation spike). Let's lay out their points one by one.
1. Some high-profile thinkers, notably Harvard Economist Larry Summers, are concerned about inflation.
RESPONSE: When lifelong Keynesians such as Summers voice inflation fears, we should all listen carefully. Summers is aligned with the party in charge at the moment, and so has political reasons to downplay the risk of inflation coming from the monetization of high levels of borrowing and spending. When someone argues against his natural philosophical tendency and against his tribe, we should not be dismissive.
2. They should relax.
RESPONSE: Telling Summers to relax is, well, dismissive.
3. Inflation "hasn't spiked yet." (The NY Times article was published on Feb. 17th.)
RESPONSE: Inflation hadn't spiked yet as of Feb. 17 when the article was published, but within three weeks of that article a number of inflationary metrics did spike on a month-over-month basis. Month-over-month changes are important because they take out the false assurance of last Spring's deflationary episode. Deflation followed by higher-than-average inflation may average out to something looking like stability, but it isn't stability and that's why looking at higher frequency month-over-month changes can capture changes in trend better than glomming together a whole year's worth of data.
4. For this reason, hawks have focused on the spread between inflation protected treasuries and regular treasuries.
RESPONSE: I suppose some hawks have depended on the TIPS spread to make their case, but that is not the only market metric signaling inflation. One can also look at gold prices, foreign exchange rates, inflation-hedging funds, and nominal commodity prices. Also the suggestion that hawks chose TIPS spreads for the purpose of buttressing their prior commitment to the hawks flock (ornithologically known as a "cast" or a "kettle"), may be fair, but does that accusation not fly in both directions? I've followed Mr. Ponnuru's work enough to see at least a suggestion that he is a long-term member of the dove flock (aka the "dule"). From where I sit, the dual between "dule" and "cast" is to some degree a matter of castes. Each hovers in the sky looking for specific strands of data to use to weave their respective nests.
5. But hawks are wrong to do argue from TIPS spreads, because that metric is focused on CPI, and the Fed targets a different inflation metric, PCE inflation.
RESPONSE: Analysts of whatever flock are not wrong to look at TIPS spreads. All data has its limits, but the fact that this particular instrument focuses on a slightly different inflation metric than the one the Fed relies on is fairly trivial since the two different inflation metrics are tightly correlated. If the Treasury offered a bond tied to PCE, that would be a slightly better tracker of the metric which the Fed tracks, but they don’t. And why don't they? Because that's the way that people wanted it. As a consumer, I would like the inflation of the whole basket, which CPI tracks, as opposed to changing the composition of the bucket when ground beef gets too expensive and I buy ground turkey instead. I’d prefer it if the Fed evaluated itself against CPI, which is a tougher judge.
6. CPI inflation tends to be higher than PCE inflation.
RESPONSE: If CPI runs hotter than PCE, all the more reason to track CPI rather than let the Fed grade itself by only evaluating the metric which is more forgiving of monetary excess. The choice of an inflation metric which is easier to fulfill is a reason to be concerned, not to relax. It amounts to a situation in which the Fed can debase currency more and still give itself a passing grade because PCE is not above 2%, even if CPI is (by their own admission) likely to be higher. Targeting PCE gives the Fed a fudge factor of about 1/3rd of a percent on average; the fudge factor is larger when inflation is higher.
7. We cannot trust a spread based on treasury bonds because the Fed buys treasury bonds and this distorts the yields.
RESPONSE: This topic is complex and requires separate treatment. There is significant merit to this argument. The Fed does manipulate bond prices which introduces political noise into the market signal. However, the argument is fairly selective: the Fed distorts both the nominal treasury market and the inflation protected one. So telling us that rates are manipulated doesn’t automatically mean that inflation risk is being overstated. In point of fact, there are technical aspects of this which are helpful to the dules but also somewhat helpful to the casts, but probably mostly the former. A fairer approach would look at both. We've taken a deeper dive into this mind-numbingly technical debate in a separate article.
