Inflation

EconBuff Podcast #33 with Rex Pjesky and Ryan Mattson

Dr. Rex Pjesky and Dr. Ryan Mattson talk with me about inflation and the current conditions of the economy. Dr. Pjesky walks us through what inflation is and why it matters. We discuss the nature of the current inflation of episode, what it means for inflation to be transitory or persistent, and which the current inflation seems most likely to be, and both Dr. Mattson and Dr. Pjesky explain what the implications are for wages, prices, and interest rates. Dr. Mattson addresses the idea that the Federal Reserve disagrees with economists and argues that there is disagreement amongst Federal Reserve officials as to the nature of inflation. Dr. Pjesky lays out ways we see inflation that do not seem to be price increases at first glance, such as changes in product packaging. We discuss the impacts of stimulus bills such as the CARES Act in terms of inflation. Dr. Mattson explains the FED is already addressing inflation in part by tapering, reducing the size of their balance sheet. Finally, Dr. Pjesky explains how inflation affects the economy, particularly that its effects are non-uniform across the economy, we explore the role of supply chain issues in causing inflation, and how real asset markets reflect inflation.

Photo by Jack Prichett on Unsplash

Transcript

Stitzel: Hello, and welcome to the Econ Buff Podcast. I'm your host, Lee Stitzel. Today is a very special episode. It's the first one where I'm going to have multiple guests, and we're doing it in front of the line of the live studio audience. With me today is Dr.. Rex Pjesky. Rex, he's a Professor of Economics at West Texas A&M University. Rex, welcome.

Pjesky: It's good to be here again.

Stitzel: My other guest is Ryan Mattson. Ryan is at the Center for Financial Stability, and a Professor at West Texas A&M University. Ryan, welcome.

Mattson: Thanks. It's good to be here and thank you to my class for doing this.

Stitzel: Yeah we're very thankful to have an audience here that's going to be interested and engaged today. So our topic is inflation. You couldn't pick a better topic in terms of what's going on right now. We're going to start with just sort of what is inflation. I’m going to direct that to Rex. Rex, what's inflation.

Pjesky: Inflation is and, you know, very simply inflation is an increase in the average price of everything. So it's not, you know, it's not an increase in the price of gas. It's not an increase in the price of milk. You know, those things in isolation are determined by supply and demand forces which, you know, any, you know, any student of macro should know. But inflation is, you know, when everything is going up, you know. [a] certain percentage every year on average.

Stitzel: So what I want to do is ask the question that's being asked in the public sphere. And that question is whether this is transitory or persistent inflation. But I think to do that we need to talk about what those two concepts even are. So let me direct that to Ryan. Ryan, what/how do we understand whether inflation is transitory or whether it's persistent?

Mattson: Well, I think in terms of transitory inflation --- that would be something that is changed by people's short run expectations of what these prices are going to do (or actual shocks in the real business cycle). A more permanent and persistent inflation though would be caused by expansion of the money supply (by The Federal Reserve or the central bank of the country). So transitory tends to be market forces. Permanent tends to be regulatory forces or central banking.

Stitzel: Rex, is that a definition you agree with?

Pjesky: Yeah, certainly. And, you know, of course the reason that we're talking about this right now because inflation year to year ---- inflation right now sitting [at] --- [because] I think producer prices are going up 8-9%; [whereas] consumer prices are going up by how much is it?

Mattson: 6.2

Pjesky: 6.2%, so, you know, very, very, you know, we're having an unusual episode in The United States of inflation. We haven't had significant price increases for 40 years maybe?

Mattson: 30 years.

Pjesky: Early 90s yeah we had some. But it was never --- it's, you know, never --- like what we had now, I don't think. But yeah, you know, it's been over a generation at least since we've had high inflation (of the prospect of high inflation).

Stitzel: So Scott Sumner [is] an economist who represents a macro-school of thought called Market Monetarism. He gets talked about a lot on this podcast obviously. He's of the opinion, you know, inflation isn't fundamentally transitory or persistent. He calls it Schrödinger’s inflation, which I found very clever. What he says is: whether it will be transitory or persistent is going to depend on what The Federal Reserve's response to that is. So let me go to Ryan. Ryan, does that fit with the discussion that you just gave? Or how would you differ from Professor Sumner?

Mattson: Yes, I think that fits with the discussion that I gave. I think he's giving less credit to the short run fluctuations for transitory inflation. I think he's putting more on The Fed (which is in line with Friedman and Schwartz’s work back in the 1950s and 60s regarding what happened with The Great Depression, and also research on what happened in the 1970s with the stagflation that we have) that longer term issues are due to policy responses rather than real business cycle swings.

Stitzel: Right? That would be consistent with something you're saying that also fits…

Mattson: Yes.

Stitzel:…with your idea about expectations?

Mattson: Yes. Yes.

Stitzel: So talk to us a little bit about expectations. Because I think there are going to be some people that are going to say: wait a minute. How could [reiterates] how could there be price reactions just based on expectations? And that doesn't have to do with anything in the real business cycle? So just…

Mattson: Sure.

Stitzel:…just for the listeners, real business cycle…

Mattson: So…

Stitzel:…it would be this idea that there would be actual changes…

Mattson: Hmm mmm.

Stitzel:…in supply that would move the economy around. And that would lead to different changes in price?

Mattson: Yeah.

Stitzel: Which we're not denying. We're just asking whether or not that's what's causing…

Mattson: Yeah.

Stitzel:…inflation?

