Yellen Wrong on so Many Things

Secretary of the Treasury Janet Yellen has been on a media apology tour admitting that she was wrong last year when she said that inflation is “not a problem,” a “small risk” and “manageable.” Not only was she wrong about inflation, but she was also wrong about other policies. Her inaccuracies have contributed to policies that have made our severe inflation problem worse.

She says she misjudged the inflation threat mostly because of “unanticipated and large shocks to the economy” as well as supply bottlenecks.

That’s not exactly genuine. She knew early last year that the total level of U.S. economic output would be back to the pre-pandemic level by mid-year. That meant although there may be shortages in some markets, the overall supply was the same as before the pandemic. Inflation, then, was primarily caused by excess demand rather than supply issues.

Noting that the Biden administration was about to increase government spending by at least $3 trillion by year-end, after spending $3 trillion to stimulate the economy the prior year, inflationary excess demand was inevitable. And that amount of spending would lead to a total debt that would exceed the debt ceiling.

She was also not right when she said that Congress should remove the debt ceiling. She said that even though Congress has the authority and responsibility for government spending, Congress should not have the power over debt limits.

Her position would make it possible for the government to spend any amount of money that was desired, even the large sums that Yellen says are necessary to avoid the “worst impacts of climate change.” Even though the debt ceiling is almost always raised, when necessary, Congress does need limits and Congress needs to debate the level of debt regularly, which happens when the debt ceiling is raised.

To justify her position that inflation would be temporary, she said that traditional Monetary Theory was outdated. Instead, based on what occurred during the Obama years she argued, that rapid growth in the money supply would not lead to inflation, in spite of what traditional monetary policy said.

This was referred to this as Modern Monetary Theory (MMT). Many economists knew MMT was wrong and would indeed lead to much higher inflation. It turns out the behavior during the Obama years was an anomaly. Rapid money supply growth didn’t lead to inflation because the Dodd-Frank bill reduced the velocity of money.

The parts of Dodd-Frank effecting velocity were, however, repealed in 2018, meaning rapid increases in the money supply would indeed be inflationary.

Then she tried to justify that all of that excess government spending would not be inflationary, by coming up with another modern theory. This time it was the Modern Supply-Side Theory, which is also wrong and led to more inflation.

Supply-side economic theory was developed in the 1980s. The theory said that instead of concentrating government policy on managing demand, policy should be geared toward managing and increasing supply. The increased output would grow the economy and put downward pressure on prices. The theory works well when the economy is experiencing high inflation and/or stagnation. Presidents Reagan in 1982 and Trump in 2018, used this theory. And it worked very well.

Secretary Yellen says that if the government spent more money, demand will initially increase. But if that spending is targeted toward investments, it would eventually lead to more supply, and therefore it would not lead to more inflation. The reality is that the huge increases in government spending will always stimulate demand. When there already is excess demand, the government spending is purely inflationary.

She hinted that she believes the current inflation may be descending. Again, she is wrong. The CPI number for May will be released shortly. It will likely be over 1% for the month. That will take the annual inflation rate to near 9%. The June number will probably be as bad. That means we could see double-digit inflation by late summer.

The Secretary of the Treasury is an important adviser to the President. Secretary Yellen is well qualified, and she has experience as Federal Reserve chair. As such, let’s hope in the future she is right much more than she is wrong.

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