That “theory” has been an unreliable guide over much of the past quarter-century, and so it was again this time. Macroeconomic modeling may work well when relative prices are constant and major changes in the economy revolve around aggregate demand, but not when there are large sectoral changes and concomitant changes in relative prices.
When the post-pandemic inflation started more than two years ago, economists quickly divided into two camps: those who blamed excessive aggregate demand, which they attributed to large recovery packages; and those who argued that the disturbances were transitory and self-correcting. At the time, it was unclear how the pandemic would unfold. Confronted with a novel economic shock, no one could confidently predict just how long it would take for disinflationary forces to appear. Similarly, few anticipated markets’ lack of resilience, or how much temporary monopoly power supply-side disruptions would confer on select firms.
But over the ensuing two years, careful studies of the timing of price increases and the magnitude of aggregate-demand shifts relative to aggregate supply largely discredited the inflation hawks’ aggregate demand “story.” It simply did not account for what had happened. Whatever credibility that story had left, it has now been further eroded by disinflation.
Fortunately for the economy, team transitory was right. Let us hope the economics profession absorbs the right lessons.
Joseph E. Stiglitz, a Nobel laureate in economics and university professor at Columbia University, is a former chief economist of the World Bank (1997-2000), chair of the U.S. President’s Council of Economic Advisers, and co-chair of the High-Level Commission on Carbon Prices. He is co-chair of the Independent Commission for the Reform of International Corporate Taxation and was lead author of the 1995 IPCC Climate Assessment.