Mattson:…so we have two concepts of supply in macroeconomics (at least in the Keynesian model). What we have is the long-run supply --- that is the kind of boom and bust around a trend, right? The U.S. should be growing around 1.8 to 2% per year. Some years we grow more. Some years we grow less. And that has nothing to do with the prices or the inflation. Our real productivity is not affected by money. The short-run aggregate supply though is affected by people's expectations. There's this concept of stickiness --- that firms sign contracts that go into one to two years or the short run --- where they fix a certain level or percentage of what's being paid. And these expectations are what can determine some of these inflationary or disinflationary shocks in the short run. And it becomes this almost self-fulfilling prophecy --- if you expect higher inflation, [then] you behave in such a way that gives you higher inflation. So if we're talking about a supply shock in the U.S. right now, it's not necessarily/and I would argue it's not the actual real supply shock of all these ships stuck in the Los Angeles Harbor and the lack of trucks to transport goods. It's that firms are changing their expectations on the contracts they sign, on the prices they sign, and the prices that they pay. And that leads to this more permanent inflation. Because if you start expecting, instead of 2%, 4%, [then] you rewrite your contracts. And then there's this inertia that goes through the short-run that can lead into that long-run inflation.

Stitzel: I think the listener, to an explanation like that, is to say: how can you [reiterates] how can you tell me that the thing that is actually happening (that we've all seen the reports that says: there's a hundred ships off the Coast of California with nowhere to make port and offload their supplies), [that] that's not the thing that's driving prices. It's actually the reaction to that by businesses and their contracts. First, I'll phrase this in two ways. One --- what's your reaction to just that simple idea [of] how can it not be the real actual thing…

Mattson: Hmm mmm.

Stitzel:…that is happening?

Mattson: Right.

Stitzel: The ship's being stuck. And two --- how can firms rewriting their contracts be a big enough thing to cause 6 or 8% inflation?

Mattson: So the ships in the port or our particular story within the macro-economy, it's not the macro-economy as itself. And I think Dr. Pjesky's description of average prices are going up --- that means everything. It's not just that, you know, our Amazon orders are late, or they're rising, or they're raising shipping prices. But people are getting intermediate goods --- goods that are used to make other products from these ships. People are moving resources away from other, probably more efficient, areas to this. The macroeconomic shock in one particular industry (or one particular problem) of the economy can reverberate. And that has to do with what people believe is going to happen. And these fundamental beliefs then set the contracts that people write. And that's where these expectations come in. It's not just that Walmart is having an issue with trucking. But Amazon sees Walmart’s issue with trucking. And the Dollar General sees this issue with trucking. And they all begin to change their expectations and change their contracts.

Pjesky: Correct.

Stitzel: [To Pjesky] Do you have a push back on that?

Pjesky: I'm glad you said the word believe.

Stitzel: Yeah.

Pjesky: Because, you know, listeners need to realize that the word expectation is a jargon word in economics. It means something very, very specific. You know, perhaps a more descriptive word of what Dr. Mattson was talking about would be would belief. So all individuals in the economy ---- whether they're, you know, in a position to write contracts, or whether they're behaving as a consumer, or, you know, somebody looking for a mortgage, or, you know, deciding how much to work, you know, [or] what job to take or, you know ---- [make] any economic decision (we all) based on what we believe to be the current state of the economy right now. So we see the prices that we see. And we act on those prices. We might not be seeing what's going on in the entire economy. So how our beliefs (or how our expectations) can influence, you know, the inflation rate (in what we would call the short-run) would be because people are making sub-optimal decisions based on incomplete information that they have. So if an individual thinks that prices are going up, and they're not going up, then the decisions that that individual makes in response to that are going to throw the economy off; and can actually, in a self-fulfilling prophecy (again what Dr. Mattson was saying) can actually drive prices to go up.

Mattson: And to kind of expand on that belief issue (and this is the monetarist in me I guess), you know, as Friedman said “inflation is always and everywhere a monetary phenomenon.” And money is not gold, not pieces of paper, not these little zeros and ones in a bank's computer; but money is a service, and that's based on our belief of how useful it is. So this monetary illusion that we have in the short-run is influencing these price changes in the long- run. Of course now we all in the long run begin to take into account all of these [that] we don't make those mistakes, right, in the long run. After two, three years of bad forecasts and prices, [then] we change what we think is going to happen. And we get (hopefully anyway) better for…

Pjesky: Yeah.

Mattson:…that.

Pjesky: That's almost the definition of the long run.

Mattson: Yeah.

Pjesky: So the long run is a circumstance in economics where no one is confused anymore ---about exactly what prices are not, you know, not just what prices are doing around them but --- what prices are actually doing in the overall economy.

Stitzel: So that transitions nicely into one of the next questions I wanted to ask is: just your opinion on what the current state and health of the economy is? O.K. so we've talked about inflation --- what it is and how we think that it operates long and short-run. We've set it up really nicely. Just give me your take. We've already sort of thrown out some of the numbers. You guys bring any numbers you want in. Let me start with Rex. Rex how do you see the current state and health of our economy?

Pjesky: Well I think that the economy right now is in a very, very dangerous place, all right? So we do have current inflation rates that are nearing double digits which, you know, even for a short period of time, I think, could be potentially disastrous. If that inflation persists for, you know, any length of time whatsoever, [then] it will do serious damage to the, you know, to the U.S.'s economy. We have, you know, tremendous uncertainty coming from government policy right now (which is beyond the scope of a discussion about inflation). But I think that that's a test for the economy. You know, anytime that they're, you know, anytime businesses and individuals are uncertain about what's going to happen to, you know, government policies that will affect the decisions that they need to make --- [it] causes confusion and hesitancy, you know? Then finally we have, you know, sort of the aftermath of the pandemic (if I can call it an aftermath) right now. I guess we might still be in it. That still might be causing supply shocks, you know, to the economy. It's very, very interesting to me as an economist (and it's somewhat disturbing to me as a consumer) to go to the grocery store and want to buy an item that's not on the shelf.

