Inflation hurts consumers. But the traditional solution to inflation—raising interest rates—also hurts consumers. Is it possible to fight rising prices without making people poorer? Why do politicians and the press alike treat the Federal Reserve as the only game in town? On episode 51 of The Politics of Everything, hosts Laura Marsh and Alex Pareene speak with the macroeconomist Claudia Sahm, the founder of Stay-at-Home Macro Consulting and a former adviser to the White House, about what causes inflation, what’s wrong with how we usually address it, and the kinds of policy that could make a difference.
Alex Pareene: According to the Federal Reserve, the annual rate of inflation in the United States has risen to 8.6 percent, a 40-year high. As Fed Chair Jerome Powell said, many Americans have never experienced anything like this.
Laura Marsh: And they’re deeply concerned about it. Fed research says that consumers expect inflation to remain high for years. A Pew survey from May found 70 percent of respondents viewing inflation as a “very big problem,” albeit with a large and telling partisan split: It’s a major concern for 84 percent of Republicans and 57 percent of Democrats.
Alex: How can regular people have such different experiences of what is supposed to be an objective economic measure? The press often talks about inflation without exploring some pretty basic questions about it. What causes it? How do we measure it? Why does it cause panic in consumers and politicians alike?
Laura: And with the health of the U.S. economy and Democratic control of the U.S. government on the line, what should Joe Biden’s administration do about it? I’m Laura Marsh.
Alex: And I’m Alex Pareene.
Laura: This is The Politics of Everything.
Laura: We’re talking with Claudia Sahm. She’s an economist and founder of Stay-at-Home Macro Consulting. She’s worked at the Federal Reserve and the White House and has advised Congress. Claudia, thanks so much for joining.
Claudia Sahm: Thank you! I’m excited to be here.
Laura: The last period of high inflation ended in the 1980s, and a lot of people, including myself and Alex, haven’t actually lived through a period like that. To start off with, what is inflation and how can we tell it’s happening?
Claudia: Inflation is an increase in prices. The numbers that we hear bandied about in the press are usually about all prices. If the U.S. had one big shopping basket—and rich people get to put more in the shopping basket—inflation is basically what it costs to check out today versus what it cost to check out last month or last year.
Alex: How do they measure the prices?
Claudia: The Bureau of Labor Statistics is the main agency collecting the price data. They have been doing it for decades and decades. An example of the way they do this is they go to the grocery store, they have a certain basket of goods—it’s very detailed—they have a set of stores that they have chosen, they go look at those prices, and they go back a month later and look at those prices again. They spend a lot of time and care making sure that they’re comparing apples to apples. I mean, I’m making a joke there about the grocery store, but it’s really important, because over time there are new things to buy. Like when the iPhone came out: It’s a camera, it can measure things, it has a lot of goods wrapped up into it that normally the Bureau of Labor Statistics would look at separately. They have a lot of challenges in how to measure. What’s very important is that they do it consistently over time. So it’s not a perfect measure, but we can, with a lot of confidence, say inflation is high.
Alex: So we can trust the numbers. They’re going to the store, they’re comparing the price of eggs to what it was last year. We can trust the statistics on this.
Claudia: Yeah. They take their job very seriously. I think sometimes we get a little too excited about, you know, 8.3 versus 8.4. It’s like, come on—nothing is that precise. But it’s the best we have, and it’s good.
Alex: I think we want to get to the causes of this in a little bit, but just talking about the measure: Laura was saying we have no real living memory of a period of high inflation, but over the last few years I have a living memory of the cost of housing and the cost of higher education going up pretty consistently. Why was that not considered inflationary? Why wasn’t that part of the basket of prices?
Claudia: Oh, we could have a long conversation about this. I mean, you’re absolutely right. We do not have a lump of inflation. We all go out and make purchases, and they’re often very different purchases. People who bought their homes decades ago, their cost of living involves paying off mortgages whose rates were set way back then—they’re free and clear. If you are a young adult coming out, starting a family, and need to buy a home, the cost of education and childcare can be eye-popping. There are families that have been dealing with quote-unquote high inflation for years and years. And gas prices go up and down. When you have high inflation, like now, it just means that there’s a lot of stuff that’s going up. That is where it starts touching the lives of more and more people. What that looks like over time—if we look under the hood, and if we’d been looking under the hood for a long time, you would see these problems. But because, again, they affect narrow parts of the population—and then there’s this whole thing called politics—they don’t get addressed.
Laura: Before we get to the current moment of inflation, what, traditionally, are the explanations for what causes inflation?
