Who's Right on Inflation?
Lawrence "Larry" Summers v. Adam "Adam" Tooze
Caveat: Not an economist. I’m some guy who listens to podcasts and thought this was interesting. Please tell me if and when I’m wrong.
Lately, I’ve become an evangelist of the Ezra Klein Show. Each episode is an interview with an expert on really anything - economics! philosophy! octopuses! This expert-focused setup avoids the dilettante problem that sometimes plagues journalists who veer across subject matter areas: they know how to write a story, but they don’t know the intricacies of the areas they’re writing about.1 It also helps that Klein and his team pick good guests and seem knowledgeable about, or at least well-prepared for, each topic. But enough sucking up to Ezra Klein.
Recently, I listened to two opposing Ezra Klein Show episodes about inflation.
If you’re unfamiliar with the inflation saga, inflation measures how quickly the cost of everything is changing. In general, we want inflation to be positive (because everything getting a liiittle more expensive incentivizes people to buy things now, which keeps the economy humming) but low (because nobody wants a sandwich to suddenly cost $27). The ideal inflation is 2% per year.
Who says 2% is ideal? The Federal Reserve, aka the Fed. They’re responsible for monitoring inflation (and the US economy overall) and pumping the brakes if it gets out of control. Unfortunately, inflation jumped in April 2021 to 4.2% and has been rising since, reaching 8.5% in March 2022. Inflation numbers like these haven’t been seen in 40 years, so obviously some people have been yelling at the Fed to pump the aforementioned brakes. Others, however, think the inflation is ‘transient’: it’ll go back down on its own and, if the Fed intervenes unnecessarily, it’ll throw the US into another recession.
In the Ezra Klein Show, he interviews two experts, one from each camp. First up is Adam Tooze, who (at least when he was interviewed) thought the inflation was likely transient. Several month later, Klein interviews Larry Summers, who wants the Fed to slam the brakes like there’s a slack-jawed deer in the road. Tooze was interviewed in September 2021, Summers in March 2022. So yeah, there’s an asymmetry here. Summers has 6 more months of information to work with.
Even accounting for that asymmetry, though, Summers comes out looking way better. Maybe that’s obvious given that inflation rates kept rising, exactly like Summers said. Listening to the two conversations back-to-back, though, it’s why Summers is right and Tooze is wrong that sticks out. Most of all, it’s eery how closely the conversations align before suddenly diverging.
In the interview with Summers, the conversation turns to wage growth and its relation to inflation (emphasis mine):
In a sense, wages are the ultimate measure of core inflation. Most costs go back to labor.
And so who knows what’s going to happen to used car prices, who knows what’s going to happen in some month to semiconductor prices or to the price of asparagus. But in some sense the growth rate of wages is what ultimately is determining inflation over time. And wage growth had ratcheted up to a 6-plus percent rate by the end of the year. And there were desperate labor shortages, worse than we’ve ever had. And they were forecast to continue.
And the response that, frankly, the progressives who had advocated all of this were saying was that this labor shortage was fantastic because it was going to lead to even more wage increases for workers. So the theory of how this was all going to work out to moderate inflation with even lower unemployment, it would all make sense if there was an element of wage restraint. But when it was all happening with accelerating wage growth, I found it difficult, even before what we have seen, to see the scenario to soft landing.
In short, progressives were claiming that we could get rocketing wages and moderate inflation. Summers is saying that most costs go back to what you pay people, and hence if wages rise rapidly, so will costs. If baristas make more money, your coffee will cost more. Maybe that’s a net good thing! But you can’t have one without the other.
What’s interesting is that Tooze specifically acknowledges Summer’s argument:
Adam Tooze: And we know that the power balance in labor markets has radically shifted. In fact, somebody like Larry Summers started 2020 by publishing a rather brilliant paper on precisely this point. And so it’s particularly surprising, I think, to find somebody like him now arguing what seems like the other side of the same point.
Ezra Klein: Can you say what he said in that paper?
Adam Tooze: Well, he was arguing there that the fundamental unifying fact — if you just had to point to one idea, the grand, unifying theory of political economy, in the current moment — is the shift in the power balance between labor and employers, and that it helped to explain profit margins. It helped to explain inequality. It helped to explain the tendency towards low inflation that we see across most of the advanced economies.
Here, Tooze fundamentally agrees with Summers about the underlying relationship between employer-worker power balance and inflation. When the employer wields more power than workers, workers have to accept lower wages. Lower wages means goods cost less to make, so profits go up and inflation goes down. When worker power grows, wages go up and inflation with it.
But immediately after this, Tooze makes a strange claim:
And now, all of a sudden, now we’re in 2021, and he’s concerned about inflation. And yet, the power dynamic, of course, has not shifted. If anything, the position of workers is, in total, weaker than it was before.
His objection isn’t against Summers’ view of inflation, but Summers’ view of worker power. Sure, more worker power could lead to inflation, Tooze says, but it’s not like we’re actually seeing more worker power.
Even in September 2021, this seems completely wrong. All the talk of the Great Resignation, managers struggling to find workers, and wages rising clearly pointed to one thing: it was (and is) a worker’s market!