Stitzel: Hmm mmm.

Pjesky: You know, and for, you know, to see, you know, friends of mine that manage grocery stores post things on Facebook like: be kind to your grocer because the shortages of food, you know, [are] not the grocery store's fault. That is very [reiterates] that is very interesting and disturbing to me at the same time, because those are things that we typically do not see. So it's an extremely rare and remarkable event to go to the grocery store and not be able to buy something that you want to buy.

Stitzel: Hmm mmm.

Pjesky: That's just almost, almost unheard of. And then the you know you drive by car lots [and] they're empty. It's just they're, you know, a lot of personal anecdotal observations that I've made that make me really, really concerned about the next (at least few years) in the U.S.'s economy.

Stitzel: So I was wanting to get to supply issues and how they factor in. I think we did a good job laying the groundwork of broadly how we view inflation. So I have two questions I want to back up these comments about supply with. The first thing that I would ask you is: do these supply shortages --- are those sort of upstream or downstream of the inflation? I guess the answer could be both, right?

Pjesky: Well it could be both, I mean. I mean that's a really good question. When you have a reduction in supply, and at the same time you are, you know, basically priming the economy with a lot of (what we would call) money, then inflation is inevitable.

Stitzel: Hmm mmm.

Pjesky: So if you get this kind of monetary stimulus in the presence of a supply shock, [then] you are going to get inflation (which is exactly what we are seeing). It's an entirely different thing if The Federal Reserve or if the government has a sort of inflationary policy and there's a demand shock. That's a different thing. But when you've got all of these, you know, factors surrounding the pandemic, that is causing supply, perhaps to contract, [then] monetary stimulus is certainly going to be inflationary at that point.

Stitzel: So we had an opportunity with our Economics Club here on campus to talk to one of our former students that now works in supply chain…

Mattson: Hmm mmm.

Stitzel:…business that provides products to restaurants, and hotels, and grocery stores, and things like this. And she was telling us they’re providers. So when they actually talk to Cola-Cola, what they're doing is --- they're struggling to fill their orders. They can't do that anymore. So what they're doing is --- they're sticking to their products that are their mainstays. So they're going to fill all their orders with Cola-Cola. And they're going to divert all their efforts away from all other (however many hundred) products Cola-Cola produces, [in order] to make sure that they get Coke products (the actual Cola-Cola itself, the original Cola-Cola) that's on the shelf. And maybe you're going to have a hard time finding Diet Coke. Or maybe you're going to have a hard time finding Cherry Coke or something like this, that they're going to divert their efforts away from. That is what's showing up in part on your friend’s grocery store shelves there's just not stuff there anymore. I think this is also hidden inflation, right? Because one of my pet sayings, right: is if the shelf is empty, [then] the price of the good on the shelf is infinity. There's no amount of money that can buy something that isn't there, O.K.? So now you've got a grocery store full of things you can't buy, that you could have bought. So what's wrong with my idea here? Inflation is way higher than we think it is, if there's a bunch of products for which the price is now infinity. This is what I mean by upstream/downstream for supply.

Pjesky: Yeah, I mean and that would certainly be the case. And there's no way to measure that. There's absolutely no way to measure that. And that's another cost of these supply issues that we're seeing. So if I'm unable to buy, you know, Cherry Coke because it isn't there, all right, I still might buy Dr. Pepper. I still might buy regular Coke.

Stitzel: Hmm mmm.

Pjesky: And the price of those items might be normal, you know, (whatever normal is) for a, you know, two liter bottle of Coke or whatever. The price of that may not have gone up, but there's still economic damage there, because I'm not getting the product that I want. And so if a lot of that is going on, then the official inflation numbers could understate inflation, and understate the real damage that's being done to the economy (and to people's welfare) because of inflation.

Stitzel: So Ryan, let me turn to you ask you the same question, [and] let you weigh in on that.

Mattson: Hmm mmm.

Stitzel: But I also want you to focus on: where do you see inflation as it stands now? And where do you see it going?

Mattson: Well as of this morning with the 6.2% inflation rate, I am less inclined to believe that this is a transitory shock. As Dr. Pjesky has said: with a supply shock, if you have a central bank or Federal Reserve increasing the money supply, [then] you will get inflation. Last year when we did a podcast on the Covid-19 Recession and the lockdowns, it was a very pure aggregate demand shock --- disinflation, contraction, and output. What we have now (and the concern that I have, and this I think also goes towards what Dr. Pjesky is talking about) with goods not on the shelves, but we also have workers not in the work force. And how do we price them --- the people that have dropped out of the labor force at this point? So if we have these supply shocks going on (excuse me), [if] we have what's been a very accommodating policy from The Federal Reserve, [if] we have a lot of deficit spending (so expansionary fiscal policy) that's encouraging this inflation growth; [hence] people will point to the numbers and say: well aggregate demand is recovering [and] maybe this is just a sign that we have higher output and higher inflation. And we will come back to our 2% target. Or we'll come back to our potential GDP target. But the unemployment rate, while showing it has recovered, is not showing the amount of people that have dropped out. And that to me shows evidence of a supply shock. So we now have, say, this short run supply shock has contracted. Expectations on inflation are going up. People are asking for higher wages in general. And on average we see this going on. But at the same time, we also have a significant population (even since The Great Recession) that has been dropping out and staying out of the labor force. So how do you price them as well, in terms of the wages they'll make, and their spending power?

Stitzel: So when the government/federal government puts together a stimulus bill like The Cares Act (or what they're working on now) --- is that inflationary?

