The Football Game Theory of Inflation

If you don’t think of economists as party animals, you’re right. Or at least that’s the conclusion one might draw from the fact that several prominent economists carried on a thoughtful, earnest online debate about inflation over the past weekend — that is, on New Year’s Eve and the day after, when I thought we were supposed to be drinking champagne and then nursing hangovers.

But it really was a good discussion — the kind of thing I was looking for all those years ago when I chose economics as a profession, relatively free of politicization and nastiness. That is not to say that it was without political implications.

The discussion was kicked off by Olivier Blanchard, the former chief economist of the International Monetary Fund (a towering figure in the profession, who happens to be one of the economists who has gotten recent inflation more or less right).

He started off by making a point that he said is “often lost in discussions of inflation and central bank policy.” He went on: “Inflation is fundamentally the outcome of the distributional conflict, between firms, workers and taxpayers. It stops only when the various players are forced to accept the outcome.”

Although Blanchard is nobody’s idea of a leftist (OK, Republicans seem to consider anyone more liberal than Attila the Hun a Marxist, but still), he nonetheless got immediate pushback from economists who insisted that inflation is always the result of excessive demand, of too much money chasing too few goods or, what is roughly the same thing, the consequence of an excessively hot economy.

Others rose to Blanchard’s defense, notably M.I.T.’s Ivan Werning, who has been doing research on wage-price spirals. Jared Bernstein, a member of the White House Council of Economic Advisers, also weighed in, praising Blanchard for bringing the role of economic power into the inflation discussion.

So what was all this about? To some extent it involved people talking past each other, emphasizing different aspects of the same story. But there are also some real policy issues that, as Blanchard suggested, tend to get lost when we think of inflation merely as a question for the Federal Reserve and its counterparts abroad.

At one level, of course Blanchard is right. Companies that charge higher prices and workers who demand higher wages aren’t doing so because the money supply has increased; they’re trying to increase their incomes (or offset declines in their incomes caused by, say, rising energy prices). And inflation happens when the attempts of firms and workers to claim a bigger share of the economic pie are inconsistent, when the additional purchasing power being demanded exceeds what the economy can deliver.

Reading the discussion, I found myself remembering a remark made way back in the 1970s by William Nordhaus, another eminent economist (and Nobel laureate) who happens to have been my first mentor in the field. Nordhaus compared inflation to what happens in a football stadium when the action on the field is especially exciting. (If you don’t find American football exciting, think of it as a soccer match.) Everyone stands up to get a better view, but this is collectively self-defeating — your view doesn’t improve because the people in front of you are also standing, and you’re less comfortable besides.

Now, what people who claim that inflation is caused by a hot economy are saying is, in effect, that while the immediate source of stadium discomfort is that people are trying to get a better view of the action at others’ expense, the root cause of the problem is that the game has gotten too exciting. Companies would always like to raise prices and workers would always like to negotiate higher wages, but they only go for it when sales are high and jobs are abundant. Cool things down: Make the game less interesting — that is, push the economy into a slowdown or even a recession — and people will return to their seats — that is, inflation will slow.

And that is, in fact, basically the policy major economies are pursuing to control inflation. The Federal Reserve and the European Central Bank are raising interest rates in a deliberate effort to slow their economies and risk recession, precisely to persuade companies that they no longer have “pricing power” and persuade workers that they can’t demand such big wage increases.

But is that really the best we can do? We want football games to be exciting; must they remain boring to keep spectators in their seats? Correspondingly, there are many good aspects to a hot economy — among other things, tight labor markets seem to be leading to a welcome fall in wage inequality, which had been rising for many years. Must we forsake these gains to control inflation?

Back in the 1970s, there was widespread talk of “incomes policy” — some combination of incentives and moral suasion that might reconcile low inflation with a hot economy. Such talk faded away partly, I think, because of a bad experience with Richard Nixon’s price controls, and partly because of a general loss of faith in government competence.

But there have been some historical examples of successful incomes policy. Notably, in 1985 Israel cured high inflation without a severe recession, in part by imposing temporary wage and price controls.

Realistically, nothing like that is going to happen in major economies in the foreseeable future. But is it really foolish to imagine that we can make the fight against inflation somewhat less painful by looking for tools that go beyond just raising interest rates until businesses and workers have learned their limits?

President Biden has been given considerable grief for jawboning corporations that he accuses of taking advantage of inflation to engage in profiteering. European nations have been criticized for trying to contain energy bills with price controls. We can debate the specifics of these policies, but are they wrong in principle?

The answer I took from this weekend’s discussion is no. And it’s definitely encouraging to see prominent economists willing to reconsider the policy orthodoxy of the moment.

Quick Hits

Did you know that Hungary has extensive price controls?

Some echoes in the current debate of Latin American “structuralism” from the 1960s.

Did Gerald Ford kill incomes policy with a really bad slogan?

What economists consider a “very short toy model.” (It’s lovely.)

Facing the Music

A Bob Dylan cover from Barcelona, which somehow hit the spot.