Remember when, not so long ago, central banks said they wished we had an inflation problem? “We know how to deal with it,” they used to say.

Yes, well…

I have published in The International Banker an article that discusses the current high inflation crisis: how past policies got us here, how hard it will be to get inflation back under control, and, most importantly, the lessons that I think policymakers should draw from the current predicament and how they should inform economic policymaking going forward.

I have reposted it with permission from the magazine. Please CLICK HERE to read the article.

I published this post first on JuST THINK. To stay up to date, come to https://justthink.substack.com/ and subscribe for free!

For the past three years, China and Covid have been inextricably linked. The China-Covid nexus played a critical role in the global pandemic response, the global economic recovery and China’s economic prospects. And it continues to do so.

The pandemic model child…

The Covid pandemic started in China. Strong evidence suggests the virus might have been developed in a Wuhan laboratory; but from day one, US and global health authorities dismissed this possibility as a conspiracy theory, setting the tone for the entire Covid debate — a debate which allowed no room for honest discussion or any dissent from the official view of the day.

China implemented some of the most draconian lockdowns anywhere, shutting down entire cities and literally locking people inside their apartment complexes. This zero-tolerance approach was widely praised — and even envied — by health authorities and media in the West. China’s approach seemed successful, keeping the official count of infections and deaths much below that of most other countries. Proponents of mask mandates and lockdowns leveraged this apparent success to bolster their case for extensive restrictions to social life and economic activity.

Common sense however suggested that yes, a policy of complete social isolation could drastically limit contagion, but no, it would not cause the virus to disappear and no, it could not be maintained for ever — as China is now finding out. Official statistics place China at the very bottom of the Covid casualties rankings (#220 for deaths per million people and #227 for cases per million people, according to Worldometers); but these outcomes (even if true) will now be a lot harder to maintain.

…now stuck in a zero-Covid trap

As most other countries began to ease pandemic restrictions earlier this year, China found itself in a “zero-Covid trap”:

1. Extensive use of strict lockdowns has successfully limited the spread of the virus, which means natural immunity is very limited;

2. China’s authorities insisted on using only China-made vaccines, much less effective than those developed in the West; even with a black market for Western-made vaccines, this implies that vaccination has provided limited protection;

3. To make matters worse, China’s elderly have proved especially reluctant to take the vaccine — so that the most vulnerable section of the population has the least degree of protection;

4. Finally, while China attracted international praise early in the pandemic for its ability to quickly erect temporary large scale emergency medical facilities, it has proved unable to bolster its health care capacity over the last three years, so that a large scale Covid outbreak could overwhelm its health care sector.

China therefore continued to lock down entire cities at the smallest flare-up of infections, even as international soccer fans crowded together maskless in Qatar’s stadiums. Exasperated, Chinese citizens have taken to the streets in the largest protests since Tiananmen Square, calling for restrictions to be lifted and, in some cases, for Xi Jinping to step down.

Oh, the hypocrisy

It’s been a bitter irony to see Western media and politicians express support with Chinese protesters, and argue that demonstrators are right to be exasperated with prolonged lockdowns; many of these same journalists and politicians were steadfast supporters of strict lockdowns in the West, and showed zero patience for domestic dissent and protest. Canadian Prime Minister Justin Trudeau is perhaps the most outrageous example, given his China-style crackdown on truck drivers’ protests last February.

China has now started to ease Covid lockdowns and restrictions, while hardening the repression of protests and dissent. This could ease the pressure in the short term. But if infections surge again and hospitals come under pressure, China’s leadership will be back at square one. This will remain a hard challenge for Xi Jinping’s regime.

Some have argued that Xi Jinping knew all along this Covid strategy was not sustainable, but wanted to keep the virus bottled up until he could be confirmed as leader at the recent Party Congress. There might be truth to it, but it begs the question of why he did not prepare better for what will now be a fraught transition — for example stepping up — and even mandating — vaccinations at a much earlier stage.

Has China’s model failed?

Many commentators now hail China’s predicament as manifest proof that China’s governance model has failed.

Before Covid, and through the first two years of the pandemic, the dominant argument was that China’s autocratic and meritocratic system of governance delivered better performance than democracies did: an extended period of strong economic growth, an impressive rise in living standards, the eradication of extreme poverty, and an effective management of the pandemic.

Now the narrative has been reversed, and we are told that an autocratic system was always bound to fail and that China’s leadership has proved incompetent: It mismanaged the pandemic by failing to protect its population with effective vaccines; it clipped the wings of its dynamic private economy in order to reassert political control; and now finds itself exposed to another health crisis and with crippled economic prospects, no longer able to challenge the US’s dominant position.

Not so fast

I think — and I hope — that this new consensus opinion will prove to be wrong.

First, while China has in fact mismanaged the pandemic, so have most other countries. The West’s response to Covid has caused massive disruption to the global and national economies; unprecedented erosion of civil liberties, an enormous damage to public health and to education outcomes that we are barely beginning to acknowledge, and a lasting lack of trust in public institutions, from health authorities to government to media. China’s failure does not make our performance look any better.

Second, China’s economic success was not all an illusion. China’s companies have become a crucial part of global supply chains and some of them have already achieved excellence in important manufacturing sectors. China has made huge progress in new technologies, notably Artificial Intelligence. And its education system continues to churn out large numbers of STEM (Science, Technology, Engineering and Mathematics) graduates, compared to the West’s predilection for lawyers and history majors. Innovation thrives best in a democratic market economy, which gives the US a major advantage. China’s recent moves to reassert political control over its economy will no doubt damage its growth potential. But most western countries have also moved towards heavier government intervention, which is similarly bad news for long-term growth potential. And the current struggle to bring inflation under control has exposed a decade and a half of unsustainable macro policies.

It was foolish to hail China as a superior and unstoppable model of economic progress; but it would be equally misguided to now assume that China is destined to languish in middle-income mediocrity. Commentators have noted that Japan once seemed set to surpass the US’s economic might, and never did; true, but Japan did become and remains a major economic power.

