Economics Needs a New Approach to Inflation

Four years have passed since the COVID-19 pandemic’s inflation in the wake of the American economy’s reopening hit its peak, and the American business cycle is today in a strange way. Wanting to slow the rise in prices that accompanied the reopening and construction boom, the Biden administration and the Federal Reserve cut social spending and raised interest rates. Nonresidential construction has been falling since late 2023. Residential construction investment collapsed in early 2023, then rose briefly in 2024, but has been falling for over a year now. As the unemployment rate crept up slowly throughout the second half of the Biden administration, economists and journalists consistently warned of the risk of a recession. Yet despite falling construction spending and creeping unemployment, the recession never came.

Instead, nearly two years into a change in management, the American economy in the summer of 2026 was again seeing accelerating inflation. Having fallen from 9 to 3 percent during the Biden administration and stabilizing below that through the presidential election and the chaos of the new tariffs of “Liberation Day,” the annual rate of the change of the Consumer Price Index (CPI), the monthly report most commonly used to measure inflation, rose from 2.4 percent in February to 4.2 percent in May. Driven by petroleum products — motor fuel, fuel oil, and natural gas, primarily — the course of prices has closely followed the Iran war: slowing considerably with news of the sixty-day Memorandum of Understanding in June and July.

The August inflation report, released September 11, maintains this brisker pace of 3.4 percent. With all eyes in finance waiting to see what action the Federal Reserve takes in response, the news reinforces expectations for an increase in short-term interest rates at its policy meeting next week. Data center construction has been propping up the construction industry, and that has rested on a credit boom that may become more difficult to roll over if interest rates increase further. While the stock market continues to boom, as last year’s top-end and corporate tax cuts leave more money for the wealthy to invest speculatively, median wage growth has fallen so far that even the 3.4 and 3.3 percent inflation of recent months means workers’ income is falling in real terms.

“The biggest worry,” explains the Wall Street Journal, “is that current, elevated inflation levels could work their way into people’s inflation expectations — which can in turn affect future inflation.” This is because, according to the conventional wisdom, higher prices threaten higher wages. “If workers believe inflation will remain high,” the Journal continues, “they can push for wage increases beyond the price increases they have already seen.” If the Federal Reserve raises interest rates next week, the official justification will be to stop such a wage-price spiral from turning.

Why has the Federal Reserve become the institution to which presidents, Congress, businessmen, and journalists instinctively turn when considering what to do about inflation? Last year, two economists offered a rather startling answer. As Mark Blyth and Nicolò Fraccaroli explain in Inflation: A Guide for Users and Losers, the academic economics profession has since the 1970s constructed a self-congratulatory delusion about the role of central bank inflation targeting and central bank independence. “[O]ur underlying theories of inflation are quite fragile,” they explain, resting less on rigorous science than on partisan humanities — namely, history. And it is precisely to mask this fragile intellectual foundation on which “the field as a whole not only agrees . . . but upon which it bases many of its core concepts and hence its authority claims” that the intellectual politics of inflation have become so closed with its return since the coronavirus pandemic.

Good, Bad, and Ugly Inflation

While these conclusions may not come as a surprise to those who came of age during the Great Recession, the publication last year of this short, earnest, and plaintive but restrained book is worth considering not only for its argument but for the identity of its authors. Fraccaroli is an economist at the World Bank, one of the two international financial organizations, along with the International Monetary Fund, created after World War II to govern international finance and development. He is also a visiting professor at Brown, where Blyth is a professor of international economics.

The authors have their feet in the worlds of mainstream academic macro-finance, understand that economics is the “language of power” that “sets the field of play for everyone else,” and are therefore concerned that “the ideas of the 1970s and the institutions that they spawned in the ’80s that were supposed to safeguard us against inflation” — independent central banks with inflation targets — “nstead made us more vulnerable to its return.”

In making this argument, they have to cover a lot of ground, and the speed with which they do so may diminish the force of what they are saying. What should land with the impact of a meteorite is obscured by the orbit required to survey the landscape of “mainstream” consensus on inflation and inflation policy: what is measured and how; how economists theorize and conjecture about the relationship among measured variables; how central the unmeasurable variables have become to the consensus; and how governments and business typically interpret and react to those measurements.

About half the book is made up of this background material. To establish that there are “different kinds of inflation,” Blyth and Fraccaroli employ the spaghetti western terminology of Fabio Panetta, the governor of the Bank of Italy: “the good, the bad, and the ugly.”

“Good” inflation is where “wages, in theory at least, rise in line with workers’ productivity” — around 2 percent, though some have advocated for 3 — and “even if prices increase, wages are catching up, and people can afford the same amount of goods, if not more.”

