When to be humble about inflation forecasts
The old certainties of economics have been shocked into a new reality that requires more deliberation and listening.
One thing is certain about America’s debate over whether harmful inflation is on the horizon in a hot economy: The agency in charge of managing inflation, the Federal Reserve, is very uncertain about what to do. And that may actually be a virtue.
In March, 11 of the top 18 officials in the U.S. central bank were predicting low inflation and thus saw no need to raise interest rates before 2024. By June that flipped: Thirteen of 18 saw a need to raise rates before 2024. Not only is the Fed divided, but its leaders are also in deep deliberation, listening for clues, alert to uncertainties, and willing to shift opinions. They perhaps know that two recent unpredicted shocks – the 2008 global financial crisis and the 2020-21 pandemic – have made economists engage in reflective self-criticism and be less prone to hubristic predictions. In the “dismal” profession of economics, a cautious bias has replaced a confidence bias.
That point was made this week by three prominent experts during an Aspen Institute session and in a recent joint paper. Robert Rubin, a former treasury secretary; Peter Orszag, a former head of the Office of Management and Budget; and Joseph Stiglitz, a Nobel Prize-winning economist – who all differ in ideologies – argue that current economic debates should “be informed by copious amounts of humility, particularly given the role of impossible-to-predict events (including pandemics, wars, and [market] bubbles).”
They contend bad economic and fiscal projections in the past have made a case for humility. Policymakers can no longer hope that their “confidence would itself instill confidence,” as the paper stated. Last year, the United States experienced a rare service-sector downturn. Globalization may now be in reverse. Despite a recession in 2020, household savings went up while credit card debt declined. Uncertainty is pervasive, they say.
They do not argue for policymakers to do nothing. Instead, they warn that traditional top-down “anchors” in economic policies may no longer work. And the Fed’s internal debate over inflation and interest rates reflects this reality. “One of the arguments for humility is that economists have been very bad at forecasting,” said Mr. Stiglitz.
The three do propose a solution. They call it decluttering. Congress should set up “automatic stabilizers” for parts of the economy in which there is little policy disagreement and “we know what works,” such as tying jobless benefits to a recession or triggering road-building projects to boost income. “Stimulus measures, such as state and local aid, should be automatically tied to the state of the economy,” they write.
That would then free up politicians to engage in democratic deliberation over what is truly unusual and needs consensus building. “The uncertainties policymakers face are myriad and deep – not just about the course of interest rates but also about possible global macroeconomic shocks, rapid changes in the geopolitical environment, and climate change. We cannot even ascertain the probabilities of such events.”
True to form, the three admit they may be wrong. “Perhaps the world will turn out to be more certain,” they state. Yet the willingness to self-correct and listen for the deeper currents of change is long overdue. The greatest insights often come from the greatest humility.