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Dear Lord, Is This What They Teach At Harvard?

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Perhaps we can explain some of the global disconnect when we consider the economics that appears at the School of Government at Harvard:

Leah Downey is a PhD candidate in the department of Government at Harvard University

Or maybe we should concur with Leah’s own estimation of her knowledge. Considering that she is still in education she clearly agrees that she has more to learn.

If people expect their costs to go up, they raise prices to compensate. High inflation expectations beget actual inflation. The most “dangerous” version of this story is the fabled “wagey-pricey” spiral in which workers expect prices to rise, and thus the cost of living to increase, and as a result, they will negotiate higher wages. This forces firms to raise prices, which spurs workers to negotiate raises, and on it goes – an inflation spiral. This is what Andy Haldane, the chief economist at the Bank of England, has in mind when he says, “once it’s in pay packets as well as prices, the genie truly is out”.

But this same spiral could look very different. As we come out of lockdown and begin to spend again, firms could use this extra capital to invest and hire more people, leading to rising incomes and more spending. In other words, instead of inflation we get growth.

Umm, that connection between more spending and more capital is a little shakey. We normally think of this the other way around. That if people are spending more then they’re saving less leading to there being less capital available for investment.

Then there’s that idea that rising incomes and spending isn’t inflation. Which, of course, it can be – the distinction between nominal and real is rather at the heart of what we mean when we talk about inflation.

This is also rather fun:

Before we conclude “it is clear that inflation is here” we should think long and hard about what is causing prices to rise and who has the ability to influence that trend. The prevailing narrative is that inflation is the product of overly “ambitious government spending”. The chancellor, Rishi Sunak, has expressed these fears. And the former US treasury secretary Larry Summers said of President Biden’s spending proposals: “I’m concerned that what is being done is substantially excessive.”

Comments such as these are dangerous because they can create a narrative that threatens much-needed government spending.

We mustn’t talk about how excessive government spending might cause inflation because talking about it will cause the inflation. Or, shut up peasants, we in the school of government at Harvard know what we’re doing.

Yet we are living in a world in which many people, specifically many price-setters, believe that high government spending will necessarily cause inflation. This mistaken belief, if allowed to exert performative power, could have serious consequences. First, it could result in actual inflation. This might not be such a bad thing, because inflation has been below target in most advanced countries for many years, and because evidence suggests that the negative effects of inflation only kick in when it hits double digits.

The real danger is that a performative belief that high government spending causes dangerous inflation could stymie government spending despite the fact that high government spending – especially on fundamentals such as physical and social infrastructure – need not lead to dangerously high inflation.

Actually, not just shut up peasants, shut up everyone. Which , when you think about it, really is what we expect from Harvard’s school of government.

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4 COMMENTS

  1. Just curious, but this bit seems a bit dodgy to me ” workers expect prices to rise, and thus the cost of living to increase, and as a result, they will negotiate higher wages”. It seems to me workers (individually or in a group) would negotiate the highest possible wage regardless of inflation expectations. If I’m really good at what I do (I once was) I got double-digit increases even though inflation as quite low at the time. I don’t see why an employer would pay more if the reserve army of the unemployed is available, despite inflation.

    Something else going on here to explain this?

    • I think this sentence assumes something like a union or other cartel to somehow prevent the reserve army from coming into play.

      • But I think Esteban’s point still stands, MM: the union will extract the maximum wage it can, irrespective of inflation assumptions.

  2. Going to the Government building at Harvard, or any other school for that matter, might not be the optimum course to find rational, hard core economic theory and discussion. ‘Course going to the Economics nest at most universities is likely be no better.

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