Beware Schadenfreude

China’s autocratic model, however, implies an additional degree of potential volatility, at two levels. Power transitions in autocracies can be a lot less smooth than in democracies. The latest protests therefore carry higher risk than the social unrest we have witnessed in western countries over the past few years. The protests currently seem unlikely to threaten Xi Jinping’s freshly reasserted leadership; but when people’s desperation or hope overwhelms their fear, authoritarian systems break — a major bout of political instability in China is unlikely, but not impossible.

The second level of volatility is geopolitical. If domestic social unrest threatens to spiral out of control, China’s leadership might be tempted to divert popular discontent towards an outside opponent — with a spike in tensions over Taiwan, for example.

That’s why I hope that China’s harshest critics will prove to be wrong.

China deserves its Covid comeuppance. But we should not use it as an excuse to forget how badly we in the West have messed up, or to underestimate the economic challenge that China still poses — and the global risks that a China upheaval would entail.

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I published this post first on JuST THINK. To stay up to date, come to https://justthink.substack.com/ and subscribe for free!

The second largest crypto exchange, FTX, blew up and went bankrupt. Meta (the company formerly known as Facebook) has seen its market value collapse. The giants that drove the latest tech boom are laying off thousands of employees. Elon Musk is seeking a different business model for Twitter.

Was this last wave of innovation just hype, as skeptics claimed all along?

Not quite.

I’ve come to the world of innovation from an unlikely angle — I was GE’s Chief Economist when the company embraced the digital revolution and I had joined GE after a decade and a half in policy and finance. So I am especially attentive to the hardware/software nexus, the marriage of bits and atoms. I see the power and the limits of pure digital innovation, but also the enormous value digital can bring to the world of manufacturing — constrained by the laws of physics.

From this perspective, here are my five innovation lessons from this latest tech crash:

1. The pyramids are still standing

They said “crypto” would reshape finance. A bottom-up revolution would replace banks, insurance companies and even central banks with a more efficient democratized setup. The hype brushed aside all obstacles and complications: technology, incentives, regulations, and more. But the hype on the new technology hid some very old-fashioned bad behavior.

Blockchain is a revolutionary technology with a wide range of applications. Cryptocurrencies will remain embedded in our financial system in some form. But the explosive growth of the crypto universe had little to do with innovative technology. It was a good old pyramid scheme.

(Calling these schemes “pyramids” is both accurate and misleading. Yes, you need a large base of participants at the bottom so that a few at the top can extract value. But the actual pyramids last forever — go see them — they are extremely stable structures. Financial pyramids always collapse. They are reverse pyramids — upside down. Maybe they will be stable in the metaverse.)

There will aways be manias and bubbles. This time central banks set the stage by providing ample liquidity and making it impossible to generate any returns without taking outsized risks. Then a technology that sounds way too complex to understand but translates into a simple idea acted as the perfect bait. A clever con-man — FTX founder Sam Bankman-Fried — dressed it up in the feel-good disguise of effective altruism. In a recent response to a reporter, Bankman-Fried candidly admitted the cynical hypocrisy behind this: it is a “dumb game we woke westerners play where we say all the right shibboleths and so everyone likes us.” And so a con-man gets the open endorsement of politicians, sports stars and entertainers, from Bill Clinton and Tony Blair to Tom Brady and Katy Perry.

Hopefully the crypto crash will just burn off some excess liquidity with limited impact on the financial system. Hopefully.

First lesson: in the new world, look out for the same old traps.

2. Value-add vs. Risk-add

The first question we should always ask when evaluating a new technology is: what does it add? The “old economy” measures every step in the economic chain in terms of value added. I buy cloth and sell you a jacket: the value added lies in my craftsmanship, and gets embodied in better functionality and style. That’s what you pay for (and in countries with a value added tax, that’s what the government taxes.)

Many of the innovations in crypto operate on a risk-added rather than value-added basis. FTX helped you swap dollars for volatile tokens, and might have used your dollars to place risky financial bets of its own, through its affiliate Alameda Capital. This added a lot of risk and no value — except for the value we assign to gambling. That’s what you paid for: the additional risk intrinsic in a gamble. The way you pay for a lottery ticket. The innovation, it turns out, served mostly to blindside regulators and avoid the traditional safeguards of the “old” financial system.

Second lesson: make sure the new technology adds value, not (just) risk

3. Mad Men

Speaking of value, what are you selling, really? Innovation is not everything — it matters what you can offer, how you make money. Some of the new tech giants grew so fast because they gave us services for free. That of course meant we were not the customer — we were the product. They lured us with clickbait and harvested our data, which they sold to advertisers. Advertising accounts for nearly all of Facebook’s revenue (98%); about 90% of Twitter’s and over 80% of Google’s. These are not tech companies, they are media and advertising companies. It should have been obvious all along.

The joke was on us, but also on those shelling out big bucks to bombard us with ads for the same pair of running shoes we have already bought: there is zero evidence that internet ads increase sales — try this Freakonomics podcast for an entertaining and informative take on the topic.

Now, as the tide of generous central bank liquidity goes out, financial markets might finally be repricing these companies for what they really are: media companies whose growth will be ultimately be capped by the hours we can spend on our screens and by their sponsors’ naïveté.

Third lesson: check how the new technology makes money, and compare the new company to “old” companies that make money in exactly the same way.

4. Value is in the eye of the beholder

“We wanted flying cars, instead we got 140 characters.” In 2013 venture capital investor Peter Thiel captured pithily how digital innovation had skewed towards social media and entertainment. Northwestern economist Robert Gordon has been similarly dismissive of digital innovation, arguing that its economic potential does not even get close to that of the industrial revolution.

