Last week, the Bureau of Labor Statistics reported that inflation—as measured by the annual change in the Consumer Price Index—fell to 3 percent in June, down from a high of 9 percent last summer. The decline was broad-based across all categories except heavily lagging shelter inflation, indicating that while price pressures are still significant, the economy has made significant progress.
The good news brought surprising victory laps from those who once believed that inflation would be “transitory”—that the price spikes beginning in early 2021 would be narrowly contained and short-lived. For example, Treasury Secretary Janet Yellen said in May 2021 that she expected higher inflation to last “for several more months” and then fade away. Given the central role of massive, procyclical fiscal expansions in Biden administration policy, such predictions, widespread in 2021, were often based as much on political exigency as economic analysis. The “transitory” claim was a justification for keeping the combined stance of monetary and fiscal policy at its most historically reckless level, despite mounting price pressures.
After the BLS reported last week’s inflation number, many economists who originally claimed that inflation was merely transitory began revising history to claim that they had been right all along. New York Times columnist Paul Krugman wrote on Twitter, “Transitory after all? . . . the original Team Transitory proposition was that inflation would subside without the need for a big rise in unemployment.” Elaborating in the Times, he wrote that “one possible answer is that Team Transitory was actually mostly right, except that ‘transitory’ meant years, not months.”
But that’s sophistry. Those who asserted that inflation would be transitory never predicted that it would last for years. Just as Yellen described inflation as a matter of “months,” Krugman himself in June 2021 agreed with the view (which he ascribed to the Federal Reserve) that inflation was “a blip” that “will soon be over.” While finding the exact moment that separates transitory inflation from persistent inflation can verge on a Sorites paradox, it should be obvious that any inflation that lasts for years is not transitory.
And even this truism misses the key point. In the last 18 months, the Federal Reserve has tightened interest rates at the fastest clip in modern history, delivering the strongest monetary shock to the economy in decades. To argue that inflation would be the same today with an alternate monetary history for the last year is absurd. Without the Fed’s actions, price pressures would likely have remained at nosebleed levels, ingraining higher inflation expectations and sticking around for many years; claiming inflation was transitory is like claiming that a cancer was transitory and neglecting to mention that repeated rounds of chemotherapy had managed to kill a tumor.
For instance, consider shelter inflation, which comprises 35 percent of the consumer price index, or 44 percent of the “core” index (which excludes volatile food and energy components). Given its huge weight in most families’ budgets, housing expenses can drive index-level inflation. With the rise in bond yields, mortgage rates have jumped from 2.75 percent to 7 percent, dramatically raising the expense of buying a home. Despite this increase, home prices are hovering near their all-time highs; a number of unusual factors this cycle have served to prevent the drop in home prices that might be expected from such a rise in mortgage rates.
The critical counterfactual to ask, given housing’s enormous weight in inflation indices, is: Where would home prices be if the Fed hadn’t hiked rates, and mortgages were still below 3 percent? In this scenario, despite surging inflation and wages, low interest rates would likely have pushed housing and equity markets to new highs. Given the 45 percent run-up in home prices since the pandemic, increasingly negative real interest rates rather than rising mortgage rates might have pushed housing another 20 percent higher. (If the Fed holds nominal interest rates constant but inflation moves higher, then inflation-adjusted real interest rates move lower, becoming more stimulative and pushing prices higher.) Assuming that rents kept pace with home prices—which tends to happen, since investors can arbitrage across income-generating assets—then core inflation could easily have been almost 4 percentage points higher from housing alone. And that ignores any additional inflationary effects of stimulative monetary policy, for example rising car prices.
The decline in inflation was possible only because the Federal Reserve implemented one of the most vigorous monetary-tightening cycles in history. Though the Fed was late to start, it eventually got on the right path and delivered policy changes sufficient to combat inflation.
Arguing that the definition of “transitory” can be stretched enough to cover over two years of elevated inflation is a linguistic error. But pretending that inflation would be where it is today if interest rates were 5 percent lower and mortgage rates looked as they did before the Fed began hiking is an economic error. Many who argued for transitory inflation also argued that record levels of fiscal stimulus can be poured into an overheated economy with no consequences—and that the Federal Reserve should keep interest rates at record-low levels to accommodate such political goals. Team Transitory’s victory laps now, two years after inflation began to rear its head, are ridiculous.
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