Treasury Secretary Janet Yellen has now followed Federal Reserve Chair Jerome Powell in finally admitting that she was wrong last year in thinking that inflation would be a transitory phenomenon rather than becoming the country’s number one economic problem. That is to be welcomed especially considering how difficult it is for economists to admit that they were wrong. However, like Mr. Powell with the Federal Reserve, she has been very careful to avoid admitting that the policies of her Treasury Department had anything to do with inflation’s acceleration to a multi-decade high of some 8 ½ percent.
This lack of a real assumption of blame is very much to be regretted. It risks that nothing will have been learned from what former Treasury Secretary Larry Summers warned early last year as the most irresponsible of budget policies in the past forty years.
Janet Yellen’s Worldview Won’t Help
In Ms. Yellen’s worldview, the primary cause for inflation’s unwelcome acceleration was due to factors entirely beyond her control that were very difficult to anticipate. How was she reasonably to know that an Omicron variant would extend the Covid-19 pandemic and thereby keep global supply chains and international shipping disrupted for such an extended period of time? How too was she to reasonably know that Russia would invade Ukraine on February 24, 2022 and thereby send international oil and gas prices through the roof?
While to be sure a disrupted global supply chain and a Russian oil and food price shock have played some role in today’s higher inflation, they cannot explain why inflation has become as pervasive as it has become today or why it has reached a 40-year high. Nor can they explain why the economy is overheating as indicated by a very tight labor market and by a marked pickup in wage inflation.
The truth of the matter is that at a time when the US economy was experiencing reduced supply as a result of the global supply chain disruptions and the Russian commodity price shock, both the Treasury and the Federal Reserve were fueling a large increase in aggregate demand by their highly expansive macroeconomic policies.
The Treasury did so by cheerleading President Biden’s March 2021 $1.9 trillion American Rescue Plan. Coming on top of $3 trillion in bipartisan budget stimulus in the previous year in response to a Covid-induced recession , the Biden stimulus meant that the economy would receive almost $5 trillion, or some 20 percent of GDP, in budget stimulus in two years. With output estimated to have been only some 4 percent below its potential level in early 2021, it is little wonder that such a large amount of budget stimulus should lead to economic overheating by the end of last year.
Not to be outdone by the Treasury Department, Jerome Powell’s Federal Reserve kept its pedal to the monetary metal throughout last year despite the fact that the economy was recovering strongly and receiving its largest peacetime budget stimulus on record. It did so by keeping its policy interest rate at its zero lower bound and by buying $120 billion a month in Treasury bonds and mortgage-backed securities at a time when the equity and housing markets were on fire.
The only real line of defense for Ms. Yellen’s inflation negligence is that she was not to know that the Powell Fed would be even more irresponsible than her Treasury Department in letting the inflation genie out of the bottle. However, I would not recommend that line of defense to Janet Yellen’s if she wishes to remain Treasury Secretary for much longer.
Desmond Lachman joined AEI after serving as a managing director and chief emerging market economic strategist at Salomon Smith Barney. He previously served as deputy director in the International Monetary Fund’s (IMF) Policy Development and Review Department and was active in staff formulation of IMF policies. Mr. Lachman has written extensively on the global economic crisis, the U.S. housing market bust, the U.S. dollar, and the strains in the euro area. At AEI, Mr. Lachman is focused on the global macroeconomy, global currency issues, and the multilateral lending agencies.