Mattson: Yes, O.K. I mean, here/but here's the issue. Here's the issue with this. Well O.K. Let me backtrack on that. Excuse me. You've trapped me into fiscal and monetary policy. All right. Aggregate demand should go up. So by my take, this is an increase in the velocity of money. This is not an increase in the money supply. This is something that's being spent, hopefully, on real goods and going into the economy. And that is more towards this kind of, I would say, a long-run productivity shock. When The Federal Reserve then comes in (and you bring up The Cares Act --- I'll switch takes here and bring up The Payment Protection Program, yes that was a fiscal stimulus, but it was The Federal Reserve that was going out) and [begins] guaranteeing all of these loans. It was The Federal Reserve that was calling firms and banks and saying: we will lend. The accommodating monetary policy is inflationary. And that's where it comes in. And that's where the money supply changes and increases. So let me --- that's qualified. Yes. There I mean --- no, but yes.

Pjesky: I think what we've seen recently is there's less and less of a distinction between fiscal and monetary policy right now. So the fiscal authority, the government (like what we would say in a 2103 class they want to expand government spending --- whether it's The Cares Act, whether it's sending out checks, whether it's [The] Paycheck Protection Act, whether it's any number of things) --- if the ultimate source of those funds is basically guaranteed, or backed, or printed (to use a really, really crude but maybe not an inaccurate term), [and] if those policies are basically bankrolled and guaranteed by The Fed, then you have fiscal policy and monetary policy essentially doing the same thing. And, you know, that that's why Dr. Mattson uses the word accommodating. So if The Federal Reserve accommodates any increase in spending that the government does with new money, then those fiscal policy actions will be inflationary; because they're really increasing the money supply. The Federal Reserve, if it did not want those policies to be inflationary, then it could put the brakes on them by not increasing the money supply (as the government does whatever it does). So I am from, you know, sort of on the extreme end of the spectrum of the, you know, Friedman and Sumner type view on this --- that anytime that you see inflation, it's a monetary phenomenon. So whoever controls the money supply can control inflation. Because if it sees velocity going up, and it doesn't want inflation to go up, it can cut back the money supply (If it has the/if it wants to, if it has the political will to, if it thinks that it's a good idea to hold the inflation rate constant).

Mattson: Well that brings up a question though. I mean, do you think especially in the wake of The Great Recession, that monetary policy is effective in expanding or contracting the money supply?

Pjesky: Well that's another question. So, you know, that's and, you know, opinions differ on that. Opinions differ on that as well. So do The Fed's actions --- are they really expanding or contracting the money supply? Is it possible for them to do that? Have we (and there would be lots of ways to think about this), but have we reached a saturation point --- where more money really doesn't have any impact on any real or nominal variables at all, because it's no different than just, you know, printing it and just stacking it in the corner somewhere?

Mattson: Hmm mmm.

Pjesky: You know, if The Federal Reserve printed a bunch of money and just stacked it in the corner in their offices, [then] it wouldn't really be expanding the money supply at all, because that money's not out there. It's not being used.

Mattson: Right.

Pjesky: So I think (and correct me if I'm, you know, correct me if I'm wrong about this), but a lot of economists have thought, especially since The Great Recession, that the actions of The Fed to further provide monetary stimulus has --- the monies just went out there. And it's just, you know, not literally sitting at somebody's office, but it's just sitting somewhere.

Mattson: Sitting in a bank vault.

Pjesky: Sitting in a bank vault somewhere.

Mattson: Sitting at The Federal Reserve.

Pjesky: Yes, exactly. And so if that's, you know, if that's the case then, you know, it would be concerning that our policy institutions can't really act at all.

Stitzel: O.K. but if that's the case, why do we have inflation today?

Pjesky: Well that would be the question, right? That would be the question. I mean, we could have inflation because, you know, we do have the same amount of money out there. But if we've had a massive ---- you know, if velocity stays the same, if money supply stays the same, and we have a contraction in the amount of goods and real GDP (in the amount of goods and services that we're producing), then you would have to have inflation.

Mattson: But this is interesting, because the velocity (at least in the United States) seems to have been going down on trend since The Great Recession. If you look at the M2 money supply (which is a terrible measure, but let's go ahead and use it because that's what The Fed uses), we have the velocity of money decreasing and then attempting to expand (into) greatly during The Great Recession and as well during the [Covid-19] Pandemic. We have an explosion in these money supply measures and interest rates dropping to zero with what seems like very little effect. And we don't see that inflation when we wanted it in 2020. And now we're into 2021 and The Fed has begun, more or less, begun tapering. They've at least stopped buying as many assets and stopped pushing more money into the system. But we now see inflation. So that to me is an indication that this is an expectations and supply side story --- which disagrees with what I said last year. In the middle of the pandemic I was, I think, I was very clear. I was like: no, no Lee, this is definitely an aggregate demand shock. And now we're looking at this data. This does not look like aggregate demand, but rather these expectations of inflation bleeding into people's decisions.

Stitzel: So is that why The Federal Reserve is buying more assets more directly? I mean, look at their look at their balance sheet and, you know, it just goes…

Mattson: Sure. I, mean…

Stitzel:…well, straight vertical here…

Mattson: Yeah.

Stitzel:…in the pandemic.

Mattson: The Fed has a has a middleman, right --- the primary dealers that the 12, or 14, or largest banks. So whenever they enact monetary policy, they give this money to these banks and they say: lend out. What incentive do these banks have in order to actually lend that out? So now The Fed has to go increasingly into other markets it has to. We had quantitative easing in The Great Recession. They went from buying three-month bonds to buying 10-year bonds. Now we have and mortgage-backed securities as well. Now we have programs of direct lending by The Fed. They're trying to skip over the banking system in this case (or at least it seems to me anyway) to try and get the stimulus out there (or at least they were). And now they're beginning to pull back now that they see 6% inflation.

