Economic Overheating Worries Overblown

In just the past few days numerous analysts have opined on the risk of overheating from aggressively easy monetary and fiscal policy continuing even as the pandemic drag abates.  This overheating could, the story goes, lead to an acceleration of inflation.  The worry is misplaced.  

The concern is an artifact of faulty economic theory.  Growth that is “too fast” causes inflation.  No, it doesn’t.  

To understand why, recall the observations we made in our last post, Financial Media Discovers Inflation.  Conventional inflation measures, narrowly focused on domestic consumer prices, lag actual inflation.  The expectation that we will first experience a surge in real GDP, followed by a surge in inflation, simply results from measuring inflation with a lag.  Since real GDP is calculated by measuring nominal GDP and then backing out inflation, the understatement in the early inflation measurement results in an overstatement of real GDP.  Then as inflation filters into lagging measures, it’s recognized as such.  This leads to the fallacy that the early growth in real GDP played some causal role in the following inflation.

What actually happened:  The inflation was there all along.  It was not caused by “the economy running too hot”.  It was caused directly by the aggressive monetary and fiscal policy.

One thought on “Economic Overheating Worries Overblown

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