The third item on the 2024 Republican Party platform, after promises to seal the border and engage in mass deportations, is a pledge to “END INFLATION, AND MAKE AMERICA AFFORDABLE AGAIN.”
WSJ OPINIONOn the first part of that pledge, I don’t know whether the platform’s drafters — who mainly seem to have copied and pasted their items from Donald Trump’s posts on Truth Social — are aware that inflation is already way down. But the second part is more interesting.What do they mean by making America affordable again? Depending on the interpretation, that’s either something that has already happened or a really bad idea.Before I get there, a word about falling inflation. I get many comments to the effect that whatever official statistics may say, Americans don’t see inflation coming down. Such claims about public perceptions are, however, false. Surveys that ask Americans how much they expect prices to rise over the next year show a sharp fall in inflation expectations, roughly back =p~ . Here, for example, are the results of a survey conducted by the New York Fed:
The rate at which prices are rising — is way down. What is true is that we had a burst of inflation in 2021-22, which has left the level of prices considerably higher than it was a few years ago. A dollar doesn’t buy as much as it used to. On the other hand, American workers are taking home more dollars: Recent years have seen a surge in wages as well as in prices.So, has America become unaffordable? In normal life, when we ask ourselves whether we can afford something, we compare its price to our income. and if we use that normal-life standard, America is more affordable now than it has ever been; most workers’ wage gains over the past five years have comfortably exceeded the rise in consumer prices. But many people get upset, even angry, if you point this out. That’s not really surprising. Recent research confirms an old observation, going back at least to the 1970s, that very
few people think of inflation as a process that raises both prices and wages. Instead, most believe that they have earned whatever income gains they’ve experienced, and that inflation has snatched away those gains.So are the people who drafted the Republican platform saying that we should try to reverse the postpandemic rise in prices? My guess is that they haven’t thought it through. But I think it’s worth going through the reasons no economist I know believes that trying to reverse past inflation, as opposed to controlling future inflation — which we’ve already more or less done — would be a good idea.
The thing is, getting prices back to what they were in, say, 2019 would require putting the U.S. economy through a major episode of deflation — falling prices. And the historical evidence is clear: Imposing significant deflation on a modern economy leads to very high unemployment.
Most of that historical evidence is quite old. Aside from Japan, which is a special case in ways that would take too long to explain, deflation has been very rare in modern economies since World War II. Before the war, however, there were a few deflationary episodes. The United States experienced sharp deflation after World War I and huge deflation in the early years of the Great Depression:
An even more relevant example is Britain in the 1920s. Like many nations, Britain went off the gold standard during World War I and experienced substantial inflation. After the war, however, the chancellor of the Exchequer — a guy named Winston Churchill — decided not only to restore the gold standard but also to restore the prewar gold value of the pound. He rejected vigorous arguments by John Maynard Keynes that this would be a terrible idea, arguments Keynes laid out in a classic essay, “The Economic Consequences of Mr. Churchill.”
Keynes was right. Getting back to the old gold value of the pound required, in effect, making Britain affordable again — that is, putting Britain through a sustained period of deflation:
And as a result, while America was going through the Roaring Twenties, Britain remained persistently depressed:
Why is deflation so hard to achieve? Thee most important reason is that any large decline in prices also requires a big fall in wages — and wages are very difficult to cut, even if workers aren’t unionized. The economist Truman Bewley explained why in his book “Why Wages Don’t Fall During a Recession,” based on interviews with hundreds of business and labor leaders. Basically, everyone agreed that cutting wages would damage worker morale, and that the costs of this damage to morale would outweigh cost savings except in extreme conditions. So wages and hence prices tend to exhibit “downward nominal rigidity.”
The exceptions prove the rule. The most conspicuous modern example of deflation is Greece, which was forced by the combination of a debt crisis and its membership in the euro area to engage in “internal devaluation” — cutting wages and prices to gain competitiveness against its neighbors. Greece did in fact achieve substantial wage cuts, but only at the cost of incredibly high unemployment:
By the way, this same logic explains why we had a burst of inflation as the economy recovered from the Covid-19 pandemic. The lingering effects of the pandemic led to large-scale disruptions — overstretched supply chains, a huge shift toward remote work and more. These disruptions led to large increases in some prices. To have avoided a rise in average prices would have required large price reductions in other parts of the economy, and almost surely would have required high unemployment. Allowing a one-time burst of inflation, then stabilizing subsequent inflation, was arguably the right policy — and it’s more or less what we did.
So can we make America affordable again, in the sense of getting prices back to what they were before the pandemic? Almost surely not, nor should we try. It was important that inflation not get entrenched in the economy, and it didn’t. Instead, we seem to have achieved what many thought impossible: a soft landing that combines low inflation with low unemployment.
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Interesting theories...
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