“Bad” inflation is a onetime jump in prices, kicked off usually by some single-industry or country problem: Ukrainian wheat and Russian oil getting cut off in 2022, for example, before Brazilian and Persian Gulf supplies could meet the higher price level.

“Ugly” inflation is when “prices and wages push each other upward in a cycle,” and the “bad” inflation kicks into a self-sustaining race between companies, workers, households, and investors to stay ahead of the game.

Such distinctions are tolerated within the mainstream. Nobody disputed that there were different kinds of inflation in Washington in 2021: the debate within the mainstream was whether the bad inflation that began that year would turn ugly without austerity and interest rate hikes — whether it was “transitory.” What economists disagree about is how a bad inflation turns ugly.

Arguing the point requires what Blyth and Fraccaroli call “inflation storytelling,” the narratives constructed to explain causal relationships in the price system. For “team transitory,” during the pandemic inflation, the story was that the price level rise was a one-off event. “Let markets work” was a common refrain of progressive economists opposed to Federal Reserve interest rate increases in late 2021: having jumped from 1.3 to 6.2 percent in the first ten months of 2021, the inflation would slow and come down as supply caught up to demand on its own. In the terms of economic theory, inflation “expectations” remained “anchored.”

“Team permanent,” their intellectual opponents both within the White House and among its partisan enemies, told different stories: excessive government spending from the Coronavirus Aid, Relief, and Economic Security (CARES) Act and the American Rescue Plan was raising household spending or creating a disincentive to work, reducing supply; too-tight labor markets from lockdowns, or lazy or greedy workers, were pushing wages up too far, too fast. In economic theory terms, “expectations” were becoming “de-anchored.” The ease with which national broadcast media slipped into the “labor shortage” hysteria of late 2021 and 2022, as the inflation accelerated, demonstrated the stakes of these narratives. The failure of the 2021–22 Congress to pass a budget for the administration’s first full fiscal year until ten months after it began demonstrated their effectiveness.

Missing from this account of the Joe Biden years is what most people actually believed. Blyth and Fraccaroli cite a May 2022 survey from Deloitte that found 60 percent of Americans thought “companies are taking advantage” of the pandemic “by raising prices beyond their own rising operating costs in an attempt to increase profit.” While economists and journalists disagreed among themselves about whether or when the Federal Reserve should raise rates, they agreed almost unanimously that this was wrong.

Blyth and Fraccaroli rely heavily on the example of Isabella Weber, the professor of economics at the University of Massachusetts-Amherst, who argued in late 2021 that the reason the inflation had not subsided was the expansion of corporate profits, particularly in monopolistic industries. Controversy ensued. The existence of the Deloitte survey is itself an artifact of how profoundly challenging the perspective was to what those who control major corporations were willing to countenance: six months after the Guardian published Weber’s infamous opinion, the world’s largest accounting firm, itself a key multinational corporation organizing the informational lifeblood of capitalism, felt compelled to test the popularity of the idea. They found that what a majority of people believed squared with Weber’s contention.

Even though this is the story “that intuitively most people think is right,” Blyth and Fraccaroli note how “economists hate it with a strange passion.” The reason for that is not obvious from the perspective of economic theory. While orthodox price theory holds that in a competitive market, a ceiling on price will prevent the expansion of supply, resulting in shortages, nearly a century of research on “imperfect competition” and “oligopoly” has demonstrated what anyone in America knows about corporate competition: most industries have a few key players that drive what the industry as a whole is doing.

Whether like oil refining, in which “[o]ne firm leads the price increase, and the others follow,” or the much more common “market structure of oligopoly, in which a handful of firms can set prices above marginal cost, but only if they cooperate with each other,” pricing arrangements in which sellers have a degree of discretion over profit margins exist across the range of real-world market structures.

The relevance of this fact for theories of inflation is not that corporate pricing power can kick off inflation. Usually, the risk of losing market share prevents this. Rather, the existence of “imperfect” or “monopolistic” competition means that when a bad inflation does occur, owing to a natural disaster or war or other “supply shock,” it can become a pretext for the kinds of collective action among corporations that would not normally be possible. The resulting price rise in some parts of the economy becomes rising costs for others, and it is in that moment that businesses can act together to raise the general level of prices.

As Blyth and Fraccaroli explain the logic resuscitated in the work of Weber and her colleague Evan Wasner, “price gouging may not be the fundamental cause of inflation, but once inflation gets going it’s arguably a large part of what keeps it going.”

Demonstrating the relevance of the point to inflation theory, they cite one survey of retail corporation earnings calls from late 2021 as finding that 56 percent of companies admitted to shareholders “that inflation gave them the ability to raise prices far beyond what they would have needed to offset higher production costs.”

