I don't know what to think about Mr. Kashkari's pronouncements. It was easier back in covid-2020 when we had a post with a two word introduction:
"Minneapolis Fed President Kashkari Urges 4-6 Week ‘Hard’ Shutdown"That's demented
From the Federal Reserve Bank of Minneapolis, January 4:
Making sense of mixed signals and how to move forward
As I’ve discussed publicly for some time, I have been trying to make sense of the mixed signals the economy is sending. When I travel across the Ninth Federal Reserve District, the overwhelming concern I still hear from businesses of all sizes is one of a labor shortage. And, yes, wages are climbing, but on average they haven’t been keeping up with inflation. Real wages have been falling. Is this really a tight labor market? Corporate profits are up, and the labor share of income is actually declining. If the labor share isn’t going to increase in this “tight” labor market, when will it?
I’ve also been wrestling with why we missed this high inflation and what we can learn going forward. To state clearly, I was solidly on “Team Transitory,” so I am not throwing stones. But many of us—those inside the Federal Reserve and the vast majority of outside forecasters—together made the same errors in, first, being surprised when inflation surged as much as it did and, second, assuming that inflation would fall quickly. Why did we miss it?1
A Useful Analogy
I have come up with an analogy that has helped me to make sense of the mixed economic signals we are seeing, and that I believe sheds light on why I didn’t see the high inflation coming. This story, then, has implications for learning from our miss and potentially for incorporating these lessons going forward.One feature of ride-sharing apps such as Uber and Lyft is “surge pricing”: When an unexpected rainstorm hits, people don’t want to walk or ride bikes. They call for cars, and the price of a ride can surge from, say, $20 to $90. The high price accomplishes two goals: First, it reduces demand, and second, it incentivizes all available drivers to come out and increase supply. The market then clears at the elevated price. I don’t consider surge pricing to be nefarious. I consider it economically necessary given supply and demand dynamics.
Imagine a rainstorm hits, and the price surges from $20 to $90. But imagine, in my analogy, the ride-sharing company owns all the cars, and the drivers are its employees. When the storm hits, the company notifies all their drivers that they will pay time and a half. So, all the drivers come out to drive. The company doesn’t raise wages even more because they are car constrained: All their cars are deployed.
My story is of course too simple—just a demand surge, rather than both increased demand and disrupted supply—but the resulting characteristics resemble the economy we have been experiencing: Prices soar. Corporate profits climb. Income for drivers climbs, but not as much as prices. Real wages actually fall. Even though worker incomes are up, labor’s share of income is down. Labor markets are tight, but capital is the constraint on supply. Inflation has soared, but it soared because of supply/demand dynamics—what I will call “surge pricing inflation.” Economists would say the market hit the vertical part of the supply curve.
And this is key to our miss: The inflation in this example is not driven by the two primary sources that traditional Phillips-curve models used by policymakers, researchers, and investors consider: (1) labor market effects via unemployment gaps, and (2) changes to long-run inflation expectations.
In these workhorse models, it is very difficult to generate high inflation: Either we need to assume a very tight labor market combined with nonlinear effects, or we must assume an unanchoring of inflation expectations. That’s it. From what I can tell, our models seem ill-equipped to handle a fundamentally different source of inflation, specifically, in this case, surge pricing inflation.
This is not a criticism of economists inside or outside the Fed, or of my fellow policymakers. It is meant to be an honest assessment of what we missed and why we missed it (and why so many of us missed it the same way) in order to shed light on what we should learn going forward.
My staff pushed back on me when I made these arguments to them. They said: “shocks” hit the economy, both demand shocks and supply shocks. Shocks such as COVID, supply chain disruptions, the Delta wave, the Omicron wave, missing workers, unprecedented fiscal stimulus, and the war in Ukraine. And shocks, by definition, are unforecastable.
That is true, and indeed I recognize that we experienced very unusual shocks. That said, I see a couple problems with dismissing the miss because of shocks. First, because shocks are unforecastable, it absolves us from needing to learn from this experience and do better in the future. And second, I believe that even if we had been able to identify all the shocks in advance, I don’t think our workhorse models would have come anywhere close to forecasting 7 percent inflation. I think the root of our miss is that our models are not currently equipped to forecast the surge pricing inflation we are experiencing.
So, if you accept my story as an explanation for what we are seeing now and why we missed the high inflation, I think there are two implications for us going forward:....
....MUCH MORE
