Stanford economists pin runaway inflation on government, expect more pain on the horizon

Sept. 4, 2022, 7:44 p.m.

Inflation reached a four-decade high of 9.1% in June, prompting outcries from politicians, economists and students alike. Since then, the torrid pace of inflation has cooled, raising questions as to whether inflation will last or gradually fizzle out. Driven by a mix of pandemic supply constraints and skyrocketing consumer demand, inflation has had a significant impact on students, both through increased costs in daily purchases and consequences for tuition and student loans.

To learn more about inflation, The Daily spoke to three Stanford economists. John Cochrane is a Senior Fellow at the Hoover Institution and author of the Grumpy Economist blog. John B. Taylor Ph.D. ’73 is an economics professor, a former member of the President’s Council of Economic Advisors, and a former Under Secretary of the Treasury. Caroline Hoxby is an economics professor and program director of the Economics of Education Program for the National Bureau of Economic Research.

Inflation exploded in the last year, but price increases seem to have stalled in recent months. Do you expect inflation to be a prolonged multi-year phenomenon or do you believe it will continue to subside?

According to Cochrane, there’s no scientific way of knowing, given several factors that could shape inflation. “The government could blow another $5 trillion, there could be a new war, or the Fed could hiccup, all of which would change inflation.”

Taylor said “the Federal Reserve is still behind the curve,” with an interest rate under 3% despite the much higher inflation rate, currently 8.5%. “If the Fed moves a little more, it could subside over time.”

While there is potential for inflation to decrease, Cochrane anticipated that there would be “several years of fading inflation.”

How will inflation affect students?

“Inflation is a real problem for anyone on a fixed budget,” Hoxby wrote to The Daily. Students are no exception to this, she said, especially given that many students don’t earn income.

Inflation could also impact college tuition and increase the costs of student loans. Some colleges hiked tuition as much as 5%, CNBC reported in July. 

According to Taylor, tuition increases depend on universities’ expectations for inflation. “If universities expect inflation to persist, there will be an increase in the cost of resources and, correspondingly, an increase in tuition,” Taylor said. “But if an inflation spiral is brought under control, the change will not be especially significant.”

Cochrane said relative inflation will more significantly affect students. An issue only arises if tuition increases faster than parents’ or students’ salaries, he explained. 

However, Hoxby cautions against an excessive response to inflation. “Students have, in the past, often focused too much on the short term, including near-term inflation.”

“Since a person’s immediate expenses or first wage after graduation are not at all indicative of lifetime earnings or wealth, it is not smart to base one’s decisions on short-term indicators like inflation,” Hoxby wrote. Hoxby said she instead recommends students consider long-term indicators, such as the potential return on investment on a college education, to make financial decisions.

What impact, if any, will the Inflation Reduction Act of 2022 have on inflation?

The “humorously labeled” Inflation Reduction Act will have little to no impact on inflation, Cochrane said. 

If you could change one government policy to address inflation, what would you do?

One of the best antidotes to inflation is aligning economy-wide expectations of the Fed with the reality of their actions, Taylor said.

“If the Fed follows a known strategy, like the Taylor Rule, people can anticipate their actions, which minimizes the damage. And if the Fed followed a more systematic approach, it could’ve increased interest rates earlier, as many economists argued they should have,” Taylor said. The Taylor rule, created by Taylor, is an equation linking the Federal Reserve’s benchmark interest rate to levels of inflation and economic growth, used as a rough guide for monetary policy.

Cochrane was critical of the federal government’s fiscal policy. “The long-term problem is that the government is spending 5% of GDP more than it takes in, year in and year out, especially with rising costs from Social Security and Medicare,” Cochrane said. “The centerpiece of the solution involves fostering growth-oriented policies so that we do not inflate away our debt.” 

This solution lies in “innovation, productivity growth, and creating new things,” Cochrane said. 

For Cochrane, the issue of long-term growth, or lack thereof, is a more pressing issue than inflation today: “Around the year 2000, our growth rate cut in half. In a bad recession, GDP might fall 5% and come back. If long-run growth is cut, you lose a decade’s worth of growth and it’s lost forever,” Cochrane said. “Inflation is a mosquito bite, and long-run growth is a heart attack.”

Are we in a recession today? If not, will we face a recession in the near future?

Based on the standard definition — two consecutive quarters of negative growth — we are currently in a recession, Taylor said. However, the National Bureau of Economic Research has not yet declared a recession, he said. 

Formal definitions aside, we may face a downturn in the near future, Cochrane said. 

To counter inflation, the Fed raises interest rates, which makes it harder for people to spend money, Cochrane said. Typically, this process causes a recession, he said.

What lessons can future policymakers draw from inflation today?

“Don’t get behind the curve and wait this long to raise interest rates,” Taylor said.

“Once we’re at our supply limit, and the economy just can’t produce anymore, don’t throw more money at the problem,” Cochrane said. “If you’re going to throw $5 trillion out the window, you’re going to get inflation.”

Is there anything else that Stanford students should know about inflation?

“Incentives matter,” Cochrane said. “If you don’t consider incentives, you get unintended consequences, like what we have now.”

“There are many viewpoints on this subject but the key thing is to look at history and other countries,” Taylor said. “Think about monetary policy as a global issue, and take economics.”

Karsen Wahal ’25 is a writer from Arizona. He’s interested in studying economics and political science. Contact Karsen at news 'at' stanforddaily.com.

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