Monday, June 6, 2022
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Team transitory vs team permanent

Inflation has risen in the US, the UK, the Euro Area and elsewhere, as demand has increased following the opening up of the economy after pandemic-induced lockdowns, and supply chains have been disrupted.

This has produced a debate amongst the economic commentariat about whether they are on ‘team transitory’ [the rise in inflation will be temporary] or ‘team permanent’ [you get the idea]. Participants have been updating their guesses about which team will win, as each inflation print is released.

The debate does not really make much sense. It is very difficult to justify being on ‘team permanent’. There are not many circumstances whereby the rise in inflation could become permanent and they they require extreme and counterfactual views to take them seriously.

One way to get a validation of ‘Team Permanent’ is by central banks choosing unilaterally to raise their inflation targets.

In the case of the UK this is impossible, as their target is set by the government. The Fed and the ECB have ‘price stability’ mandates’, which they translate into operational targets of 2 per cent. It is extremely far fetched that they would revisit these targets [in both cases on recently reviewed] and push up the number above 2. There are solid grounds for doing so [I’m actually in favour: you can reduce the time you might spend at the floor to interest rates], but they have met with very little support in the central banking community and in the ECB and the Fed in particular.

A second possibility is that central banks are forced to target higher inflation by their respective governments. This is possible in the UK [we have a government with a majority that can and does do things] but highly unlikely. There is still a consensus across the political spectrum for the current inflation target. A rise in the target forced on the ECB would require a change in the foundational treaty of the European Union, which would need agreement of all member states [including the infamously hawkish Northern European states], is not going to happen. In the US, the idea is not on the political agenda and would not gain the necessary bipartisan cooperation to get through both houses.

Even without consciously changing targets, or having such changes forced on them, central banks could be forced into higher inflation, or lose control of it, due to fiscal pressures. We have coherent theoretical models of money, debt and inflation that could explain how this could happen. But there is no sign of it happening in reality. [See bond yields].

So, everyone should be in Team Transitory.

The only real debate is, given the current scheme/rule the Fed [or whoever] has for responding to events, and how they see the effect of those events playing out, how long will inflation end up being away from target?

If you think you have a better view of how events will play out [by which I mean what shocks are hitting the economy, and how they will percolate into inflation and other things the central bank cares about] you will think that you can forecast what the Fed will do better than they can do it themselves; and if you are selling your advice to people buying assets whose value depends on those interest rates, and expectations of them, precisely where you are on the ‘Team Transitory’ spectrum will colour what advice you give.

And if you are into normative policy, shouting at central banks for the hell of it in other words [as some aspiring or frustrated central bank chairs are], you will translate where you are on Team Transitory into policy advice.

A better way to frame the debate is : what is going on in the economy, and what should the central bank and fiscal authorities do about it; how much of a spike in inflation should they curate and how long should they hope that it lasts?



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