“It’s tough to make predictions,” Yogi Berra famously observed, “especially about the future.” Perhaps, then, we should forgive the Biden administration’s Team Transitory for its months of erroneous forecasts about inflation—now running at a 31-year high. What we should not ignore or forgive, however, is dissembling about inflation’s true causes. Many on the left blame corporate greed and unfettered monopoly power. Progressives are eager to deploy the Federal Trade Commission and the Justice Department in pursuit of more control over the private sector. But greed and market power were presumably just as prevalent over the many years when inflation ran between 1 percent and 2 percent as they are now. Talk of “profiteering” is at best a distraction and at worst a misguided rationale for regulatory actions likely to have bad effects.

Though Federal Reserve chairman Jerome Powell has now retired the “transitory” label for inflation, it’s important to understand why the Biden administration and Fed officials got it wrong in the first place—and why they’re likely to continue acting in ways that portend a bumpy economic ride. In Powell’s telling, “what we missed about inflation is that we didn’t predict the supply-side problems.” But that’s just the half of it.

The pandemic and associated lockdowns delivered what economists refer to as a “supply shock.” When people can’t work and produce output, prices start to rise as goods become scarce. But most economists agree that fighting inflation in this case should take a back seat to lessening the shock’s effects on employment. The textbook prescription is stimulating demand via expansionary fiscal and monetary policy—but not too much, and not for too long, or the price effects go from uncomfortable to painful.

To see what can go wrong, we need only recall the 1970s, when two major shocks to the energy sector—the oil embargo of 1973–74 and the 1978–79 oil crisis associated with the Iranian Revolution—plus some lesser disruptions and bumbling policy responses, produced not just a Great Inflation but slow growth and high unemployment. Inflation averaged 7.4 percent and unemployment 6.4 percent for the period 1970–79; by 1980, the sum of those indicators—the “misery index”—hit 19.7 percent. That unhealthy combination required economists to devise a new word, “stagflation,” and to go back to the drawing board and figure out how it all happened.

The best thinking about stagflation highlights three key factors: policymakers were guided by some bad theories; their strategies based on some good theories were badly executed; and circumstances were unique and, therefore, conducive to error.

One bad theory: we could buy sizeable and durable reductions in unemployment at the expense of relatively little inflation. This made policymakers excessively eager to stimulate demand via fiscal and monetary expansion and slow to recognize the need to back off as inflation began heating up (well before the oil shocks brought the pot to full boil).

The bad execution resulted from mismeasurement of key variables that complicated the diagnosis of the problem and, more importantly, from political pressures that prevented effective treatment. When responding to adverse supply shocks with stimulus, it’s crucial not only to apply the right amount of medicine but also to withdraw it at the right time and in the right proportions as the shock fades.

An even thornier problem is that there’s no political upside to withdrawing that medicine. Fiscal stimulus creates new entitlements; taking those away causes politicians to lose elections. The Fed is nominally independent, so theoretically it can “taper” monetary stimulus appropriately—but doing so puts upward pressure on interest rates (damaging stock prices and the housing market) and unemployment. That also carries risk for the politicians who appoint or confirm Fed operatives; it takes courageous souls to disregard those political pressures and ignore the media roasting they’ll get if the economy goes soft.

The bottom line is that it’s very hard to kick the stimulus habit. Indeed, the temptation to deficit-spend and print money may be even stronger today than in the 1970s, fueled by a new bad theory: Modern Monetary Theory (MMT), which holds that governments need not worry about running up huge debt because they can issue their own currency in payment. The proponents of MMT naïvely believe that if inflation results, then political leaders will happily commit political suicide and raise taxes or slash spending to treat it, and that (against all evidence) such a contractionary fiscal policy will neatly offset an inflationary monetary policy.

What’s more, the soaring of our national debt to 125 percent of annual GDP—quadruple the level of the 1970s—adds another reason to worry that monetary policy will stay too loose for too long. Again, the Fed doesn’t have to try to keep the Treasury Department’s borrowing costs low with massive bond purchases, but the short-term political pressure to do so is immense. The long-term risk, however, is great. It’s worth remembering that the Great Inflation ended only after a monetary contraction that produced the recession of 1981–82—at that time the worst economic downturn since the Great Depression.

The coming months will test the political and economic judgment of our fiscal and monetary leaders. It’s certainly possible that they will resist the pressures and avoid the policy mistakes that made the 1970s so miserable for so many. Based on what we’ve seen so far, though, it seems more likely that another Yogi Berra-ism will come into play, and this decade’s economy will be “déjà vu all over again.”

Photo by Mario Tama/Getty Images


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