If you think profits play a role in inflation, Blyth and Fraccaroli write, then the reason “inflation is higher in the United States than in Europe [is] simply because the American economy is more concentrated, and a handful of firms in critical sectors can set prices because they don’t face significant competition and the government does not enforce antitrust laws.”

The reason this occurs is because “those firms are critical funders of those hugely expensive US elections that elect the folks who regulate these firms.” Diagnosing the nexus of government and business power as the cause of inflation is not likely to be popular among those who hold power, and those who speak on their behalf have adjusted accordingly.

The Macroeconomic Consensus on Inflation Is Wrong

Arguing for the profit-push theory of the covid inflation, however, is not the primary purpose of Inflation: A Guide for Losers and Users. As the self-effacing title hints, the goal is to understand why, even though the evidence for it is “actually quite plentiful,” the profit-push theory of inflation “is always contested by mainstream economists.”

The taboo rests on where “storytelling” departs from social science. All four of the types of inflation stories they catalog — excess demand, excessive wage increases, supply shocks, and corporate profits — draw from different combinations of scientific work. But only one of these stories, the story of corporate profits, is met by mainstream economics as a challenge to “both the field and its members’ claim to authority.”

This is because the corporate profits story challenges the theory at the basis of the academic consensus. The “transitory” debate in Washington ultimately turned on the theory of “anchored expectations,” the idea that workers would not continue to demand double-digit wage increases, and companies would stop raising prices, because all knew the inflation would ultimately end. For “team permanent,” stories about excess demand,” a change in the “Phillips curve” (the relationship of inflation and unemployment), or even “the money supply” likewise rested on the theory of “de-anchored expectations,” the idea that the wage-price spiral would continue to turn, because nobody believed it would stop. The disagreement was not about how inflation worked but whether or not “expectations” were becoming “de-anchored.”

It is the theory of expectations that economists ultimately rely on to make the case that central banks can control the level of inflation. Indeed, the experience of the pandemic disproved every other mainstream inflation theory. While the historical record shows that central banks raising interest rates has coincided with the end of inflationary business cycle booms, that experience and almost every theory purporting to explain it all rest on higher interest rates causing a recession. But despite aggressive rate increases in 2022 and 2023, the US economy boomed, employment increased rather than decreased, while inflation in the United States came down from 8 percent to 3 percent.

“To the extent there is a debate in the mainstream,” Blyth and Fraccoli write, “the question is not really about whether the medicine works but how high the dosage should be.” The recessionless disinflation should be understood as a profound challenge to this assumption of economic policy. It is “disconfirming information” that should force scientific minds to “accept that there is something wrong with the underlying theory.”

Instead, the “mainstream response” has been to “praise the Fed.” Why? While the authority of macroeconomics has traditionally rested, like most sciences, on its predictive powers, Blyth and Fraccaroli note how economics has largely surrendered its warrant for prediction since “the failure to foresee the 2008 financial crisis” and the “support for austerity policies after the financial crisis” that resulted in the Great Recession. They also note how “circular” any theory of expectations is: those expectations can only be known by whether inflation is rising or falling.

Where does the authority of an increasingly closed and demonstrably unpopular macroeconomic consensus come from, then? Blyth and Fraccaroli come to the conclusion that it no longer rests on scientific claims at all, but rather an interpretation of history.

In the United States, that interpretation centers on the Vietnam War, the Arab-Israeli war of 1973, and the Iranian Revolution — what economists, following lay readers, lump together as “the 1970s.” “All academic fields rest upon official histories that tell them how they got to where they are today and why they think the way they do,” they write. The official history of academic macroeconomics is that an excess demand from the Vietnam War and the Great Society brought unemployment too low, empowering workers to demand too much, with inflation spiraling out of control just when the Nixon administration took the leap so controversial to conservative economists of imposing wage and price controls.

In the theoretical language of the field, the inflation of the 1970s persisted because “inflation expectations became de-anchored,” meaning that between 1965 and 1982, the price level in the United States tripled because the American public began to expect it to. The inflation ended with the restructuring Volcker Shock and Reagan recession, because with widespread suffering, the American public stopped expecting prices to rise.

It is this interpretation of history that economists cite as their bulwark evidence for the theory of expectations that guides inflation policy today. In a remarkably refreshing survey of the politics of the Nixon administration, Blyth and Fraccaroli challenge the official history of the 1970s inflation. “[W]hen we look closely at Nixon’s price controls,” they write, “it is really difficult to conclusively call them a failure.”

After all, the controls were mandatory only through the 1972 election, after which the opening act of Richard Nixon’s second term was to declare a “Phase III” of the program in which they became voluntary. Given the opportunity “to make up for all the profits and wages they had forgone in the two prior years,” corporations “hiked prices well beyond the guideposts” in 1973. This was ten months before the Arab oil embargo accelerated the inflation further. “But the damage was done, as was the credibility of price controls as a tool to fight inflation.”

