Inflation or Recession?
If you have to pick one, which should it be, why does it matter, and can you really choose just one?
Jim Geraghty, National Review’s in-house foreign correspondent, calls attention to a fascinating observation by Neel Kashkari, the president of the Minneapolis Federal Reserve Bank, in the course of a podcast interview with London’s Financial Times (Brit orthography in the FT transcript):
You know, I do a lot of roundtables with small businesses and labour groups and workers. And one of the most profound comments that I’ve heard over the past couple of years was with a group of labour leaders in my region and a labour leader who represents low-income service workers. So these are not autoworkers. These are not welders, really highly paid people. These are low-income service workers who work in grocery stores and hotels. She said to me, inflation is worse than a recession. That is contrary to conventional economic thinking. And I said, I don’t understand that, how can inflation be worse than a recession? In a recession, you lose your job. Inflation, you just pay higher prices, you still have a job. She said, because her members are used to dealing with recessions, and the way they get through a recession is they rely on friends and family. I lose my job, I lean on my sister or my parents or my friends, and they help me through it. But high inflation affects everybody. There’s no one I can lean on for help because everyone in my network is experiencing the same thing I’m experiencing. That was a profound comment for me to hear, and that really flies in the face of conventional economic thinking. And it led me and our economists at the Minneapolis Fed to debate this a lot. But she was on to something.
And if you look now, the economy is – in the US – quite strong. The labour market is strong. Inflation is coming down. And many, many people are deeply unhappy about the status of the economy. I think it’s because of the high inflation that they’ve experienced.
“Is inflation is worse than a recession?” may sound like “Is Covid worse than a broken leg?” Both are bad, but how can you compare them? Their badness is of very different sorts, and its magnitude depends on individual circumstances. Covid is a serious threat to an 80-year-old diabetic. A healthy 20-year-old athlete is far more incapacitated by a leg injury. Similarly, a recession is a nightmare for many workers and employers, but it isn’t a uniform catastrophe. Mr. Geraghty adds this:
In a traditional recession, with a large number of layoffs and higher unemployment, the typical person who loses their job is in a tough spot. And it often feels like no one is hiring, at least in a particular area, even though there are always at least some companies looking to fill positions. But if you’re one of the laid off who does find a new job, your situation gets better. Maybe the new job doesn’t pay quite as well as the old one, or maybe you have a longer commute, or the hours aren’t what you want. But you really just need one employer to take a chance on hiring you to get to a considerably better spot. And while it’s difficult to find a better job, or a higher-paying one, during a recession, it’s not impossible.
In an era of high inflation . . . the inflation is just about everywhere. (Yes, there are some regional differences, but there isn’t any region that is immune from the effects of too much money chasing too few goods and services.) You feel it at the grocery store, you feel it at the gas pump, you feel it at Walmart and Target and at small businesses. You feel it if you’re getting a new mortgage, taking out a loan, or buying a new or used car. [ellipsis in original]
At the worst point of the Great Depression, three quarters of American workers had jobs. At the worst point of the “Great Inflation” of 1965 to 1982, prices for everyone were rising at a 15 percent annual rate. Over that period as a whole, prices tripled, with an average annual inflation rate of 6.81 percent.1
And the immediate impact on individuals and firms isn’t the only way to compare the detriments of inflation and recession. There are two other important points of comparison.
First, inflation can accelerate into hyperinflation, as in Weimar Germany, Mugabe-era Zimbabwe and contemporary Venezuela. Most of the time, it doesn’t, but when it does, it essentially wipes out a generation of savings. Think of it as a 100 percent tax on all past earnings that weren’t already spent. The only comparable calamity is defeat in total war and the destruction or looting of the loser’s factories and infrastructure.
Second, recessions have historically ended on their own. Perhaps government action can hasten the end, but the evidence for that is hard to find. As Amity Shlaes showed in her myth-busting The Forgotten Man: A New History of the Great Depression, New Deal remedies lengthened and worsened the downturn that began in 1929. America remained mired in the Depression after the world’s other advanced economies had recovered.
