The inflation numbers that came out of the BLS this morning should be a source of grave concern to all. Inflation seems to be accelerating, which is a clear sign that a wage-price spiral may have begun. Once that cat is out of the bag, it can be extremely costly to put it back in. We had better hope that the FED has the fortitude to do what is needed (i.e. slam on the brakes). Given the erosion of its independence in recent years, and the ongoing debates on who should occupy the senior FED posts that are vacant or soon to be vacated, one is allowed to have doubts. If the FED does not act decisively to curb inflation, we will live with dire consequences in the years ahead. And politicians will have to deal with irate voters who will surely punish the incumbents at the polls. Such an environment would create conditions for a return to power of the populists, and that will not make the situation any better.
A lot of people have egg on their face for not seeing this coming, including many of my fellow economists. This inflationary explosion should have been apparent to all who observed economic data closely. One does not inject trillions of dollars of liquidity into the economy, coupled with an unprecedented fiscal expansion, without creating inflationary pressures. This was clear to me, as I noted on several occasions (1, 2, 3). It was also very clear to one of my favorite economists, Larry Summers. He took a lot of flak for it when he warned about inflation, but as Politico notes he has been vindicated. That's because Summers is unusual among economists in that he generally does not let his political priors get the best of his professional judgment. In contrast, most other mainstream economists wanted so badly for the government to spend trillions of dollars on redistributive transfers that they minimized the likely negative consequences of these policies.
Another institution that will suffer a loss of credibility is the FED itself. Back in August of 2020 they announced that rates would be kept at zero for five years. There is no way now that this will be the case. The FED will therefore have announced a policy that they must renege on. Should we believe any pronouncement they will now make?
One last point. The last two major shocks to the US economy were the mortgage crisis of 2008 and the COVID crisis of 2020. Policies to address these two shocks involved giving good stuff to voters - liquidity and government transfers. In contrast, addressing the inflationary shock of 2021 will entail taking good stuff away from voters - liquidity, and government transfers - in order to tamp down demand. Not only is the shock itself likely to anger voters, who dislike variable and increasing prices, but the policy solution also is likely to invite more voter dissatisfaction.