Two and a half years after the start of the financial crisis in 2007, America’s unemployment rate was kissing 10%, the Federal Reserve realised that it was out of firepower and the Obama administration had just thrown away its ability to help by promising to veto spending and tax bills that were insufficiently austere. After that moment it would take six years for America’s economy to approach full employment. The impact of deficient employment meant that output was $7trn lower in 2013 than it would have been otherwise... We have avoided all that this time around. Relative to the Fed presided over by Ben Bernanke between 2006 and 2014, Mr Powell’s team are public benefactors to the residents of America to the tune of $20trn, if you consider that there are more jobs and fewer idle factories now and in the future because of their actions. We have an uptick in inflation partly because the Fed—alongside Congress and the presidency—responded far more aggressively to the pandemic-induced recession than to the global financial crisis. A world in which the economy recovers so quickly that inflation emerges is better than one in which recovery drags on painfully for years.
He then examines the five or six previous episodes of inflation in the US over the last century or so and feels that the current one is similar to the second and third bouts in 1947 and 1951. On both occasions, well within two years supply shifted to match demand and the inflation receded without much monetary policy firepower. Also in both cases, neither workers nor producers expected inflation to stay high enough to break anchor and demand higher wages or pass on higher prices.
De Long writes,
In my view, the second and third bouts of inflation, in 1947 and 1951, are the right models. That is because the long-term inflation expectations implicit in the bond market are still trading at their normal “in-the-long-run-inflation-will-be-about-2.5%” range. Bond traders appear to expect a little extra inflation over the next couple of years, but after that a return to what has become considered normal. Unless workers and managers see more inflation in the future than bond traders—something that seems unlikely to me—they have no warrant for pushing for high wage increases or thinking that they can get away with price increases ahead of a continuing inflation wave. So there is considerable hope (though hope is not confidence) for a soft landing.
He also qualifies his opinion with the risks of a hard landing from either over-reaction by Fed (excessive tightening) or inflation getting unanchored (and reshaping expectations).
In my own evolving opinion, it's almost impossible to predict the future on such issues (like inflation) with any reasonable degree of confidence. There are too many factors at play that come in the way of even the best human minds to exercise good judgement.
For every compelling view on the ongoing inflation by a reputed financial market participant or observer there is an equally compelling different (and even opposite) view by another equally reputed commentator. I struggle to choose between Larry Summers and Brad De Long. As a distant observer of the financial market, these views make me oscillate between the different interpretations. But over time and experience, I've come to start embracing in a very small way what Keats calls "negative capabilities".
Let me explain the challenge.
The most knowledgeable of financial market participants (with both technical and practical experience) suffer from two biases that cloud their judgment. One, even the most practical and grounded experts suffer from a technical bias which blisndpots them to (or makes them discount) the role of non-technical and idiosyncratic factors. For example, it required the unpredictable twin shocks of the pandemic and Russia-Ukraine war (and not any theoretical climaxes) to bring an end to the more than a decade long period of monetary accommodation and financial market boom, and perhaps even reshape the next generation's views on risk and returns. Morgan Housel has several posts on this theme.
Second, even the most experienced investors have only seen so much, blinding them to the "long-view of history". In fact, even those non-historians who claim to take the long-view of history are ill-equipped to comprehend historical details and nuances and get captured by the logic of simplified narratives. As I blogged earlier here, Peter Turchin, Yuval Noah Harari and Jared Diamond are good examples of superficial inductive historical narrative artists. I'll add Neil Howe and William Strauss to that list. All these people occupy primarily the space of public opinion makers and are less of scientific researchers. Their incentives and works are shaped accordingly.
The best professional historians are equipped to take a long-view of history, but suffer from an inadequate comprehension of the technical aspects of the market as well as its practical realities.
This leaves us with having to find people who combine the attributes in the best among financial market participants and historians, a near null set.
So you need super-human qualities to be able to exercise good judgement. The Thomas Schelling kind of polymath.
Alternatively, and this is a view I am increasingly inclined to, it may be that people with some inter-disciplinary knowledge but imbued with the general attributes of open-mindedness mentioned above may be better placed to exercise good judgement. They are generally the wise people. This is also the view that emerges from the likes of Philip Tetlock who have researched the area of human capabilities in predictions.
In the circumstances, most of what passes off as good judgement even among the most experienced market participants is, at best, the slightly better among several deeply flawed judgements.
These flawed judgements are accepted as good or bad by audiences depending on whether it reinforces or strengthens their own entrenched or nascent priors. In this respect what is often considered as conventional wisdom or dominant view owes its rise to the reinforcement of the dominant set of priors.
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