In wall street journal, James McIntosh argues that the Fed does not deserve credit for the recent decline in inflation. “Deflation was caused mostly by things over which the Fed has no control as normalcy returned after the pandemic,” they write. Instead, improvements on the supply side are putting downward pressure on prices. According to McIntosh, the best that can be said for the Fed is that it avoided fanning a dying fire.
Mr. Mackintosh’s arguments failed. On the demand side, he ignores the important driver of inflation, which is nominal spending (current-dollar GDP). On the supply side, he confuses the price level with the growth rate of prices. It is quite clear that the Fed has contributed to deflation, and supply-side factors are largely secondary.
Like most financial commentators, Mr. McIntosh focuses on how the Fed’s interest rate policies affect different sectors of the economy. He looks at saving, borrowing, consumption, investment, housing, employment, and output growth and claims there is no evidence of Fed-led deflation. But, except the last item (production growth), all these are peripheral. It is fundamentally wrong to look for economy-wide events in specific sectors or industries. Inflation affects all markets, so we need a cause that is the same for all markets. It cannot be denied that inflation sometimes has an impact on relative prices. This simply assumes that local price changes are different from broader inflation. We are trying to explain broad-based price pressures. Mr. Mackintosh’s proposed mechanism cannot do this.
That leaves our final variable, which is output growth. Let’s look at the data: What has happened to current-dollar GDP since the Fed started tightening? Nominal output grew at an average annual rate of 11.6 percent in the last three quarters of 2021 and 6.87 percent in 2022. So far in 2023, the average growth rate is 6.0 percent. There has been a clear slowdown in total expenditure. Whether you’re looking at inflation-adjusted interest rates or broader monetary aggregates, it’s also clear that monetary policy has tightened. Your counterfactual scenario – what you think would have happened if the Fed had not tightened – would have to be wildly out of sync to argue otherwise.
Nor does Mr. McIntosh’s supply-side story work. In theory, it is true that rapid real output growth can cause deflation. But that is not happening now, mainly because we do not have fast real output growth. Starting from the second quarter, real output growth in 2021 averaged 5.33 percent. In 2022, the average was 0.65 percent. Growth was negative in the first two quarters of 2022! Real output growth was strong in 2023:Q3, but that’s an outlier, and it doesn’t change the fact that last year’s growth – the year we saw deflation – fell. So much for real supply-side deflation.
There is an even more fundamental conceptual error here. If higher prices in 2021 and 2022 were largely driven by supply constraints (for example, pandemic-related constraints) and supply constraints are lower than last year, we should see higher prices rather than just slower growth than last year. Should have seen a decline in prices compared to. There should be not just deflation, but complete deflation! Of course, this is not the reality anywhere. Although some prices have declined over the past year, most prices are much higher today than they would have been had they increased at an average rate of 2 percent since January 2020.
Like Mr. McIntosh, “I don’t agree that the Fed, which let inflation get out of control, should now get too much credit for fixing its mess.” We should not tie a medal to an arsonist’s chest for extinguishing the fire he started. The Fed is largely responsible for the price surge in 2021 and 2022. But it is also largely responsible for the ongoing deflation. Alternative explanations make no sense.
Alexander William Salter
Alexander William Salter is the Georgie G. Rawls Professor of Economics in the Rawls College of Business. Snyder is Associate Professor and Comparative Economics Research Fellow of the Free Market Institute at Texas Tech University. He is the co-author of Money and the Rule of Law: Pervasiveness and Predictability in Monetary Institutions, Published by Cambridge University Press. In addition to his many scholarly articles, he has published nearly 300 opinion articles in major national outlets wall street journal, national review, Fox News opinionAnd hill,
Salter received an M.A. and Ph.D. Earned. in Economics from George Mason University and a BA in Economics from Occidental College. He was an AIER Summer Fellowship Program participant in 2011.
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