Digital innovation holds enormous transformative potential. But so far, that potential has been realized mostly in entertainment. Yes, we all claim we need Twitter to keep up to date on news and research, but let’s be honest, what we seek is entertainment. Facebook, Instagram, TikTok, Netflix,…shall I go on? The Federal Reserve Board’s research department has 15,000 followers on Twitter; Justin Bieber has over 100 million. Say no more.

The future looks much the same. If you are wondering what the metaverse is all about, read Neal Stephenson’s Snow Crash and Ready Player One. It’s entertainment. Yes, one day we’ll be able to have realistic virtual work meetings in the metaverse — but it’s not like meetings are the best way to increase work productivity.

Value, however, is in the eye of the beholder. The metaverse might turn out to be nothing but one giant black hole of a video game where we get sucked in to spend our entire lives, while in the real world the robots do all the work. It might cripple our cognitive abilities in a more fundamental way than even social media have done so far (my friend Mickey McManus and I dubbed this The Great Cognitive Depression). But if people want entertainment and can pay for entertainment, they will pay for entertainment. And the metaverse will make money. Potentially a lot of it. In two traditional ways, however (remember the third lesson): through advertising, or by having people pay for access.

Fourth lesson: never underestimate people’s willingness to spend real money on silly things (an NFT pet rock, anyone?)

5. Does anyone remember Owen?

In 2016 GE was striving to make the Industrial Internet vision a profitable reality, with software that would improve the efficiency and performance of gas and wind turbines, jet engines, locomotives, medical devices. Finding the right talent was one of the biggest challenges: how could we compete with the likes of Google and Facebook, not to mention a vast universe of start-ups? Our marketing team launched a brilliant series of ads: “What’s the matter with Owen?”. The ads self-deprecatingly recognized GE was an unlikely competitor in the job market for software developers. But at the same time pointed out that digital work in manufacturing would create real, tangible value.

GE’s industrial internet strategy failed, but the industrial internet succeeded. Industry 4.0 has become a buzzword, and companies across a wide range of industries now invest heavily in digital technologies. The proof points are building up. It will take longer for this revolution to scale, but the value added it creates is undeniable. And it builds on the same technological breakthroughs that have given us crypto currencies and Pokemon Go. The fact that some applications look silly and useless does not mean the technology is. It’s just that realizing digital value in the world of atoms is hard and takes time.

Fifth lesson: don’t judge a new technology by its silliest applications; be skeptical of the hype, but don’t discount the long term value where serious people are working hard on serious applications.

Conclusion

The tech reset we are witnessing is a healthy one. It will puncture bubbles, expose old-style scams decked in high-tech clothing. It will force us to take a hard look at where and how companies make money, so we don’t mistake a media and advertising conglomerate for a true technology pathbreaker. But a lot of digital innovation has already made its way into the world of atoms and will continue to deliver true value in energy, manufacturing, health care and more. This wave of digital-industrial innovation will continue, and will boost productivity. It will provide job opportunities for some of the software wizards laid off by the likes of Twitter — they might want to call Owen for some career advice. Some pure digital technologies like blockchain also have solid value to deliver.

All this I believe will provide a bottom to this tech market crash. It was not all hype. Now we need to be more discriminating and patient. Yes, I know, until the next bubble inevitably comes along and we get swept away again…

I published this post first on JuST THINK. To stay up to date, come tohttps://justthink.substack.com/ and subscribe for free!

In case you’d forgotten, we are all going to die.

Not in the obvious sense that each and everyone of us will eventually succumb to our mortal nature (after all, Silicon Valley keeps seeking an immortality pill or a way to upload our consciousness to the cloud). No, I’m talking about the extinction of the entire human species.

In case you had forgotten, the COP 27 climate change summit underway in Egypt will make sure to remind you that human extinction due to global warming is fast approaching. This, unsurprisingly, creates some hysteria: in Europe activists are blocking traffic and gluing themselves to masterpieces in art museums.

The motto of JuST THINK is that whenever you want to understand something, you should look at the numbers and … well .. just think; don’t take anyone’s word for granted, not even the experts’. Especially when they tell you that a consensus has been reached, and the science is settled.

So let’s try to make sense of the clash between the “consensus” that claims the science on climate change is settled, and some highly qualified scientists who insist that it is not. Let’s listen to both sides of the debate. This post summarizes my findings, many of which will surprise you. It builds on a series of blogs I published a year ago. It’s going to be a lot less comfortable than repeating the same litany as everybody else — but a lot more satisfying.

Let me say this up front: The climate is changing — it has been changing since earth was born. The evidence is all around us, and almost nobody claims otherwise. But the science is not settled, and the term “climate change denier” is thrown around too liberally to suppress debate on a number of uncomfortable questions.

Climate change: what we know and what we don’t

One of the contrarian voices is Steven Koonin. When I told friends I was reading his book “Unsettled”, they warned me Koonin is an untrustworthy hack with a hidden agenda and a poor grasp of the issues, in the pocket of fossil fuel industries. A dangerous denier.

Another denier! Except that Koonin is a theoretical physicist who served as Undersecretary for Science in President Obama’s Department of Energy and has extensive experience on climate science. So it’s worth reading the book, comparing his views to those of notable “believers”, and assessing the arguments. The first takeaway is that it’s important to recognize what we know about climate change and what we do not:

• The planet is getting warmer, and greenhouse gas emissions due to human activity are contributing. That much we know. We do not know, however, how much of the change in climate is attributable to human activity, because:
• Human emissions play a smaller role compared to other determinants of the climate, such as variations in solar activity, volcanic activity and fluctuations in the height and density of cloud coverage;
• Climate models are unable to capture these other factors with sufficient precision; hence forecasts of how the climate will change — including due to human emissions — are subject to a very high degree of uncertainty;

But while these uncertainties are recognized in the body of the official climate reports (which run into thousands of pages), they are ignored in the executive summaries in favor of simpler messages that get further simplified and dramatized by the media. In his book Koonin documents this with plentiful quotes from the climate reports.

