The disinflation as American triumph

That is the theme of my latest Bloomberg column, score one for the Quantity Theory as well, here is one excerpt:

Enter the notion of “credibility.” A long-standing tradition in macroeconomics, sometimes called rational expectations, suggests that a truly credible central bank can lower inflation rates without a recession. If the central bank announces a lower inflation target, and most people believe the central bank, wages and prices adjust in rough sync with demand. All nominal variables move upward at a slower pace, markets continue to clear, and the economy keeps chugging along. Because individuals in markets believe the disinflation process is for real, they are willing to act in accordance with it in their pricing and wage-demand decisions.

Although rational expectations theory has undergirded several Nobel Prizes (see Robert E. Lucas and Thomas Sargent, for example), most mainstream economists these days do not believe in it as a general approach. The critics might be behavioral economists who scorn the notion that individuals are rational in their market decisions, or they might believe that full credibility is rarely if ever present. After all, do we not live in an age of low trust and mixed quality governance? Over the last year, for instance, I have been party to numerous conversations suggesting the Fed will be afraid to pursue disinflation out of fear of inducing a recession and indirectly electing Donald Trump as president.

And yet it seems the credibility has been there, and so we can give plaudits to various parts of the federal government, including President Biden, for supporting Powell and the Fed. At no point did the president intervene to bash the central bank or send a mixed message, and so the disinflation had implicit stamps of approval from majorities in both parties. It is often the job of Congress to complain, but there were no serious moves made against the independence of the Fed, even if Elizabeth Warren and a few others squawked.

As for the commentariat, a diverse array of economists ranging from the Keynesian Paul Krugman to many conservative economists recognized that rate increases and disinflation were necessary and had to be done with promptness and fortitude. And so credibility reigned.

Granted, the rational expectations view is not always correct — and a recession somewhere down the road isn’t out of the question — but at least in this instance America pulled together and did the job. This sequence of events, which is continuing, should serve as a lesson to those predicting either the decline of America or the creeping polarization and paralysis of our politics. The disinflation can serve as Exhibit A for American optimism and a demonstration that we are still capable of making our own future.

Can the UK and EU pull off the same?