St. Louis Fed, Speech: How Will Inflation End? Three Scenarios

We’ve already Chosen #1, but will it Choose Us?

• Scenario 1 (immaculate disinflation) is the obvious choice.
  • It’s quick, nearly painless and is not politically destabilizing.
    • Almost no one will lose his or her job.
  • No one’s 401k or house price will crash.
  • The opposition party won’t be able to blame incumbents.
    • Only problem: Does this work in the real world or only in economic models?
  • The best evidence for immaculate disinflation is: In select cases of hyperinflation…
  • … when a discrete and credible regime change occurs.

Is Immaculate Disinflation Really Possible?

• Radical and credible political and policy changes may end hyperinflations, such as in Weimar Germany and some Latin American countries in the 1970s and 1980s.
  • But that’s not us; what kinds of “discrete regime changes” might work in less extreme circumstances like ours? A true end to COVID, boosting labor-force participation.
  • A renewed burst of productivity growth, increasing supply.
  • A new fiscal-policy framework that curbs debt growth.
  • New political and economic leadership.
• The Fed says, “We’ll do what it takes;” but is it credible?

Why Talk About Volcker or Stagflation Now?

• No one would choose Volcker or stagflation if immaculate disinflation still seemed possible, but…
  • … how much longer can we explain away high inflation?
  • In 2020, signs of inflation were due to “low base effects.”
  • In 2021, inflation was termed “transitory,” arising from temporary supply-chain bottlenecks.
  • In 2022, inflation has been dismissed as the result of Russia’s invasion, leading to commodity-price shocks.

• But as we approach 2023, inflation is high and broadening to services; wage-price and price-price spirals threaten.

In Sum: Could Stagflation Lead to Volcker (Again)?

• We’re now entering stagflation (2022 growth and inflation will be bad), but are we ready for a new Paul Volcker?
• Volcker’s policy of punishingly high interest rates was a last resort; more than a decade of stagflation was necessary to make Volcker possible.
• It took far-sighted political courage and economic understanding on the part of Jimmy Carter to appoint Volcker in 1979, and by Ronald Reagan not to undercut Volcker immediately upon taking office in 1981.
• Will current leaders live up to Carter, Reagan and Volcker?