It is often said that Socrates’ wisdom begins with the alleged Athenian insurgents’ knowledge of his own ignorance.
If so, it seems that the current economic crisis of our time has converted Federal Reserve chairman Jerome Powell to the Socratic school. On a summer trip to Sintra, Portugal — an outpost in the wooded hills that once served as a refuge for local royalty and this week hosted a European Central Bank conference — Powell explained what he had learned from the failure of the central bank to foresee the strength and persistence of inflation that now grips the US economy.
“I think we now understand better how little we understand about inflation,” Powell said.
While we welcome this recognition, it is disturbing in two respects. First, it is often said that the Fed has a dual mandate under the law of pursuing stable prices and maximum employment. (A third mandate is there in the same statute, ordering the Fed to pursue moderate interest rates, but everyone ignores it.) So the Fed coming to realize that it doesn’t really understand much about inflation is tantamount to saying that it may not be fit for the job that Congress has assigned it.
The second problem is that the Fed’s commitment to the transient inflation theory wasn’t so disturbing that it was wrong. It was that until late last year, the Fed seemed impervious to arguments and evidence that it was wrong. Socratic knowledge of ignorance is not wisdom itself, but the path to wisdom. What made Socrates believe was his habit of questioning and investigating.
Until the Biden administration decided to blame inflation on Putin’s price hikes, it blamed the rising prices on corporate greed. Many Democrats – especially Sens. Elizabeth Warren of Massachusetts and Bernie Sanders of Vermont – remain attached to the idea that prices are rising because companies somehow use the inflationary environment as an “excuse” to raise prices. Catherine Rampell of the Washington Post has called this the “greed” theory.
If there were any closeness between the theory of greed and reality, we would see corporate profits soar as inflation climbed to a 40-year high this year. Instead, corporate profits fell in the first three months of this year, according to the final reading on gross domestic product for the first quarter published Wednesday. Adjusted for inventory valuation and capital consumption, operating profit declined 2.2 percent in the quarter, down from $63.8 billion.
Inflation tends to drive up corporate profits in the early stages, as rising demand means sales and prices are rising faster than the cost of materials and labour. We are no longer in the early stages of inflation and we see costs depressing profits and high prices depressing sales.
The confidence crash
One of the reasons inflation usually doesn’t boost revenues for very long is that it’s a major drag on consumer confidence. The latest measure for this comes from Gallup, whose Economic Confidence Index plunged 13 points to minus 58 in June, the worst since February 2009, when the economy flattened and the financial system collapsed. Americans view Biden’s economy as a serious crisis.
For the first time since 2009, the majority of Americans describe the economy as bad, Gallup said. Even more striking, 85 percent of Americans say the economy is deteriorating. In a separate poll conducted by the Economist and YouGov said 58 percent of people we’re already in a recession.
Time will tell if we entered a recession in the first half of this year. What we know is that for most Americans it already feels like we’ve done that.