Climate scientists do it with models

The climate debate is based on model estimates and forecasts. So, how good are these models?

Like economists, models disagree. Koonin notes that the global average temperature forecasts coming from the many models used by the IPCC (Intergovernmental Panel on Climate Change) can differ by as much as 3 degrees centigrade; in other words, the margin of uncertainty is as large as the temperature increase these models are forecasting.

The chart below, from the Summary for Policymakers of the latest IPCC report, shows the projected increase in global surface temperature compared to the 1850–1900 average. You see that even just the “very likely range” is quite large. Notice also that the chart starts in 1950 — rather convenient, as it turns out.

Source: IPCC Report: Climate Change 2022: Impacts, Adaptation and Vulnerability

Even more troubling: Climate models can’t explain the 1910–1940 global warming episode, which was of a similar magnitude to what we have experienced since 1970, as you can see from this second chart, taken from NASA. This is quite a shocking indictment of the models: If they can’t replicate the past, why should we think they can predict the future?

Source: NASA

What do you mean by “data”?

The data here are not hard facts, they are model estimates. In 2013, the data showed that global temperatures had remained flat over the previous 15 years. The Economist, which printed the chart below, called it “among the biggest puzzles in climate science just now.” How do you solve the biggest puzzle? Well, two years later that same data were revised to show that temperatures had been rising all along.

Source: The Economist, March 2013

Think about it for a moment. This is not uncertainty on how to estimate global temperatures in the 1500s. This means that just a few years ago we did not really know what the recent global temperature actually was. At the same time we are asked to believe that precise temperature estimates for the past 2000 years and decimal-point forecasts for the next 200 are indisputable, settled science.

There is nothing wrong with using model estimates. Gauging the planet’s temperature is hard — you can’t just stick a thermometer under its tongue. But we should acknowledge the significant degree of uncertainty in the debate and in decision-making.

Extreme views on extreme weather

“Climate change is causing more frequent and more severe extreme weather events and natural disasters.” Countless media reports, UN pronouncements and even scientific papers routinely open with a statement along these lines, presenting it as an unchallenged fact.

But is it true?

To contrast Koonin’s skepticism I turned to a podcast by Professor Adam Sobel, a Columbia University climate science expert who specializes in extreme weather attribution — figuring out whether hurricanes, heat waves etc. are caused by climate change. Sobel and Koonin are at opposite ends of the spectrum. Sobel is very critical of Koonin, and Koonin has very little confidence in weather attribution studies. Comparing their views, here is what I found:

• Both agree that our understanding of the link to climate change varies considerably depending on the type of extreme weather event. We are more confident that climate change is causing more heat waves and contributing to more severe forest fires, but we do not really understand whether climate change is likely to lead to more or fewer hurricanes, tornadoes, and winter storms.
• Koonin stresses that there is no significant trend in the global number of cyclones or in the number of US hurricanes; and no scientific evidence that global warming causes more hurricanes. He adds that we do not know whether floods and droughts have been increasing, decreasing or remained stable. We simply do not know.
• Have heat waves become more frequent? Probably. Sobel however notes that when we get a heat wave that pushes the maximum temperature to say 45°C, we cannot reject the idea that without climate change we would anyway have gotten a heat wave of 44°C: since the globe has warmed by 1°C, this has raised the baseline, but heat waves would happen anyway.
• Koonin provides very interesting data showing that high temperatures have not become more extreme, at least in the US: since 1900 the lowest temperatures in the US have gotten less cold, but the highest have not gotten hotter. You can see this in the chart below, from from Chapter 6 of the USGCRP (US Global Change Research Program) Climate Science Special Report (2017), part of the Fourth National Climate Assessment. The panel on the left shows the coldest temperatures have increased; the panel on the right shows the warmest temperatures have been broadly stable since 1950, at the same level as 1900 and markedly lower than in 1930–40.

Source: USGCRP Climate Science Special Report (2017)

But wait a second: if the highest temperatures have not increased, why does the IPCC say heat waves have become more frequent? It turns out there are various definitions of a heat wave. The Environmental Protection Agency for example defines it as a period of two or more days when the daily minimum temperature adjusted for humidity is higher than the historical average. Ok, maybe this squares the circle: we are not experiencing more frequent bouts of hotter-than-ever temperatures, but we do get more heat waves because the coldest temperatures have risen.

These two scientists from opposite ends of the climate debate show more agreement than disagreement on what we actually know — which makes the stark difference in their positions quite remarkable. Keep this in mind as you read further.

My conclusion: as the planet has gotten warmer, the risk of weather events directly linked to higher temperatures, like heat waves and forest fires, has probably increased; blaming every hurricane and flood on climate change has no scientific basis; the risk of catastrophic weather events might be increasing, or it might not — science does not yet have an answer.

Uncertainty and risk

Given that climate science is subject to enormous uncertainty, what should we do? Here we see a fundamental disagreement.

Sobel argues that uncertainty should not be an excuse for inaction. We know temperatures have been rising and we know human activity has contributed. True, we do not understand everything that is going on, and the models leave a margin of uncertainty; but that means things could get even worse than the models predict, and therefore we should err on the side of caution and take rapid action.

Koonin counters that uncertainty counsels a more cautious approach. Yes, temperatures have been rising and human activity has contributed. But our understanding is so limited that we don’t actually know how much human activity has contributed, nor whether the corrective actions we plan will have any meaningful impact compared to the underlying natural changes.

There is no objective right or wrong here, it’s a legitimate disagreement on how to deal with uncertainty.

Costs and benefits

How we factor in uncertainty matters because reducing emissions quickly carries significant costs. A 2020 study estimates that keeping the global temperature increase below 1.5°C would leave 80 million more people in poverty by 2030 (Figure 2). The energy crisis triggered by Russia’s invasion of Ukraine shows that reducing reliance on fossil fuels before we make further progress on renewables implies slower growth and lower incomes.

