. . . get a stupid answer.

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A recent article on inflation beautifully illustrates the truth of this old maxim. Before getting to the article, let’s review another maxim, this one not at all old:

Never reason from a price change.

Thus, for instance, it would make no sense to ask people about the “welfare costs of inflation”, without first specifying whether the inflation was caused by less supply or more demand.  But that doesn’t stop pollsters from asking.  Here’s The Economist (from an article entitled “Is Inflation Morally Wrong?”):

Americans who responded to Ms Stantcheva’s surveys were angry for a number of reasons. Most believed that inflation inevitably meant a reduction in real incomes. They said that rising prices made life more unaffordable and prompted them to worry they would not be able to afford the basics. Respondents did not see a trade-off between inflation and unemployment—referred to as the “Phillips curve” by economists—but thought that the two would rise in parallel. Some 70% did not view inflation as a sign of a booming economy, but as an indication of one in a “poor state”.

Notice that all of the public’s beliefs are true if the inflation is generated by an adverse supply shock, and false if generated by a positive demand shock.  Now contrast these views with the views of economists:

Why, then, are some economists more relaxed about rising prices? Inflation does present difficulties: it can undermine central-bank credibility and causes arbitrary redistribution from creditors to debtors. The constant updating of prices also carries costs for companies. Yet if all prices are adjusting at the same rate, the change is not as consequential as many workers believe. It no more means that workers are getting poorer than measuring someone’s height in feet rather than centimetres would mean that they are getting shorter. What is more, inflation is often the consequence of a hot labour market 

Notice that the perspective of economists is mostly accurate if the inflation is generated by positive demand shocks, but quite misleading if generated by adverse supply shocks.

It’s not so much that the public and economists disagree about inflation; rather they are discussing entirely different concepts.  It would be like conflating a decline in coffee prices caused by a caffeine cancer scare, with a decline in prices caused by a bumper crop of coffee beans.  The effect on consumer welfare will not be the same!

Consider the following two views, both widely held by many people:

1. The public hates high inflation.  

2.  We need an independent central bank because politicians are tempted to enact expansionary monetary policies to become more popular.

Do you see the conflict here?  The puzzle can be resolved, or at least reduced greatly, if we distinguish between supply and demand side inflation.  Clearly the public hates supply side inflation, as it is associated with falling living standards.  There are cases where demand side inflation is also somewhat unpopular (like right now), but this case is far more ambiguous.  Here are some counterexamples:

1. Between 1929 and 1933, a contractionary monetary policy reduced the cost of living by roughly 25%.  And yet President Hoover was highly unpopular. 

2. Between the spring of 1933 and the spring of 1934, FDR’s expansionary monetary policy raised the cost of living by about 10% (which is even more than the peak 2022 inflation.)  FDR was extremely popular.

3. Between 2008 and 2009, a tight money policy drove inflation sharply lower, to roughly zero.  People saw the economy as doing poorly.

All three of these anomalous cases of public opinion moving in the “wrong way” in response to shifts in inflation share one thing in common.  In each case, the inflation change was generated by demand side shocks.  These reflect the views of economists, as discussed in The Economist article.  I’m not suggesting that demand side inflation is always popular (it isn’t), rather that the welfare effects of supply and demand side inflation are vastly different, and the public has at least some ability to sense this difference.  For instance, supply side inflation reduces real income, whereas demand side inflation temporarily raises real income (i.e. real GDP.)

Many people at the Fed think NGDP targeting is a bad idea.  One argument you often hear is that the public understands inflation targeting but doesn’t understand NGDP targeting.  Nothing could be further from the truth.  NGDP targeting is far easier to explain to the public.

Any Fed official suffering from the delusion that the public “understands” the Fed’s inflation targeting policy should go to a town meeting, and explain that when inflation falls to 1%, the Fed works hard to raise inflation back up to 2% (or even 3%, as with FAIT).  Check out the incredulous looks on their faces.  Yes, some of the public has vaguely heard about the Fed’s 2% target, but they assumed that meant the Fed was trying to make sure inflation did not exceed that level.  Not one in a hundred understands the true nature of inflation targeting, which is a policy that assumes 2% inflation is actually a good thing, and that when inflation falls below that the level it is necessary to make the cost of living go up even faster.  

You might argue that NGDP suffers from the opposite asymmetry, that the public doesn’t understand why excessively high NGDP growth would be a bad thing.  Actually, the asymmetry with NGDP is much less of a problem.  It takes a PhD in economics to truly understand why higher inflation can reduce unemployment. (And sometimes even that isn’t enough—see reasoning from a price change.)  On the other hand, if you tell average people that very rapid growth in the public’s incomes might lead to the problem of high inflation, they’ll sort of understand.

The Fed needs to tell the public that monetary policy is not about interest rates, it’s not about inflation, and it’s not about unemployment.  Monetary policy is about keeping national income growing at 4%/year.  Full stop.

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