Pjesky: Well, I mean, I would have sort of a different take on this. I see and I think [that] this goes back to your original question Dr. Stitzel. But I see The Fed tapering as a good thing.

So I still think that there's some traditional monetary policy channels that are effective (or at least I hope that they are effective). And so the question of the day in economics right now, I think, is: is this inflation transitory or not? That seems to be what everybody is talking about. That's what, you know, that's what Dr. Yellen is talking about. That's what, you know, Professor Sumner (who we mentioned earlier) is talking about. And everybody who's concerned about inflation and economic policy --- this is probably the number one question on their mind. And I think it's not the right question to ask. So the question should be: does The Fed want the inflation to be transitory or not? Because the inflation is controlled by The Fed. So, you know, you're not driving in your car on a road and see a fork approaching in the road --- you don't sit there in your car thinking: am I going to turn left or right (in a way that you don't know)? But which way you turn, is determined by which way you turn. So if you're driving a car, you control whether or not you turn left or right. There's no discussion about, you know, whether or not it's a right turn or a left turn. You make the turn based on where you want to go. So The Fed is in the same position right now. If The Federal Reserve wants inflation to be transitory, [then] they will pull back. If The Federal reserve wants to put the United States on a path of higher inflation for the long term, then they won't taper. The fact that The Fed is tapering right now, you know, to me as someone who thinks inflation is really, really bad is an extraordinarily good sign. And it leads me to think that this inflation will be transitory --- that The Federal Reserve, by its contract [and] the tools that it's using to contract the money supply --- actually wants to bring us back more in line of, you know, a 2% inflation rate (which has sort of been the target that central banks around the entire world have shot for, you know, a generation at least).

Mattson: But let's let me let me kind of pushback on the policy response on this. The Fed has the dual mandate, right? I mean, they stabilize prices and they maximize employment. The --- but of course, I always tell people --- The Fed has one job, right? They have to stabilize prices. And that's been the idea since Paul Volcker back in the 70s and the 80s. The consequences of The Fed pulling back is going to be damaging to the labor market (which is already, at least in my view, with the labor force participation rate already on the ropes). We see an unemployment rate that's come back more towards normal. If The Fed begins tapering, shouldn't we expect that unemployment to go back up as we go through this? It's harder to lend, harder to borrow, [and] harder to get hold of money and expand your business. So wouldn't this have negative consequences? Couldn't we go back down into recession if The Fed decides to really, really up the ante on its tapering?

Stitzel: Doesn't all of this assume that The Fed actually can manipulate the money supply?

Mattson: Yes.

Stitzel: Which is the discussion we just came from?

Mattson: Right.

Pjesky: Right.

Stitzel: What level…

Pjesky: Well.

Stitzel:…of concern does that?

Pjesky: If they can't (in my mind) --- if The Fed cannot manipulate the money supply in such a way that has any measurable effect on inflation, then it doesn't make any difference what The Fed does.

Stitzel: Well going to your car analogy that means the steering wheel…

Pjesky: That means the steering wheel is on its own.

Stitzel:…column is disconnected. Yeah.

Pjesky: I don't believe that we're there yet or that we'll ever be there. It's, you know, when you look at when you look at history and when you look at economies that have suffered inflation (even moderate inflation) the tendency is --- I don't want to say everyone but every time an economy has experienced inflation and --- [whereby] they have solved that inflation with a tapering of the money supply [thus] they've had some increase in unemployment. Is that again --- I don't want to say every time -- but it's I don't think it's unusual.

Mattson: Hmm mmm.

Pjesky: So will this cause problems in labor markets? And the answer to that question is almost certainly yes. But, you know, I would think that, you know, having, you know, five years or more of 10% inflation is going to cause problems in labor markets as well.

Mattson: Hmm mmm.

Pjesky: So I think that we need to get away from the idea that with optimal policy, or even perfect policy, that we can solve all of our economic problems right now. Because the problems exist. The pandemic happened. And the damage that we are seeing economically stems from the pandemic --- not by good or bad economic policy. So what policy makers should be thinking about is: how do we mitigate this damage to the best of our ability [and] based on what we know we should be doing in terms of policy?

Stitzel: So another way I can ask this question [is]: how do you see the current state and health of the economy is? [And] which is worse --- the inflation or the labor force participation drop off?

Mattson: Well, I think, we do agree that the inflation is worse. But there does need to be some consideration, [some] recognition that this could lead us into a recession. Because if people are concerned about their job after Covid, then they probably need to be preparing (in terms of making certain/getting their resumes ready and being ready) for what may look like the early 1980s in terms of the recession there.

Pjesky: Yeah, I think for what you just said --- I think the inflation's worse as well.

Stitzel: O.K. so we're on The Fed. Let me turn to another question here. This is one that, sort of, sparked through this whole podcast idea of teaching my graduate class in macroeconomics. And a student asked me: why does The Fed disagree with economists on inflation and inflation topics? So Ryan, I want to start with you on that. Is that even true? Does The Fed disagree with economists on inflation?