I am optimistic about technological innovation. But here is a reality check: with all the advances in renewable energy technologies, for the last 30 years the share of fossil fuels in total global energy consumption has remained stubbornly above 80%. (Meanwhile global energy consumption has risen by over two-thirds.) In the next 30 years, it must drop to less than 30% to meet the targets of the International Energy Agency’s ‘Net Zero’ scenario. At the current pace of energy transition, we are going nowhere fast.

We need to be realistic and admit that a rapid transition away from fossil fuels would involve substantial costs. Advanced economies would have to downsize their lifestyle, and emerging markets would have to accept a much slower improvement in living standards — and a slower reduction in global poverty means more people will die. Given the substantial costs involved, we need a cost-benefit analysis; and in this analysis, the uncertainty on our climate change forecasts does matter.

Moreover, a cost-benefit analysis should consider the full range of consequences of global warming. Stanford’s Bjorn Lomborg has recently pointed out that the reduction in the number of deaths due to extreme cold far outnumbers the higher deaths due to extreme heat. Cold kills way more people than heat; hence the rise in global temperatures is saving lives. It might kill us all in the long run — but scientific reports and media headlines focusing exclusively on more heat deaths are dishonest.

The role of scientists

This is a crucial issue, and the one I find most disturbing. Contrarians like Koonin and Lomborg excoriate the majority of climate scientists for encouraging the dogmatic apocalyptic pronouncements of media and policymakers, even though they are full aware of the enormous uncertainty underlying the science. The thousands of pages of the IPCC reports recognize all the uncertainties; the summary for policymakers sweeps them away and sounds very definite; media and policymakers predict an impending apocalypse and most scientists nod in agreement.

In the podcast, Sobel explains why in a surprisingly candid way. He argues that scientists should play down the uncertainty when they communicate to policymakers and the public. He worries that disclosing too much uncertainty would lead to inaction. He thinks scientists know enough to conclude that early and decisive action against climate change is necessary, and have a responsibility to convince the public and politicians to go forward — and this requires simplifying the message.

I find this attitude troubling. If there are important trade offs to be made in a situation of uncertainty, the responsibility for the decision rests with the public and policymakers; it should not be pre-empted by scientists.

Instead, the scientists’ attitude is: if we give them full information, people cannot be trusted to make the right decision; therefore we should convey only the information that will push society onto what we believe is the right path.

Inconveniently revealed preferences

This attitude is not only unethical but also counterproductive. It undermines the public’s trust in science and experts; and by stifling the scientific debate it hinders the discovery of better solutions and the diffusion of best practices. Today young scientists know that if they want to push a line of research not fully aligned with the accepted climate change “consensus”, they will face enormous difficulties in obtaining research grants and academic jobs. The science is “settled” the way elections in North Korea are settled. This makes it much harder to advance our scientific understanding of the climate, which is still woefully inadequate.

Moreover, this attitude inevitably backfires:

• Policymakers keep telling us we are heading for extinction; but they have barely managed to agree on emission targets that they themselves recognize are insufficient to “save the planet”, and can’t meet even those perfunctory benchmarks;
• Most people keep driving, flying and running heating and air conditioning the way they always did;
• When an energy crisis comes around, Germany fires up its coal plants and the US administration begs Saudi Arabia and Venezuela to pump more oil.

In economics we call this revealed preferences: it’s your actions that show what you really want. Here they suggest that nobody really believes we face extinction — or at least nobody really wants to pay the price to avoid it.

Conclusion

Here is my conclusion — and I know many of you will disagree. The climate is changing, and this poses a challenge. There is a lot we don’t understand, and the uncertainty might well hide apocalyptic risks. Or it might not.

We should reduce emissions because they warm the globe and they pollute. We should keep improving renewable energy technologies; it’s the smart thing to do, and eventually we’ll run out of fossil fuels. But reducing emissions is not costless — particularly for the large share of the world population that still lives in poverty. We need a transparent debate in terms of cost-benefits and risk management.

Instead, media and policymakers have adopted a strategy of scaremongering, playing up apocalyptic predictions while hiding the uncertainty of data and forecasts and downplaying the cost of the proposed actions. Too many scientists have become willfully complicit. This is backfiring: people are unwilling to make serious sacrifices and governments are unwilling to adopt the measures they claim are necessary. It makes it harder to identify the best response to the climate challenge and it further undermines the public’s trust in science and institutions. If we truly want to address climate change, we need a far more honest approach.

Now unglue yourself from that Chagall and let’s make some progress.

I published this post first on JuST THINK. To stay up to date, come to https://justthink.substack.com/ and subscribe for free!

Two issues grabbed my attention this week . Both are close to my heart, they are interrelated, and they have major economic implications.

Covid amnesty or Nuremberg trial?

The Atlantic published a provocatively titled essay “Let’s declare a pandemic amnesty”, by Brown University economist Emily Oster. She calls on everyone to leave behind the acrimonious debate on the pandemic; we need to forgive each other and move on. Her article triggered a wave of outraged pushback; some of the best examples I have read include Eugyppius and Unmasked by Ian Miller here on Substack.

I share the outrage. Oster admits key restrictions imposed against Covid-19 have been proved ineffective and misguided: masks, lockdowns, school closures and vaccine mandates to name just the four horsemen of the Covid apocalypse. But, she argues, those who advocated and mandated these measures meant well, and none of us knew enough. Those who got it right, got it right by chance.

This is astonishingly dishonest:

Key features of the pandemic were evident from the very early data: that the risk was high for the elderly and immunocompromised but minimal for the young, for example; previous research had already demonstrated the inefficacy of masks; the uselessness of lockdowns became quickly evident by comparing counties and countries with and without lockdowns; and shortly after vaccines were rolled out it became apparent that they did not prevent infection or contagion. All this evidence was systematically ignored at every step of the way.