An instructive historical contrast is recounted in James Grant’s The Forgotten Depression: 1921: The Crash That Cured Itself. As the preface summarizes –
This slim volume describes a weighty and wonderful event. In 1920, the American economy entered what would be presently diagnosed as a depression. The successive administrations of Woodrow Wilson and Warren G. Harding met the downturn by seeming to ignore it – or by implementing policies that an average 21st century economist would judge disastrous. Confronted with plunging prices, incomes and employment, the government balanced the budget and, through the newly instituted Federal Reserve, raised interest rates. By the lights of Keynesian and monetarist doctrine alike, no more primitive or counterproductive policies could be imagined. Yet by late 1921, a powerful, job-filled recovery was under way. This is the story of America’s last governmentally unmedicated depression.
Industrial production declined by over 30 percent between January 1920 and January 1921, and unemployment rose to almost 12 percent of the work force (or maybe higher; there was not yet an authoritative count). Those numbers rival 1929 and 1930, but the sequel was a relatively swift upturn after 18 months, followed by nearly a decade of prosperity.
By contrast, self-cure never seems to bring inflation to an end. At present, the Fed is trying to engineer a “soft landing” from the current bout, with very mixed success. Even if that works, the goal is a two percent inflation rate, one-fifth higher than the average for 2010 through 2020. If the rate stabilizes at two percent forever, Americans born today will see prices more than quadruple during their expected lifetime.
While mild, steady inflation is conceivably bearable,2 severe, persistent inflation isn’t. Unhappily, the only remedy that any nation has ever successfully applied is a sharp contraction of the money supply, which invariably leads to a recession. Our country’s most recent experience came in the first years of the Reagan Administration, when the Fed brought the “Great Inflation” to an end through abrupt monetary restraint accompanied by a deep recession (from July 1981 through November 1982) that President Reagan was fortunate to survive politically. Luckily for him and us, “morning in America” dawned in time for the 1984 election.
The 1920 recession, too, was largely a consequence of the Fed’s monetary tightening to combat the inflation that broke out during the Great War and exceeded ten percent, averaging over 16 percent, in every year from 1916 through 1920 (way up from 1915’s one percent). In late 1919, the Fed began raising interest rates to throttle the money supply. Not seeing an instant response, it braked more aggressively in early 1920. The upshot was a brilliant success against inflation. In 1921 prices declined by over ten percent. But the side effect was the 1920-21 recession, discussed above, which, like the 1981-82 recession, began before inflation abated.
It seems that accepting inflation in the hope that it will ward off recession (the idea behind the “Phillips curve”) ultimately gets you both.
The foregoing considerations suggest that inflation deserves a higher rank among economic ills than it usually occupies. Its causes and possible cures ought to be a major concern of policymakers. Yet, judging from the interview cited above, their understanding drifts at a rudimentary level or has possibly regressed from what Irving Fisher and Milton Friedman knew. Per Mr. Kashkari:
Well, we got a lot wrong. And I've been spending a lot of time with my economists trying to reflect on this, to understand what we learned from it and take going forward. If you look at the way most economic models that we use at the Fed work to forecast inflation, there are two primary sources of a high inflation. One is if inflation expectations get unanchored to the upside or second, through a very tight labour market and what we call Phillips curve effects – tight labour market leads to high wage gains leads to high inflation. If you go back in time in the US in April, May of 2021, core inflation first ticked above 2 per cent and yet we had 6 per cent unemployment. Very hard to see how in a 6 per cent unemployment environment, the labour market is gonna generate high inflation.
And we had long-run inflation expectations that appeared to be well anchored. So by those two factors, it should have been impossible using our traditional models for high inflation to hit us. Yet we saw very high inflation. And so I think we need to have a lot of serious reflection on what our models are missing in terms of possible sources of inflation. [emphasis added]
“Serious reflection” might begin with this striking juxtaposition: From 1789 through 1912, prices in the United States (so far as they can be reconstructed over that span) increased by about ten percent – not ten percent a year but ten percent over 124 years, albeit with sometimes startling short-term swings. In 1913 the Federal Reserve Board was established to stabilize the value of the dollar. From 1913 through 2023, inflation averaged 3.16 percent per year, and the cumulative price increase was thirty-fold, three thousand percent. If your grandfather had put a dollar under his mattress in 1913, it would be worth about three cents today.
How blasé should we be about that?
All inflation statistics in this post are from this very helpful web site, one of many online calculators. Bear in mind that the “cost of living”, whose changes constitute “inflation”, is an amorphous concept and that the quality of data deteriorates rapidly as one goes back in time.
I don’t know of any real-world examples. Over the past 70-some years, Switzerland has averaged slightly over two percent annual inflation, but its course hasn’t been at all steady.