Mattson: Well The Fed doesn't agree with itself half the time. If you look at the statements of The Board of Governors (and they're usually very careful), but you have Clarida saying one thing, Powell saying another, and Brainard probably saying the same thing as Powell. At the end of the day, they'll all vote basically against inflation. They'll all try and fight the inflation. But you have a --- The Federal Reserve is not a monolith. It's not that Jay Powell goes in and makes all the decisions. You have 12 districts, I guess 10 district presidents right now, and then 6 or 7 board of governors who all have different opinions and different views. The Federal Reserve through its bureaucracy tends to produce inflation hawks. The ones that are dovish tends to be --- in dovish meaning they're more concerned with employment, so I was acting very dovish just a few minutes ago talking about unemployment --- those economists [who] tend to go towards academics, tend to critique The Fed, or tend to be, you know, at a particular Fed like The San Francisco or Atlanta Fed. The Fed, in my view, oftentimes doesn't agree with itself. So you have to wait for the FOMC decision to see where it's going on that.

Stitzel: So you're saying there's just a range of opinions out there that represents economists?

Mattson: Hmm mmm.

Stitzel: And The Fed also represents a range of opinions?

Mattson: Yes.

Stitzel: At least somewhat similar to that of economists?

Mattson: Yes.

Stitzel: Rex which is?

Pjesky: Yes, I [have the] same take.

Stitzel: O.K. so I do want to talk a little bit about --- we kind of already got into some of the supermarket stuff. But another thing that I was asked is: you know, how can people, economists, [and] The Fed (I think is who's implicit in that) think that there's no inflation (to which I told my student they do think there's inflation, but my student asked: you know, I literally see this in my grocery bill). So talk to me a little bit about how we observe inflation in the supermarket.

Pjesky: Well.

Stitzel: The place that is going to hit home.

Pjesky: You know, there was a time when many economists were saying that there was an inflation and that there wouldn't be. And yet, we do have it. The first --- I would give you a personal anecdote --- the first time I was convinced, myself, that there was going to be inflation is: I was grocery shopping one time and I picked up my favorite ice-cream. And it was the same price, but yet the container was 25% smaller --- which is a drastic change in size of a container 25% smaller. And so I was just like shocked right there. And, you know, so my kids were with me at the time and they got a quick economics lesson. And so, you know, companies have a way to, sort of, resist increasing prices because no one wants to see an increase in price. And apparently a lot of, you know, producers of goods and services think that it is better for them to shrink the size of what they're selling (the unit of what they're selling) as opposed to raising the prices. So it's better for this ice-cream company to shrink their ice-cream by 25% than it would be for them to increase their price by 25%. So I still bought the ice-cream, but if it would have been 25% higher, but the bigger container, [then] I probably wouldn't. So that's irrational in some sense [to] me as an economist. But that's exactly what happened.

Stitzel: It, I mean, it's acknowledging that there's a budget constraint. You set aside a certain amount of money that you want to be spending in the grocery store. And so they need to fit within that. And giving you a little bit less ice-cream might be better than trying to make you rearrange your budget. So where's the problem in my logic there?

Pjesky: Well, I mean, then you're rearranging your diet, right? So then I, you know, then I dish out 25% less ice-cream and I’m eating fewer calories. And so, you know, there should be a symmetry here. You know, if you did the math on this, [then] there would be a symmetry here. But yet when you look at people's actual behavior, there doesn't seem to be a symmetry there. So but, you know, maybe there is, because maybe there are just as many producers of goods and services that say: we're going to keep our products the same, but we're going to increase the price. So, and that/there might be real factors in involved in that. So if you're Cola-Cola, it's much it's almost, you know, it might be very, very difficult (I'm just guessing here). But it may be very, very difficult for you to shrink your 2 liter bottle…

Mattson: Hmm mmm.

Pjesky:…manufacturing process [in order] to make it 1.5 liters. It might be very, very cumbersome and expensive to make your 12 ounce cans [instead to be] 9 ounce cans, or whatever they would be. But the ice-cream manufacturer, that just makes paper ice-cream containers, they were very easily to tell their suppliers: just make them this much smaller. And that didn't really cost them at all. So I think that there might be --- I mean, that's an interesting topic and of itself, I think. So, you know, when does quantity shrink? And when does price shrink? But again, the same thing is happening. You have a, you know, we would measure prices by the ounce [and] not by container. So having, you know, 25% less ice-cream for the same price --- that is inflation. Because, you know, per ounce, [or] per atom, or whatever of ice-cream --- you're paying more. And there is no difference between that and them, [where] you [are] using the same size container and [they are] increasing the price.

Stitzel: So, an alternative way to frame that would be: the price of the ice-cream goes up, but I want the same amount of ice-cream. This goes back to that idea that you were you were saying a minute ago. There's fundamentally already a shock and what the response to it is. It's just doing the best under the new conditions. O.K., I show up to the grocery store I was planning on buying some steak, and some ramen, and some ice-cream. And ice-cream is 25% more expensive, and it's in the same container size. So I get, you know, 100% of the volume of ice-cream but I have to pay 25% more to get it. And so now I just swap my [preferences] to make up for the cost. [So now] I just buy a little bit less steak and a little bit more ramen.

Mattson: Hmm mmm.

Stitzel: Now I fit inside my budget constraint, but I've fundamentally changed my diet. And that's a constraint too, right? Because that's related to my preferences, related to physical needs, [and] related to any number of things, right?

Pjesky: Yeah, I mean, and that's a cost of inflation as well. And it's that phenomenon that you just described --- those substitutions across different goods is one of the reasons why inflation is very, very difficult to measure in the first place. Because it's really, really hard to pick up on the differing choices that the people make. So, you know, if the ice-cream gets a smaller container and nothing else in the store has changed yet; [therefore], it might be the case that I don't buy any ice-cream at all, and I just go and buy candy bars or something. And, you know, perhaps the, you know, pricing of candy bars has not been/hadn't been affected yet. Or I might go around the store and try to find that one item whose price and quantity hasn't changed. And so I'll substitute towards that and out of ice-cream. So if shoppers are doing that (and which we know they do), then that makes it incredibly difficult for government economists to measure inflation…

Mattson: Hmm mmm.