While historians of the United States have known this, few have felt the ability to draw judgements from it to challenge conventional economic theory. Not so Blyth and Fraccaroli: “With hindsight, one could argue that the mistake Nixon made was to declare victory too early.”

The implications of this interpretation are profound for macroeconomics.

“We use interest rates to regulate the economy,” Blyth and Fraccaroli explain, “not because they are the ideal controls, but because in the 1980s we gave up on regulating the level of prices through fiscal means such as price controls, credit limits, and other such devices.”

That resignation was driven by a “single-minded fixation on the inflation of the 1970s as being caused by the de-anchoring of agents’ expectations,” with the result that “the institutions we built in the 1980s and ’90s to control inflation,” namely “independent central banks with inflation targets,” were designed with only one theory in mind. Having decided on a solution, the mainstream of the economics profession worked backward toward a theory — the theory of expectations. “Once one understanding of a problem becomes dominant,” Blyth and Fraccaroli write, “the policy apparatus designed to respond to it can respond only in that same way.”

The Anti-Inflation Playbook Is Wrong

If the “premises” of economic policy “are wrong,” Blyth and Fraccaroli note, “then not only can inflation happen, but the standard policy playbook for fighting inflation will not work. Indeed, it will actively do harm, at least to the many.” Inflation has returned. What will the government, the economics profession that advises them, and the media that draws on economists’ arguments do?

Blyth and Fraccaroli’s mission in this context, however noble, appears quixotic. Why would an economics profession entranced by the delusive force of the “disinflationary magic” of expectations consider their challenge? As they note, more than reducing inflation, the point of raising interest rates during an inflation is to protect the wealthy whose income from securities can always rise with bond yields. This fact alone challenges the very concept of central bank independence, as they note, citing research from the Peterson Institute’s Adam Posen that whether an ostensibly independent central bank actually raises interest rates depends more on whether or not that country’s banking system is profiting from inflation.

During the era of US wars in Korea and Vietnam, American economists likewise distinguished between kinds of inflation. Rather than “good,” “bad,” or “ugly,” they described inflation in an equestrian metaphor: it was “creeping,” “trotting,” or “galloping.” There was no question then whether a creeping inflation was, just like its faster varieties, also caused by a wage-price spiral. The important difference mid-century economists saw was not between theoretical causes but how fast the spiral was turning. The key to slowing a galloping inflation into a “trot,” as a generation of economists formed in the era of government profit studies and nationwide union wage-setting learned, was to find players to the game capable of exercising restraint and persuading them into doing so — or using the government to compel them.

Unlike the theory of expectations, the explanation behind this story is one of power. A bad inflation turns ugly when organized parts of the economy try to raise their income over their costs. The reason the pandemic inflation stabilized was not because the Federal Reserve raised interest rates and “anchored” workers’ expectations, but rather because US workers are not organized in a way that would allow them to keep raising wages. We are unaccustomed to seeing the inflationary process as an economic struggle requiring a conscious truce, whether negotiated or imposed, because so many of us are no longer players to the game.

In some sense, the economics profession as a whole has missed the moment. While so much vitriolic ink was spilled in 2021 and 2022 over whether it was appropriate for the president of the United States to acknowledge the role of corporate profits in driving the rising prices of that expansion, today the president simply says consumers are being “gouged” by “the big Oil Companies.” Already, in June, the president instructed the Department of Justice to investigate profiteering among oil refiners, whose margins have grown from between $15 and $20 for each barrel of oil in February to between $67 and $73 today — a 400 to 450 percent increase. (During the Biden inflation, refinery margins peaked around $55–$60 for only three months, less than half the time they’ve been elevated this year.) On September 1, he met with executives from Chevron, Valero, Marathon, and other refinery owners to discuss how to stabilize the price of gasoline and diesel. The right to set prices, what Blyth and Fraccaroli call the “most central of capitalist freedoms,” is already being challenged by the national executive installed by the nation’s leading capitalists.

At the same time, US Treasury Secretary Scott Bessent has turned to new tools attempting to blunt one effect of inflation, falling bond prices, as investors anticipate a Federal Reserve interest rate increase. Whether or not these attempts at voluntary jawboning will work is one question. The White House’s desire for cheap gasoline certainly comes into conflict with its opposition to raising corporate taxes.

But these are political, rather than economic, problems. In the political system, the causes of inflation are no longer in dispute — except insofar as banks and corporations, and especially media corporations, have economists they can use to argue otherwise. The only relevant question is what power can be organized to do anything about it.