No, Americans Are Not Completely Stupid About Inflation

Stefanie Stantcheva was 11 years old in 1997 when annual inflation in Bulgaria, the country from which she and her family had emigrated, surpassed 2,000 percent. “The episode helped shape her eventual decision to study economics,” according to a profile in the International Monetary Fund’s Finance & Development magazine.

Inflation and how people perceive it still fascinate Stantcheva, now a professor of political economy at Harvard and the founder and director of its Social Economics Lab. This year she released a pair of papers on the topic, the first about why people dislike inflation and the second, with a pair of co-authors, about how they understand it.

The two papers’ bottom line is that people dislike inflation much more than one would expect from a textbook economic framework and that their understanding of it is likewise at odds with what we’re taught in Econ 101.

Some people will take this as evidence that ordinary Americans are simply wrong. “The first lesson you learn as a pollster is that people are stupid,” Tom Jensen of Public Policy Polling, a Democratic polling firm, told Politico in 2012, presumably in a moment of frustration.

That’s not Stantcheva’s attitude. “My conclusion is that this is people’s lived experience,” she told me.

I’ll take it one step further. I think in some cases, the people Stantcheva surveyed for her papers might be closer to the mark about inflation than the textbooks, which themselves don’t reflect the latest thinking in the profession.

For example, Stantcheva wrote, “There also appears to be a widespread belief that managing inflation does not require significant trade-offs, such as reducing economic activity or increasing unemployment.”

The public’s disbelief in trade-offs goes against the conventional wisdom that the way to squelch inflation is for the central bank to raise interest rates enough to choke off business investment and consumer spending, thereby reducing the demand for goods and services so prices stop rising. In a 2022 speech, Larry Summers, the former Treasury secretary, said it would take “two years of 7.5 percent unemployment or five years of 6 percent unemployment or one year of 10 percent unemployment” to contain inflation.

But what if inflation could be reduced without throwing lots of people out of work? Wouldn’t that be better? Actually, that’s what’s been happening. Inflation has fallen to not far above the Fed’s 2 percent target, from a peak of 9 percent in 2022, while the unemployment rate has remained below 4 percent.

A key reason for the success is that people believed that the surge in inflation was transitory. They were mostly right. Inflation lasted longer than the optimists hoped but went away more quickly than pessimists such as Summers feared.

Inflation is partly a failure of coordination. Everybody raises prices (for products, for their labor) to compensate for other people’s raising their prices. The upward spiral is disorienting. Stantcheva found that the thing people hate most about inflation is how it complicates their lives: “It’s harder to fit stuff in your budget. And it just requires a constant rethinking, re-budgeting, as prices keep changing.”

The Fed fixes the coordination failure by getting all the players to coalesce around a slow, predictable pace of price growth. If the Fed’s credibility regarding its inflation target is strong enough, it can achieve that coordination without inducing a recession. President John F. Kennedy achieved the same effect in 1962 when he jawboned against a steel price increase that he thought was unjustified.

The public “has it right” in believing that bringing inflation down doesn’t have to cost jobs, Laurence Kotlikoff, an economist at Boston University, told me.

True, this all depends on the government’s credibility. The Fed under its chair, Jerome Powell, is keeping rates high now — despite the risk to growth — to prove beyond any doubt that it can and will reach its inflation target. Whether it’s overdoing things is a question for another time.

I do think Stantcheva’s respondents are simply wrong in some of their other beliefs about inflation. For example, she found that many attributed price increases to inflation, but the offsetting wage increases to their own hard work and excellence. Nearly half said inflation was high prices, when it’s actually the change in prices. (If prices rise but then level off for a year, annual inflation is zero.)

According to Stantcheva, a lot of people think that high interest rates worsen inflation, which of course is the opposite of orthodoxy at the Fed. There’s a grain of truth there, in that a rise in interest payments hits the bank account just as surely as a rise in food prices. As I’ve written, the government excludes interest from the Consumer Price Index on the grounds that interest isn’t consumed, like apples. It’s the price you pay to consume now instead of later.

But I can’t go along with the consequent theory that lowering the interest rate would lower inflation. That’s what Turkey’s central bank tried, with disastrous results, under President Recep Tayyip Erdogan.

I asked Stantcheva what her findings on public opinion imply for government policy. She demurred: “Policymakers should know what people’s preferences are. This is not our job as economists. This is a policymaker task from here on.”

Elsewhere: Uber Drivers Consider Outside Options

Economists connected with Uber Technologies have found that raising fares doesn’t raise drivers’ hourly earnings over the long run. The reason: Drivers respond to the higher fares by spending more time available for rides. So they make more money per ride, but no more per hour spent on the platform. Also working against them is that higher fares decrease usage.

The three authors — Jonathan Hall and Daniel Knoepfle, both of Uber, and John Horton, of M.I.T., whose wife is a former Uber employee — said their 2023 working paper on the topic is solely their work and was not reviewed by the company before it was released. Hall, Uber’s chief economist, wrote to me last week that drivers for Uber appear to increase or decrease their time on the platform based on how much they can earn on it versus other opportunities they have. “We think this is strong evidence that an outside labor market option is the primary determinant of drivers’ hourly earnings,” he wrote.

Quote of the Day

“Either the United States will destroy ignorance or ignorance will destroy the United States.”

— W.E.B. Du Bois, Niagara Movement Speech (1905)