To make sure I wasn’t going crazy and that this “worker’s market” existed in mid-2021, I pulled up a few articles from the time:
“Workers Are Gaining Leverage Over Employers Right Before Our Eyes”, NY Times in June 2021.
“Chipotle will increase its menu prices as labor costs rise”, NY Times in June 2021.
“American workers rush to take advantage of pandemic bargaining power”, NBC News in August 2021.
“Walgreens to raise wages for hourly workers to $15 by November 2022”, NBC News in August 2021.
“Walmart's wage bump signals pressure to raise pay in industry battle for labor”, Reuters in September 2021.
“Wage Growth Is Holding Up in Aftermath of the Economic Crash” from June 2021,
“The Revolt of the American Worker” from October 2021. From the article:
On one side, workers are quitting their jobs at unprecedented rates, a sign that they’re confident about finding new jobs. On the other side, employers aren’t just whining about labor shortages, they’re trying to attract workers with pay increases. Over the past six months wages of leisure and hospitality workers have risen at an annual rate of 18 percent, and they are now well above their prepandemic trend.
In the interest of intellectual honesty, I also found the Washington Post article “No, the pandemic hasn’t given workers more power” from September 2021. Despite the title, the article is about how the boom in perks and pay used to attract workers isn’t really worker power if you think about it, you need unions for that and also CEOs still make a gazillion dollars a year and companies are designed more like dictatorships than democracies and those things need to change for workers to really have more power. Which, fine. (I agree!) But increased wages and the ability to be picky in job searching counts for something in worker power, even if other things count more.
Regardless, even this article doesn’t dispute that there were tons of job openings, which led to more worker bargaining power, which led to higher wages. But Tooze writes off the position of the worker as “if anything… weaker than it was before.”
When economists disagree, I expect it to stem from a philosophical disagreement about how the world works. I expect it to be based on different beliefs about the ROI on government spending, or the efficiency of markets, or whether MMT is genius/crackpot. I don’t expect it to be over a generally agreed upon fact.
So why did Tooze get it wrong?
I am, of course, oversimplifying.
Inflation is complicated. Boiling it down to r/WallStreetsBets logic of “wages up, inflation up” is unfair. Suppose wages go up 0.1% but supply explodes by 20% because, I dunno, a global pandemic ends and unlocks a ton of previously bottle-necked supply. In that scenario, it would make no sense to ignore the increase in the supply and conclude that there must be inflation because wages went up. It’s all relative. How much are wages going up, how much has demand increased, how much has supply been limited, and what types of supply/demand have changed - they all matter relative to each other.
To steelman Tooze, he probably thought the changes in wages were negligible in comparison to other issues, like supply chain issues. He makes the case that despite high year-on-year CPI growth, other signals point to transient inflation:
I think there’s every reason to think that [inflation rates] will ebb away over time. Already, in fact, we’re seeing signs that the really rapid surge in inflation that we saw in some sectors at the beginning of the year is decelerating. So month-on-month inflation rather than year-on-year inflation is now much calmer than it was earlier in the year. So if you take the year-on-year measures, you are, as it were, lagging. You’re not quite capturing how rapidly things are calming down.
What about rising worker wages? Were they rising quickly enough that Tooze should have realized they could drive inflation? Well… in September 2021 when Tooze was interviewed, wages were rising quickly, but that not far outside of the historical range:
At the time, worker wages were quantifiably rising and, in some sense, at the highest point they’d been since the 2008 financial crisis. That’s misleading, though - the September wage growth was at the high end but still within the 2002-2008 and 2016-2020 ranges. It’s in the following months that wage growth shoots over 5% and into the range that gives Larry Summers an aneurysm.
So in Tooze’s defense, the evidence of increased worker bargaining power isn’t totally overwhelming. There’s lots of signs - see the previous articles and the rising wage growth - but these signs could be a post-pandemic blip that fades as the economy finds its groove. I still don’t know how he got to worker power being weaker, but whatever.
Moreover, Tooze was used to deficit hawks screeching about impending crises that never materialize. This was the case in the 2008 financial crisis, which he wrote a book about. 2020 rolls around, the U.S. government throws trillions into the national money hole (again), deficit hawks freak out (again), and the horrible consequences they predict don’t materialize (again, at least for a while). Tooze sees them as the economists that cried wolf.
In this mindset, I can almost see how he would brush off the signs of renewed worker power. Once you notice the pattern of hawks looking for any excuse to get stingy, you’re more likely to view the evidence they present as yet another excuse rather than a good-faith argument. And when the signs for increased worker power are present but not rock solid… well, maybe you think that narrative is overstated to drum up concern about inflation.
Still, it strikes me as a cautionary tale for learning the lessons of history a little too well. History repeats itself, sure. But sometimes it contradicts itself just to fuck with you. Over-index on how things went before - in this case, inflation hawks freaking out over nothing - and you might end up making the opposite mistake.
What are you looking at? Have you never seen a hypocrite before?
Good analysis. It seems to me there was a lot of motivated reasoning going on, but a lot of economics is using arguments as bullets... basically all the time.