8. The spread is implying an inflation rate which is below the Fed's target.
RESPONSE: If the real spread puts inflation below the Fed's target, that is important, and does have merit. The adjusted spread does have a high correlation with future inflation, but not a perfect one. It has its blind spots and it just so happens that its blind spots historically coincide with some of the conditions we see right now. More on that in a separate piece. In addition, when the Fed thinks inflation will be low, is that not inherently risky, because that allows it to give itself permission to do what's easy, to spike the punchbowl even more?
9. The Survey of Professional Forecasters is predicting inflation of roughly 2%.
RESPONSE: That matters, but your argument suggests that markets know more than experts, and markets are predicting higher inflation than that.
10. The Cleveland Fed's ten year forecast is also subdued.
RESPONSE: Seems like a hawkish sign to me. When Fed is nonchalant about inflation risks, we should be ‘chalant’. If the Fed expects low inflation, it will be more likely, rather than less likely, to excessively expand money supply. If they were more worried about inflation, I’d be less worried about it.
11. The Fed itself doesn't forecast hitting its inflation rate for at least ten years.
RESPONSE: See point 10.
12. When investors are frightened or uncertain, they tend to buy treasury bonds, which lowers yields.
RESPONSE: Yes, risk-averse climates cause investors to buy treasury bonds, but TIPS are treasury bonds too. What needs to be shown in order to discredit the predictive power of the spread is to show that frightened investors are distorting the yield of one type more than the other. In terms of default risk, both types of treasuries are the same. So they are both havens against default risk in scary times.
13. Some commentators wrongly predicted high inflation ten years ago.
RESPONSE: The fact that some wrongly predicted inflation ten years ago is pretty tangential. Some wrongly predicted non-inflation in the '70s. If the argument is an argument from authority, then perma-dules are in a pretty weak position. For my part, I prefer arguments from evidence over discrediting the source of the predictions. Though I certainly have had my fill of macro-economic frighteners. For more on this, please refer to the "supply versus supply" debates between supply-siders in the mid oughts at National Review Online. I have certainly been wrong sometimes, but perma-hawk I am not. Consider me more of a mockingbird, one who changes his song as circumstances warrant, in order to feather my nest.
14. Low inflation, such as below 2% annual rates, can be a problem.
RESPONSE: Perhaps there are some sectors which need inflation above 2% PCE, but what about the rest of us? Near zero interest rate policy and an environment in which inflation becomes a permanent part of our planning regime seems to hurt almost all of us as savers and consumers and taxpayers, to the benefit of some of us.
15. The economy needs not just real GDP to grow, but nominal GDP to grow as well, i.e. it needs inflation because certain contracts have the need for such inflation built into them.
RESPONSE: The argument needs more detail. Which specific contracts require the nominal growth of at least 2% inflation to function properly? I understand that our economy, with its various price floors -- especially in labor markets -- handles deflation badly, but that does not mean that we need plus 2% inflation. Also, most contracts seem to possess cost of living adjustments or interest rates tied to various benchmarks which can move freely. Further, a number of tax-bracket cut-offs and tax calculations are still not indexed for inflation, which means inflation raises taxes.
16. The Fed hasn’t done enough yet.
RESPONSE: Expanding the balance sheet 130% in one year isn’t enough? Pushing Fed Funds rates to near zero isn’t enough? Double digit money supply creation isn’t enough? I think that given the historically extreme actions of the Fed, that’s a real uphill climb to tell us that it needs to do more.
17. The real danger is the inflation hawks themselves. The reason is not specified, but the suggestion is that they will influence the Fed to not be sufficiently inflationary.
RESPONSE: Are the hawks really a threat? The argument so far has been that almost all the forecasters are doves. The Fed itself has a dovish outlook. Almost no one in Washington is calling for rate hikes (at least no one with any pull). The fiscal outlook is rising debt, which makes us more or less addicted to easy money. Even the markets want easy money, throwing taper tantrums at mere rumors of even minimal monetary restraint. Even big names at the flagship conservative opinion journal are telling us that we should all relax about inflation. Seems like the dule is ruling the roost, while the cast issues plaintiff cak-cak-cak's and kiks (Cooper's Hawk Sounds, All About Birds, Cornell Lab of Ornithology) from far away.