Pjesky:…to begin with. And also it makes the welfare effects of inflation really, really hard to measure. Because, you know, if I spend my sweets budget on Hershey's bars instead of ice-cream and, you know, how much is that costing me in terms of welfare? We know it cost me some because I wanted ice-cream, and I bought candy bars instead. But we don't know how much that affects my own personal welfare.

Mattson: Well it's important to remember these measures are supposed to be overall --- they're aggregate. We're losing a lot of information as we move up to CPI. And the grocery store is, you know, relatively speaking to, you know, compared to durables and non-durables --- it's a smaller part of our economy. It's not the whole thing. These shocks can be very uneven going down the street from the grocery store. If I'm going downstream from United Market down to, you know, the Ford dealership --- used cars, in terms of their prices, have gotten more and more expensive. [However] new cars have gotten cheaper, and that is this strange unevenness that aggregate measure will not capture; because in the CPI (we're not really) we don't distinguish new and used. I think we only have the new at that point. So we may not see/ we may have this drag on say, you know, new vehicles produced; whereas, we have this rise in used vehicles produced. And so the inflation effects become lumpy. They become very different in certain aspects. We could see a larger inflation in durables than in non-durables like groceries. But in this case what we're seeing is, of course, at the grocery store. This is where that's happening and what we're feeling. We're not always buying cars. We're not always buying TVs and refrigerators (which may be going down in price). But we are constantly repeating this this exposure to grocery store prices.

Stitzel: So that that's an interesting point talking about the non-uniformity of prices on how it affects inflation. But I want to say this, and get your both of your reaction to it first. So, on one hand, there is a resistance to things that will push prices up on the supplier side. I don't want to be the person in a competitive market that raises my prices first; because then my competitors will take more of the market share, will take more of the sales, and I'll potentially be pushed out of business. O.K., so we resist inflation there. It strikes me as very symmetric that [through the] downstream of those price changes, the consumers will also resist the inflation change; [where]by substituting towards things, so the net effect of the inflation…

Mattson: Hmm mmm.

Stitzel:…is being reduced on both aspects (in terms of how we would actually observe it). Now as Rex said, that will have welfare effects and so on. But this brings us to one of those points that is really critical to extract from microeconomics. Like you were talking about earlier --- your prices are determined emergently, right? The prices that you're seeing in the supermarket --- they are not being determined by strictly by producers. That is only half the equation. This is one of the things that's really hard to teach a principles class, especially in a micro-class. But hopefully it's done in a macro-class as well. That you don't --- people that are selling things don't pick prices out of the air and then force buyers to buy right? That is those supply and demand forces. Prices emerge from both sides. Both of those seem to be having a resisting effect on inflation. So give me --- Rex let me start with you --- give me your thoughts on that.

Pjesky: Well, I mean, I think what your listeners should realize is it's very, very instructive that this conversation keeps drifting away from inflation. Because you can't have a conversation about inflation and its effects without talking about other things.

Mattson: Hmm mmm.

Pjesky: So this isn't just, you know, at a first pass, you know, we might think about inflation like this: well, if the price of everything goes up by 10% percent, and my wages go up by 10%, then inflation is it's not something really be worried about. But that is never an accurate description of what is happening. So this uncertainty --- and this this goes back to what Dr. Mattson was talking about with expectations mattering --- this uncertainty about what exactly is going on with prices in individual markets versus increases in overall prices (the, you know, that which we would that which we would call inflation) has an extremely profound effect on the decision that every firm makes with how to respond ---so, you know --- whether or not it's to raise the price or cut the size. You know, another thing/another way that this spills over into labor markets would be the decision that firms are making right now --- with whether or not to increase wages or do their best to hold down wages. If a firm is having problems, and we see this anecdotally --- I don't to the point where I don't think it's anecdote anymore --- you know, we see labor shortages everywhere. So it's difficult to get out certain things, because businesses cannot hire workers to do it. So, you know, the donut shop might close temporarily because they have no one to work there. You know, and in situations like that in every kind of firm causes problems for consumers getting goods. Well, the first reaction of any economist is going to be: well these firms should just increase their wage offers. And then they would be able to attract employees back into the workforce. And then they would be able to operate as normal. They'd have to raise prices to do that. Well a firm (if I'm the owner of a firm), you know, like a, you know, donut shop or, you know, some simple little shop like that and I'm sitting here thinking: you know, I usually pay $10 dollars an hour [and] I can't get anybody to work for that. So maybe I should offer $18 an hour. And if I offered $18 an hour, I could fully operate and sell my donuts. But once that wage is offered, there's no pulling it back. So if a firm decides to operate as normal, with wages that are substantially higher than what is, you know, normal (and I'm making air quotes with my with my hands) they're running the risk of a “transitory inflation.” So if inflation is indeed transitory, and a firm increases the wages that they offer by a lot, [then] when things return to normal (whatever that was), then they are in a really, really tight spot. Because they will not be able to pay $18 an hour anymore, because all of their competitors are paying less and less charge less. And so they won't be able to operate with a high wage and a high price environment. So the alternative is for them to weather out this six months [of] this year of labor shortages; and do what they can to do to still be in business, to still survive in a year. But yet, you know, [they can] restrict their hours or completely close down for a while. So these are the decisions that businesses are making, that are causing all kinds of real problems in the economy, [and] that relate directly from this question of inflation that we are talking about. So whenever prices increase, it's not just a factor of everything going up and the numbers are just changing. This disrupts the decisions that people need to make in their consumer behavior and in their producer behavior. And this is the destructive nature of inflation. Because if businesses do not do the right thing, because they're acting on their beliefs, they're acting on their expectations (to use the economic jargon word) --- and if they get that wrong, it is very bad for them. If they get that right, then it is obviously very, very good for them. But that indecision, that confusion, means that some firms are going to go some direction [and] some firms are going to go the other direction. And they're operating under tremendous uncertainty. And going forward, even a transitory inflation is going to be extremely costly because a lot of these businesses are not going to survive it.