Claudia: At a very simple level, prices rise when demand is more than supply. That is, if people are able to still buy stuff. Sometimes we have a shortage and you just can’t. But if you’re still able to buy—it’s like, if I’ve got a lot of money and I really want that, well, I’m going to be willing to pay more, and if there’s a lot of me, then prices start going up. Normally, businesses, if they see people really want to buy something, then they go make more of it. They actually make more money if they sell something than by selling less stuff at a higher price. The market is supposed to work its magic. I mean, this is Econ 101. Now, because it’s Econ 101, it can miss subtleties. The last year is obviously an example in many ways of how that hasn’t worked. Consumers came back a lot faster than the stuff they wanted.
Laura: Just to step back for a second, you said it’s when demand is higher than supply. Would it be fair to say there’s a couple reasons that could be? It could be that there’s more demand. It could also be that there’s less supply. Then the other could be that there isn’t actually an imbalance between demand and supply, but companies are gouging because they figured out a way to do that, maybe because they’re monopolies, they’re not regulated.
Claudia: It’s a little tricky because inflation is an increase in prices. Corporations have to have more pricing power for it to go up, and often they have more pricing power when there’s a lot of demand and not much supply. It’s kind of hard to pull it apart. One thing that I think economists miss that people understand is that at the end of the day, businesses set prices. We actually have this thing in macroeconomics called the Calvo fairy. It’s a modeling thing, but basically it’s like this little fairy goes around and changes prices. Sometimes I think we forget that that’s actually not the case. A business is going to decide what the price is and how much to raise the price, and a business will often know, you know, “If I raise the price, will the consumers come or will they go somewhere else?”
Alex: It’s funny, you describe that as sort of a controversial statement in economics, and I guess price setting is this really sort of fundamentally complicated thing that economists have been arguing about for years. On the other hand, I went into a pizza place the other day and there was a guy crossing off the prices and writing 50 cents more for everything. There’s price setting.
Laura: That really happened? In real time?
Alex: Yeah! I saw a guy, he was crossing off all the prices, and everything was now 50 cents more.
Laura: Oh wow.
Claudia: I don’t want to be too irreverent to the models, but it really is the case that businesses set prices. They’re going to decide if prices increase or not, and the consumers are going to decide whether they’re willing to pay the price or not. Somebody who walked into that pizza shop might have turned right around and gone down the corner and eaten pizza there.
Alex: After the break, we’ll talk about what makes this particular moment of inflation unique.
Laura: We’re talking with Claudia Sahm. Claudia, what’s special about this moment? What’s triggered businesses to change their prices recently?
Claudia: What’s special about this moment? Well, it’s like, what isn’t special about this moment?
Laura: Mm-hmm.
Claudia: There are a couple of things, and it affects different businesses differently. Covid-19 was extremely disruptive. We essentially shut a $20 trillion economy down. Early on, consumers stayed home, businesses shut down. It was so hard to imagine what was going to happen next. First of all, businesses laid off workers—millions of workers—really fast. Then a lot of businesses that sell stuff were like, “Wow, there aren’t going to be any consumers for a while.” So many of them canceled orders. Those semiconductors, right? Businesses in early 2020 were like, “There’s nothing here.”
Alex: They were expecting an economic disaster.
Claudia: Yeah. I helped advise on this. I mean, it looked bad, but then as we got further along, things were reopening. This stuff especially became a problem because even if people were still at home, working from home, they needed a new computer for their office; they needed, like, “My dishwasher broke, and the entire family is at home.” Then that ran into the fact that a lot of businesses had stopped their orders. You had customers who wanted things, you had supply in a very unusual way. It wasn’t just that supply wasn’t growing, it was like we were missing supply that we would have had if we hadn’t had Covid. That’s the supply chain disruptions that we hear about. The other place that was really important is, you hear a lot about labor shortages. It took a little longer, but you had people going back to the restaurants, going to the hotel, and a lot of these businesses had a hard time hiring back those workers that they laid off within days. They had to increase pay to get people back, but then you have to pass that cost on. That’s all with Covid. Then Putin invaded Ukraine. There have been so many unusual events. You had this collision of missing a lot of supply and people ready to get back out and spend.
Alex: Sort of unexpected demand, right?
Claudia: The other thing that happened is that about this time a year ago, inflation had started stepping down. For about four months, it stepped down and stepped down. Then we got delta, and then we got omicron. I often say—and I mean it sincerely: Inflation was not transitory, but Covid was not either. Like, we are not out of this. That makes it very hard. If that’s your cause of inflation—the supply—no Federal Reserve interest rate increase is going to fix that problem.
Laura: Let’s get to that. What is the thing that the Federal Reserve can do? What is the tool they have? How would that work? Then maybe we can talk about the things that it can’t do.
