“The war on inflation is over. We won without paying a high price.” This statement by Nobel Prize-winning economist Paul Krugman in 2008, shared on X (formerly Twitter) after the release of US inflation data for September, generated a flurry of criticism. Such disputes are common on social media, but proclaiming victory prematurely seems to lack substantiated reasoning.
Krugman’s statement disregards several factors, primarily the substantial price increases. He supported his statement with an inflation graph limited to specific products, which have little relevance to the typical consumption patterns of an average American household. By excluding categories like food, energy, housing, and used cars, he significantly reduces the basket of goods and services usually considered in consumer price inflation calculations, nearly by two-thirds. Furthermore, his choice of utilizing a six-month time frame and extrapolating it to a full year further skews the results, resulting in an inflation increase of merely 1.9%. This approach narrows the focus to components of overall inflation that are currently experiencing the slowest growth, while the most significant contributions to inflation in September and the past year have been attributed to housing, energy, and food prices.
Indeed, it is accurate that headline inflation and the less volatile core inflation (excluding energy and food) have exhibited a declining trend over the past few months. However, claiming victory in the battle against inflation appears to be premature. Inflation rates still significantly exceed the US Federal Reserve’s (the Fed) 2% target. Notably, the Fed members have refrained from discussing interest rate cuts in their recent statements, signalling a divergence from Paul Krugman’s analysis.
The latter part of Krugman’s tweet, “We have won, without paying a high price,” seems more in line with reality. Despite implementing the fastest monetary policy tightening in the last four decades, the damage caused by the Fed remains relatively contained. Even though the latest labor market reports do not provide a clear future outlook, the United States maintains near full employment. Economic growth has remained robust due to sustained consumer spending and government stimulus measures, with a projected 2.1% growth rate by 2023, a figure that has been consistently revised upward since the start of this year. Furthermore, financial markets have weathered the tightening of monetary policy without significant disruptions, even though financial constraints remain in place.
Declaring a premature victory in the war against inflation seems unjustified when considering economic history. The last era with such high inflation was in the 1960s and 1970s, and after each inflationary shock, there were successive aftershocks that necessitated further tightening of monetary policy by the Fed. This led to economic slowdowns, recessions, and at times, extremely restrictive monetary policies, with interest rates reaching nearly 20%, sometimes exceeding inflation rates by almost 10%.
The battle against inflation is an enduring, long-term effort. Laying down arms too hastily and declaring victory prematurely can result in devastating consequences. It is prudent to assume that the Fed’s policymakers, unlike some sideline commentators, remain mindful of this historical context.