In recounting her personal experience, Oster shows herself to be one of those who totally ignored the available data and evidence — shocking for a PhD economist trained to seek and analyze data.

“We didn’t know,” says Oster. Yet advocates of draconian restrictions professed absolute certainty backed by The Science. They ostracized, boycotted and canceled those who argued against the consensus– from the authors of the Great Barrington Declaration, condemned as dangerous by their own colleagues in the health care community and by public health authorities, to the countless individuals who lost jobs and friends for refusing the vaccine.

Now we see mounting evidence of the adverse side effects of vaccines, of the mental and physical health damage caused by lockdowns, delayed medical screenings, and school closures — and we are all experiencing the economic consequences: high inflation and a looming recession. We have mounting evidence of how information was censored for fear that it would undermine support for the official policies. (A lot of this censorship and misinformation was blatantly evident at the time; if you want a few laughs and a walk down memory lane check out my Ministry of Truth and scroll from the bottom up).

It would be irresponsible to forgive and forget, pretending that we could not have done any better. Especially because the mistakes continue — see the ongoing push to vaccinate young children. Data and information are still being withheld.

Yes we should move on. But we need to understand and acknowledge why the pandemic reaction was botched so badly — particularly because this reaction ignored key lessons from previous epidemics, for example on data collection, as I noted in a May 2020 blog inspired by Hans Rosling. And we need to put in place mechanisms and safeguards to make sure next time we do a better job — this recent post by Vinay Prasad would make an excellent starting point.

Emily Oster would like an amnesty. Others would prefer a Nuremberg trial. What we need is a failure analysis so we can agree on why we got it so wrong. And it needs to be a transparent exercise this time.

Academic freedom

The Stanford Graduate School of Business Classical Liberalism Initiative has convened an Academic Freedom Conference. If you have not been following the debate on academic freedom, you will be either puzzled or alarmed at the news. Alarmed is the appropriate reaction. The introduction to the conference’s agenda details why — I quote it below from John Cochrane’s blog:

Academic freedom, open inquiry, and freedom of speech are under threat as they have not been for decades. Visibly, academics are “canceled,” fired, or subject to lengthy disciplinary proceedings in response to academic writing or public engagement. Less visibly, funding agencies, university bureaucracies, hiring procedures, promotion committees, professional organizations, and journals censor some kinds of research or demand adherence to political causes. Many parts of universities have become politicized or have turned into ideological monocultures, excluding people, ideas, or kinds of work that challenge their orthodoxy. Younger researchers are afraid to speak and write and don’t investigate promising ideas that they fear will endanger their careers.

Academia was always meant to be a sanctuary for intellectual exploration, freedom of thought and open debate — the forces that ultimately drive innovation, better institutions and rising living standards. If we lose this, we lose our way of life.

The first day of the conference has already offered scores of examples of this dystopian transformation of universities — some hilariously surreal, others outright chilling — and the impact it is having on research and on how students are being trained to (not) think.

Creeping censorship

You can easily see the connection between these two issues. Both arise from a creeping censorship justified by an appeal to a higher cause: “we can’t allow anyone to question the lockdowns — otherwise we are all going to die”; “we can’t allow this line of research, its results might have unacceptable social consequences.” This attitude inspires a sense of righteousness and security: “I know what’s right and I will stand for it.” But stifling open debate always leads to the worst outcome.

The economic consequences are clear and clearly disastrous — the dogmatic response to the pandemic has inflicted the worst economic disruption on record; curtailing academic freedom will cripple innovation and economic growth. More momentous long-term implications than even a Fed policy decision.

Censorship carries an exorbitant price.

I published this post first on JuST THINK. To stay up to date, come to https://justthink.substack.com/ and subscribe for free!

The same Federal Reserve (Fed) that used to say, “we only fear deflation, we know how to fight inflation,” now says “we only fear inflation, we know how to fight recession (and deflation).”

I closed my previous blog arguing that Fed Chairman Powell would need to send a message to investors, and he sent it loud and clear at the end of yesterday’s Fed policy meeting:

• He emphasized that however you measure it, inflation is way too high and shows no signs of coming down; with the labor market tight and consumer spending fueled by record-high savings, it will not come down by itself — more rate hikes are needed.
• In fact, he warned, interest rates will need to go higher than the Fed previously thought and stay there for longer. It’s way too early to even talk of a pause — the point where the Fed will stop hiking and watch higher interest rates take their toll on the economy.
• He stressed that no-one should doubt the Fed’s commitment to bringing inflation down. He needed to, because the Fed’s dovish history engenders skepticism on its ability to stomach the reduction in employment and asset prices needed to bring inflation back to 2%.

Regime change

But here lies the biggest change in the Fed’s attitude, and financial markets still can’t quite accept it: for the past two decades the Fed always de facto prioritized asset prices. Whenever equity markets faltered, the Fed eased policy. More: with zero interest rates and massive Quantitative Easing the Fed deliberately pumped up asset prices, encouraging markets to take more risk.

So you can forgive investors for thinking that, with equity markets down 20% so far this year, the Fed would soon reverse course, stop hiking and start cutting rates.

Except it won’t.

Gravity has reasserted itself. With a big push from recklessly loose fiscal policy, inflation has surged and risks getting entrenched at an uncomfortably high level. That would undermine both economic and financial stability. So the Fed doesn’t really have a choice.

It gets worse: every time stock prices rally, financial conditions get looser, offsetting some of the Fed’s tightening effort and making its job harder. Therefore now the Fed has to push against financial markets, taking a more hawkish stance whenever investors get their hopes up — this was the clearest takeaway from yesterday’s press conference.

Remember MMT?

Until just over a year ago, the prevailing mantra was that the world had changed, inflation and interest rates would forever be low, weak aggregate demand had consigned economies to secular stagnation, deflation was the only real and present danger, monetary policy had to stay ultra-loose and governments could borrow for free and should do so with abandon. Modern Monetary Theory (MMT) — which claims governments do not have a budget constraint because they can print as much money as they want — was taken seriously by many. US macro policy became de facto an experiment in MMT.