Stitzel: Are those potential costs and metrics though either? Because if they raise their prices in survival in the short run, then they're less likely to survive in the long run if they're wrong about inflation being persistent versus transitory (compared to what happens if they try to hold out a little bit longer). I have a sense that they're going to have a better intuition about how long they can hold out, [rather] than what the long run prospects for inflation are. This would help explain why we're seeing the labor force issues that we're seeing.

Pjesky: And that might be the case. And we are seeing everything going in in lots of different directions. So, you know, I do see a lot --- and again this is just anecdotal I do see a lot --- of firms restricting their hours or shutting down. And I'm also seeing a lot of firms that are boosting wages, you know just directly. And, you know, the firms are paying bonuses to try to attract applicants. So, you know, some firms might give you a bonus if you apply. Some firms might give you a bonus, along with your first paycheck. You know, wages are going up in some firms and not in others. So, you know, to me that's evidence that the owners of these firms are acting on their own local information [thus] trying to do the best that they can. They might face other constraints too. So, you know, the firms that are paying the bonuses, and the firms that are increasing wages (to me, again anecdotally, [and] not [a] scientific statement) to me, they seem to be the bigger firms. The smaller firms are much more hesitant to increase wages and much more hesitant to offer the bonuses. So that might be evidence that these firms face some sort of constraint --- that even if they wanted to increase wages, [in actuality] perhaps they could not increase wages. Maybe they know. Maybe they can't come up with the money in the extreme short run. Maybe they know that they absolutely cannot raise prices, because they feel like that if they, you know, doubled their prices because they doubled their wages (just, you know, I know it's not exactly that), they would lose all their customers and go out of business anyway.

Stitzel: Right. O.K., so I want to bring this episode in for a landing. Ryan I'm going to give you the last shot here. You were talking before about non-uniform effects of inflation, and all the things that Rex was just bringing up [that] I think are interesting in the context of non-uniform inflation, right? So he's saying: you got businesses --- and they're trying to make decisions that keep their business in the best position that it can be. And [these businesses are] potentially just try to survive this time period, knowing that they'll face competition from within their industry, [and] within their particular market. And that's what's driving their particular decisions. But this would be as you said a moment ago: different across different industries.

Mattson: Hmm mmm.

Stitzel: And if you mean something more broad by non-uniform effects of inflation like you were talking about if you mean something more broad than across industry I'd like to hear a little bit about that too. But talk to us a little bit about this idea that these kind of pressures that Rex is talking about. We could see those behave differently in different industries. And the way that those two industries shake out --- we could go right back to that substitution effect that we were talking about before.

Mattson: Hmm mmm.

Stitzel: And we could see consumers making choices over/across different industry products.

Mattson: Yeah. So people are --- we have prices in economics because it's supposed to be a signal. It's supposed to be giving us information that we have. And when people stop trusting the price signal, that's when they stop engaging in the economy. And so if we have the larger firms that are able to increase their wages, and they're thinking: well maybe it's transitory, so let me just offer a two-month bonus, and then things will calm back down. But the smaller firms are making a shutdown decision. And this also could potentially affect, you know, (if people are worried about) industrial organization and monopoly structures. [So] this kind of crisis would put the smaller firms out of business long before it puts the larger firms out of business. It's not McDonald's and Walmart that are going to go out of business from this --- it's the local restaurants and local department stores. So those non-uniform shocks and inflation could translate into non-uniform shocks in people's economic behavior and activity. Is that approximating what we're/what you're getting [at] now with your question there? Is [that a] yeah?

Stitzel: You know, I think that's good. So just --- if you're getting different types of --- if the way that inflation is affecting these different industries we could…

Mattson: Hmm mmm.

Stitzel:…potentially see a different industry mix.

Mattson: Yes.

Stitzel: I phrased that question so long before…

Mattson: Yeah.

Stitzel:…but I think that's my core idea, right, is: you can end up with an inflation episode like this that changes the eventual industry mix, because of the pressures that Rex was talking about…

Mattson: Hmm mmm.

Stitzel:…being combined with the non-uniform inflation effects there. Any thoughts on that?

Mattson: Well, and I always go back to The Great Recession. So instead of a permanent inflation, maybe more of a permanent disinflation. You look at the actions of The Fed --- was to lower the interest rate as much as possible [and] make it as easy as possible to borrow and lend. And you saw increasing concentration of the largest banks. The largest banks hold the most assets within The United States. We went from 7 or 8 big banks maybe in the 90s to 5 or 6 in in the late aughts [another term for 2000s]. We lost quite a few there. This kind of pressure --- then you could say the same thing for the restaurant industry. It will change the composition of how restaurants go. I would expect McDonald's and Taco Bell to survive very well. I wouldn't expect a local restaurant or a food truck to survive very well with this.

Stitzel: Special thanks to the audience today. My guests today have been Rex Pjesky and Ryan Mattson. Gentlemen, thank you for joining me on the Econ Buff.

Thank you for listening to this episode of the Econ Buff. You can find all previous episodes on YouTube at Econ Buff Podcast. You can check out our website www.econbuffpodcast.wixsite.com. You can contact us at econbuffpodcast@yahoo.com.