Claudia: The Federal Reserve has one tool. It has one tool and two jobs. The tool it has is interest rates. Interest rates, again, are a price. They are, “What does it cost you to buy stuff now instead of later?” If interest rates are high, you could save and not spend, and then you get a little bit more later. The reality is that if interest rates go up, it pushes down spending now. A lot of Americans don’t have savings or a cushion. They have debt. Interest rates go up, they’re spending more money servicing debt; interest rates go up, it’s harder to buy a house, a car. I mean, a kind of crass way to say it is the Fed just makes us poorer, so we spend less. They would never say that. In some ways it’s not their fault. Like, the only tool they have is one that can encourage less spending or, during the recession, more spending.
Alex: You should explain the dual mandate, because you alluded to it.
Claudia: OK. So like I said, the Fed has one tool and two jobs. You can imagine how this is gonna go. Their dual mandate is price stability—
Alex: So no inflation, or limited inflation.
Claudia: Low and stable inflation, which is not what we have right now. Their other mandate is maximum employment. With the price stability they say, “OK, what we think of that is 2 percent inflation using the personal consumption expenditure price index,” which is a little different from the consumer price index. They have a very specific definition. They tell us what data; they tell us what number. Maximum employment, they have this line that is like, “We look at a wide range of indicators. The Federal Reserve cannot determine what max—” They basically punt on this thing. The basic idea is unemployment is low and it’s as low as it can be before we start having inflation.
Laura: So the Fed has these two jobs, and if they raise interest rates, that can typically or traditionally lower inflation, but how does it affect unemployment? This is very confusing to me as someone who knows relatively little about economics. I don’t understand why, when I hear wages are too high or too many people have jobs, how that could be a bad thing.
Claudia: Well first of all, when you hear that, they’re wrong. In the past, just as kind of an empirical regularity—like, just something that happened in the world, is you see a negative relationship: To get inflation down, unemployment has to go up. It’s referred to as the Phillips curve. The thing is, even before the pandemic, when economists looked at this and we tried to take the data and really figure out exactly how much that trade-off is, it had broken down. But you know, the logic is there. How does the logic work? Remember the Fed is raising interest rates just to cool off demand. It doesn’t necessarily want us to buy less. It’s just like, “Chill out just a little bit.” If that works, and interest rates convince people to say, “I’m just going to hold off. I’m going to wait, not going to buy as much,” then that means they’re not going in the store as much. Well, if a business has fewer and fewer customers, they don’t need all these employees. That’s where less spending leads to less revenues for businesses. That means employers need less people, or at least workers don’t have the bargaining power to get better stuff, and that means those workers spend less money. You get a kind of spiral going, we call it a multiplier—macroeconomists should not be allowed to name anything—but that’s kind of what the Fed needs.
Alex: It’s all sort of described with what I would say is very dry terminology, but there are people who argue—I don’t think you argue this—that the Fed needs to cool off the economy. They actually mean, “Make people poorer so that inflation gets better.” Is that what they actually are arguing for?
Claudia: Yeah. One of my many frustrations right now is acting like the Fed is the only game in town.
Alex: I was going to ask that.
Claudia: The much more supportive way, compassionate way, is to increase supply. Inflation is a problem, but we could solve the problem in a way that’s a win-win. Policymakers and then advisers like me have this tendency to be like, “The Fed fights inflation.” It’s like, “Hi, you—Congress and the White House—have actually a lot more tools, and you have the tools to increase supply. So please, let’s spend less time yelling at the Fed for either doing too much or not doing enough, and oh, ‘We need a recession,’ and blah, blah, blah.” It’s like, “No, actually we don’t need those things. Congress in the White House could do a lot.”
Alex: Yeah.
Laura: You mentioned also that the tool the Fed has isn’t sufficient to fight what’s causing inflation right now, because gas prices are a big part of this and also the price of goods. What’s the worst-case scenario if we don’t tackle those issues separately and the Fed still goes ahead with using the one tool that it has?
Claudia: It’s like, “Be careful what you wish for.” The Fed can get inflation down regardless of what it is. J. Powell cannot print oil. He cannot print wheat. The Fed can’t increase supply, but they can bring down demand—and they can bring it down a lot if they need to. Back in the early ’80s glory days or whatever, inflation had been high for a decade. Paul Volcker was the Fed chair at that point; that Federal Reserve engineered, intentionally, a deep recession. So the Fed can do it. If we ask them to go it alone, and we don’t finally get some things to break our way—like in terms of Covid—then it’s going to be very hard. But it’s different than the 1970s. This Fed is not going to cause a recession intentionally. I mean, we’ve had a year of high inflation. This is not like a five-alarm fire right now.