It ended the way any sober economist expected: a massive surge in inflation. The world has not changed that much after all and the basic laws of economics and common sense still hold: too much money chasing too few good results in inflation.

Today the only one who follows MMT’s wisdom is — you’ll be surprised — Rishi Sunak, the new UK Prime Minister. I am only half joking: MMT argues that in the unlikely event that inflation should rise, the government should raise taxes. Sunak is indeed set to tighten UK fiscal policy, though he’s guided by a much more orthodox perspective: when interest rates rise, you need to reduce borrowing to reassure financial markets.

The devil you know is back

Back in those days, when anyone suggested that persistent ultra-loose monetary policy could eventually cause an inflation problem, the Fed responded, don’t worry, we know how to fight inflation, it’s deflation that we fear. Better the devil you know, in other words. Well, the devil you know is back and looks a lot scarier than you remembered…

Which explains the “pivot” in the Fed’s hierarchy of fears: inflation has jumped to the top, recession and deflation suddenly look a lot less concerning.

I think the Fed is doing the right thing, and I believe it will show the fortitude to keep its word and bring inflation down — though this will likely take longer than many expect. I also think the Fed will finally be forced to look at the whole chessboard — they can’t afford to ignore growth and employment risks the way they ignored inflation risks. I hope the government will eventually do the same, adopting responsible fiscal policy and supply-boosting reforms. The time for MMT-inspired populist spending is over.

For financial markets, this becomes a brave new world, one where asset values will depend a lot more on fundamentals, a lot less on policymakers’ largesse. The adjustment is painful, and it’s not over.

But then IMF head Georgieva stated in her remarks: “What we are experiencing is a fundamental shift — from a period of relative stability, low rates, and low inflation to a period of high rates, high inflation, and much greater uncertainty.”

Now, hold on a second.

Yes, we are (finally) moving from a long period of low rates and low inflation to a period of high inflation and high rates. But greater uncertainty? Again? We’ve heard the “greater uncertainty” argument for over a decade now: the unprecedented uncertain recovery from the 2008 Global Financial Crisis; the risk of the Eurozone breaking apart in the 2012 debt crisis; the fiscal cliff and (preposterous) fears of a US sovereign debt default in 2013; recurring predictions of a China crash; fears of a new global financial crisis in 2016; the (spurious) 2018 reports of extremely high economic uncertainty; the risk of surging protectionism, the possible devastating impact of robots and Artificial Intelligence on employment…

Over the past decade, policymakers have routinely used the “greater uncertainty” argument to justify persistently loose policies. It was never the right time to normalize policy because there might always be some adverse shock lurking around the corner.

Paradoxically and predictably, those loose policies seeded today’s fundamental uncertainty. What causes real concern is not so much new global health scares or new energy and food price shocks, to pick from the IMF’s lengthy list. It’s how financial markets will handle the unavoidable transition to normal monetary policy settings.

The recent turmoil in UK financial markets might have been triggered by the unforeseen blunders of a clumsy new government; but its underlying cause is that a long period of extremely low interest rates forced pension funds into taking extreme leveraged risks.

IMF head Georgieva reiterates that “After navigating extraordinary challenges over the past two-and-a-half years, further extraordinary challenges lie before us.” It’s the Lake Wobegon global economy, where all challenges are extraordinary. (Note how high inflation has been reclassified from temporary nuisance to extraordinary challenge.)

Irony aside, I find reassurance in a closer reading of the IMF’s position. When you are competing for headlines with threats of nuclear Armageddon, you are forced to argue that your challenges are extraordinary. But the IMF’s recommendation for how to face these extraordinary challenges is largely a pragmatic reversal to common sense macro policies: monetary policy needs to stay the course to restore price stability; fiscal policy should “remain sufficiently tight” to support the disinflation effort, while targeting help to those who really need it (forget Universal Basic Income); and for those governments with sufficient strength and vision, a little attention to supply side reforms, please.

I could not agree more. Extraordinary times call for ordinary measures.

[This story was first published here: https://www.annunziatadesai.com/blog, where you can find more of my blogs and subscribe to the mailing list]

At their annual symposium in Jackson Hole, central bankers professed full commitment to fighting inflation, while lamenting that the world has become a much more difficult place for monetary policymaking. There was virtually no critical assessment of how the macroeconomic policies of the past decade contributed to the current problems. Central bankers admitted they underestimated the inflation surge — how could they not? But they blamed an adverse external environment the way you would blame the weather, something outside your control. Pandemics, wars and supply chains failures — they argued — plunged us in a world where reducing supply-driven inflation through monetary policy becomes more difficult and painful.

Fed Chairman Jay Powell, to his credit, admitted that US inflation has also been fueled by excess demand, not just adverse supply shocks.

But to reduce the risk of further macroeconomic problems down the line, we need a more comprehensive assessment of how we got here. Some deeper self-reflection is needed, given that less than a year ago the same central bankers assured us the inflation surge was “transitory” and supply problems would quickly self-correct.

The first step should be to recognize that policies greatly exacerbated the impact of supply shocks.

Let’s start with the most controversial consideration: governments across the world mismanaged the Covid-19 pandemic with disastrous economic consequences. A growing number of studies shows that lockdowns were ineffective in containing the virus; and restrictions on global trade and travel crippled industries and supply chains but did not stop Covid-19 from spreading. Much of the adverse economic impact from the pandemic was self-inflicted. Some of the damage will prove long-lived: think of the curtailment in labor supply and the unconscionable damage to kids’ education through prolonged school closures. As I said, this is a highly controversial issue, but that is part of the problem: policymakers are still shying away from any rational assessment of their policy response.

