Krugman Throws Stones From A Glass House

New York Times columnist Paul Krugman wrote the following last month: “Recently the Federal Reserve released transcripts of its monetary policy meetings during the fateful year of 2008….What’s really striking is the extent to which they were obsessed with the wrong thing. The economy was plunging, yet all many people at the Fed wanted to talk about was inflation.”

Krugman has also been faulting “conservative” (his word) economists for predicting that consumer-price inflation would result from Federal Reserve easing after 2008. He calls them “inflation obsessives.” Krugman even suggests that conservative-inspired inflation-obsessiveness is responsible for the poor quality of the recovery from the Great Recession. As he has written:  “I’d argue that the clamor from inflation obsessives has intimidated the Fed, which might otherwise have done more.”

In September 1982, while working for President Ronald Reagan’s Council of Economic Advisors, Krugman and Larry Summers wrote a memo to CEA chair Martin Feldstein called “The Inflation Time Bomb?” It began:

“We believe that it is reasonable to expect a significant reacceleration of inflation in the near future. Much of the apparent progress against inflation has resulted from the temporary side effects of tight money….”

And it concluded:

“Our very rough guess is that [the] correction…will add five percentage points to future increases in consumer prices….This estimate is conservative….”

The memo represented the consensus of professional economics at what turned out to be one of the crucial junctures in modern American economic history. For the previous thirteen years, from 1969 to mid-1982, the United States had been experiencing what we now call the Great Inflation. Prices in that period went up 7.5% per year. The worst of it was 1979-81, which were three straight years of double-digit inflation.

It appeared that major inflation was an intractable problem, a permanent fact-of-life. In reality, that very moment, late summer 1982, marked the end of the Great Inflation. Prices were flat the last four months of the year, and for the next twenty-five years inflation averaged a consistent 3%.

Krugman (and Summers) envisioned an additional five percent on “future increases” in consumer prices. Presumably, this meant that inflation would remain at double-digit yearly rates throughout the 1980s. It was a missed call at the very terminal point, now so clear after-the-fact, of the stagflation era.

People are entitled to poor reckonings, and Krugman’s Keynesianism, or whatever it was, was the wrong model. But there are consequences (as Krugman tells us today) of such mistakes. What were these in the wake of the assurances in 1982 that high rates of inflation were sure to persist?

The most pernicious was the effect on the Congressional budget process. It was an article of faith among the opposition Democrats in Congress that “Reaganomics” was inflationary. Indeed, the specific reason that George W. Bush had called Reagan’s policies “voodoo economics” in the 1980 Republican primary was that Bush felt that they would compound consumer price increases, a view soon co-opted by the Democrats.

Therefore, when spending resolutions arose in Congress in 1982, 1983, and 1984, it was an act of party disloyalty for Democrats not to insist on increases of 10% per year in agency budgets, on the grounds that the Great Inflation was certain to continue under the auspices of Reaganomics. The position Reagan had to bargain from as he tried to keep spending within reason was an inflation premium that in reality did not exist.

This contributed decisively to the large size of the budget deficits in these years. Had the Democrats conceded that inflation was permanently low by late 1982, and budgeted accordingly, federal spending would have been lower by tens of billions of dollars per year.

Krugman wants to hang the mediocrity of the recovery from the Great Recession on those vigilant about the Fed in recent years. Yet the consensus he contributed to with respect to inflation in the 1980s has no less blood on its hands than the notorious deficits of that era.