Alex: I think the politicians and policymakers will, it feels like, almost praise the independence of the Fed and ask it to tame inflation … as a way for not having to take any difficult steps of their own to address these complicated problems.
Claudia: The chair of the federal reserve, J. Powell goes—all federal reserve chairs go—twice a year to Congress: the Senate and the House. This morning he was testifying in the Senate. I watched about a half an hour of it, and I logged off because I was so angry. Half of the senators were like, “Fed, you’re not doing enough to fight inflation,” and then the other half were like, “If you do too much you’re going to cause a recession.” I’m listening to this, and I’m like, “If you adjourned and went off and worked on some legislation…”
Alex: You guys could get together and write a bill or two.
Claudia: Wouldn’t energy policy be neat right now?
Laura: Well, where does this idea come from, of just leaving it to the Fed? What’s the rationale for that?
Claudia: The conventional wisdom—particularly after Paul Volker, who was put on a pedestal: “He was the bravest Fed chair, he beat inflation”—was like, “Oh, see, the Fed can do this.” Over time it got to the point where it was like, the Fed alone should do this. But housing was really expensive and a problem before the crisis. Congress back in the day could have been building housing. Maybe that would’ve made the Fed’s problems easier. You know, I have a lot of respect for members of Congress—they are elected, they have a hard job, the White House also—but my impression was that many policymakers don’t really understand the Fed.
Alex: Mm-hmm.
Claudia: This idea that like, “Oh, the Fed fights inflation; the Fed can take care of this”—it’s like, “Yeah, but you could make it better.” I think because high inflation hasn’t happened for so long, the skill set has atrophied.
Alex: No one’s had to figure out anti-inflation policy for many years, so they just kind of think that that’s the Fed’s job, not theirs.
Laura: We’ve talked about how the Fed can’t do this on their own. What could Congress do to help them?
Claudia: There is a long list. One that has a particular urgency would be energy policy. The price of gasoline has doubled since before the pandemic, and it has risen $1.50 in the last three months since Putin invaded Ukraine. That is a massive change in a very short period of time. That creates a lot of hardship. There is an opportunity for Congress to come together and pass energy legislation. The thing that will bring down gas prices is either an increase in the supply of gas or a decrease in the demand for gas. You know, a proposal from President Biden is supposedly on its way to repeal the federal gas tax. So, have a gas tax holiday. That, you know, mechanically should bring down the price at the pump. Maybe not the whole amount. Unfortunately, when you bring a price down, you create more demand.
Alex: More demand for it, yeah.
Claudia: Right. People’s demand for gas is much more stable than a lot of things. Nobody’s like, “Oh the price of gas is down, I’m gonna drive to work twice.” But you know, I’ve been talking with a lot of people—wonks—and really the only way to get more supply is to work with oil producers. Like, we have to refill the strategic petroleum reserve. You could give options to producers and say, “When we go to fill that, we guarantee we’ll buy back your oil at a certain dollar amount.” There are things that you could do to increase supply. Then, decreasing demand: The one I think would be so simple is, we saw during Covid, actually, a big decrease in the use of gas. In part that was from us all being sent home to work. Now people are going back, and so you’re seeing the gas demand get to what it was before. It’s like, just say work from home for all federal government workers; corporations work from home. I mean, this would actually be a popular way.
Alex: I think this gets to what you’re saying about politicians not having any experience with inflation. It does seem like there’s a ton of ways they could reduce demand without making it seem like a punishment for people: Encourage a four-day workweek, encourage hybrid work from home, subsidize electric vehicles for people. There are all sorts of things they could be doing for this one specific thing, but it does seem like they’re not thinking that creatively.
Claudia: I had the opportunity to speak before a large group of House Democrats in March, right after Putin invaded. I told them, “You need to move heaven and earth to get gas prices down.” Not only is the politics outrageously bad for them, but it’s a hardship. Lower-income people spend more of their income on gas—it’s one of these quote-unquote regressive taxes. You need to do something, and calling it the Putin price hike, well, I agree with that—the $1.50 in three months, it’s clear where that’s coming from—but people can’t fill the tank with patriotic, warm fuzzies. There’s been this big delay; I don’t understand why. I can be very frustrated with other policy advisers like myself. Many people are like, “Oh, this wouldn’t work, it wouldn’t be the full amount.” It’s fine to be critical of a policy—nothing is perfect—but like, what’s your better idea? Because doing nothing is really the worst thing, because people are suffering.
Alex: Claudia Sahm, thank you so much for joining us today.
Claudia: That was so cheerful.
Alex: I know, I know…
Alex: The Politics of Everything is co-produced by Talkhouse.
Laura: Emily Cooke is our executive producer.
Alex: Myron Kaplan is our audio editor.
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Alex: Thanks for listening.