Slightly less controversial and more openly debated is how western countries were caught unprepared by the energy shock triggered by Russia’s invasion of Ukraine. We could have acknowledged long ago that nuclear power needs to play a bigger role in a clean energy mix; that we need a reliable supply of fossil fuels while we boost renewables and await the necessary technological advances in energy storage. Just as public health policy focused single-mindedly on Covid-19 ignoring all other health, social and economic costs, energy policy focused single-mindedly on climate change and ignored energy security.

Central bankers don’t bear responsibility for energy or public health policy. But they do bear responsibility for having kept monetary policy on an extraordinarily loose setting for far too long. Misjudging the inflation surge as transitory was the lesser mistake. The bigger mistake was failing to normalize monetary conditions as the economy gained strength — both before and after the pandemic. Once inflation shot up, central banks like the Fed ad ECB found themselves with monetary policy so far away from the appropriate restrictive stance that they faced two unpalatable options: tighten policy hard and fast, and likely crash the economy, or tighten more gradually and risk high inflation getting entrenched. All while keeping a nervous eye on financial markets addicted to central bank support. This too was largely self-inflicted.

This mistake came from a blind focus on the demand side of the economy. Signs of supply problems abounded over the past decade: low productivity growth, weak investment, subdued labor force participation. But macroeconomic debates centered almost exclusively on the demand side (including the soul-searching on “Secular Stagnation”) and macroeconomic policies focused on stimulating demand. The latest supply shocks exacerbated the situation, but the demand-supply imbalance was long in the making. Central bankers acted as if loose monetary policy could compensate for supply weakness in a permanent way.

After some hesitation, central bankers sound fully determined to fight inflation. We’ll see whether they stick to their guns once unemployment rises and inflation drops a few percentage points. They say they will, let’s assume they mean it.

But a key lesson of the current predicament is that policymakers should see the whole chessboard, not focus on one narrow goal at a time, and recognize that we can’t buy prosperity through monetary and fiscal stimulus. Pondering this lesson would help much more than lamenting the misfortune of an adverse macro environment.

[This story was first published here: https://www.annunziatadesai.com/blog, where you can find more of my blogs and subscribe to the mailing list]

I find it kind of funny how “zero inflation” has come to be hailed as a blessing; not that long ago it was feared as the brink of deflation, that terrifying economic bogeyman.

Don’t get me wrong: it was a relief to see July consumer prices unchanged from June, with the year-on-year inflation rate declining to 8.5% from June’s 9.1%. The improvement, driven by a 4.6% decline in energy prices, was stronger than expected. Core inflation, which excludes energy and food prices, also came in lower than expected at 5.9%. Medium term inflation expectations came down in the latest New York Fed survey, though they were slightly up in the Michigan survey.

This is all good news. If commodities stop adding fuel to the inflation fire, the Fed will have an easier time restoring price stability, and families will preserve more of their purchasing power.

The key question though is: once the smoke of the energy shock clears, what rate of inflation are we looking at? Since the July overall price level was unchanged even though energy prices fell, it means other prices kept increasing at a solid pace. Food prices rose 1.1% on the month — that’s an annualized pace of 14%.

Food and energy prices tend to be more volatile, so core inflation is a better gauge of long-term price trends. Core CPI rose 0.3% on the month, an annualized pace of close to 4%. Various measures of underlying inflation (like those calculated by the New York Fed and the Atlanta Fed) are still running at 5–6%.

Bottomline: even without adverse supply shocks we probably have inflation running at more than twice the Fed’s 2% target. The Fed’s job is definitely not done yet.

My friend and former colleague JP Soltesz raised another important question in a LinkedIn comment to my last blog: the high inflation rates of the past twelve months have generated much hand-wringing, but we know inflation had undershot in past years; so are price levels now about where they would have been if inflation had been running at 2% all along?

In its new monetary policy framework launched in August 2020, the Fed promised to let inflation run above 2% for long enough to make up for previous undershoots. In other words, it said it would aim to achieve 2% inflation on average.

So, mission accomplished?

It depends. If we take the Fed’s favorite inflation rate, the Personal Consumption Expenditure deflator (PCE), the answer is yes. The Fed never specified over what time horizon inflation should average 2%. Let’s take as a starting point the beginning of 2009, when the global financial crisis brought us the specter of deflation (I am being generous to the Fed here, because inflation ran consistently above target during 2000–08). PCE price levels are now about 1% higher than they would have been if PCE inflation had been running at 2% per year since 2009. On this metric, mission accomplished.

CPI prices, however, are 7% higher than if CPI inflation had been running at 2% all along. That’s a significant overshoot — and a big chunk out of households’ purchasing power.

That’s quite a difference. So which one should it be, CPI or PCE? There are two main differences between the two measures. One is technical: the PCE adjusts more rapidly to take into account changes in what people actually buy. The other relates to coverage: for example CPI measures out of pocket medical expenses, whereas PCE also captures health expenditures covered by employers, Medicaid and Medicare; PCE gives a much lower weight to housing costs (23% versus 42% in CPI). If you are interested you can find more details in this Brookings piece.

One can make a solid argument in favor of PCE. However, (1) the Federal government relies mostly on CPI, for example to inflation-adjust Social Security benefits and income tax brackets; (2) most other countries use CPI, so international comparisons are based on CPI; and (3) the public debate on inflation centers on CPI. With inflation running so high, and given that CPI inflation tends to run consistently higher than PCE, it becomes awkward to anchor monetary policy on PCE.

I’ll conclude with a mischievous question. The Fed’s 2% average inflation target sounds symmetric. So, if inflation keeps overshooting the 2% trend, should the Fed then force a new period of below-2% inflation to make up for the overshoot? I would strongly suggest not, and I doubt the Fed would consider it. But this shows that the Fed’s new policy framework was not just poorly timed but also poorly designed. Poorly timed because it made the Fed too slow to react as inflation accelerated; Poorly designed because it could increase volatility in both monetary policy and economic outcomes. I would prefer a humbler, statistical interpretation of an average inflation target: try to steer inflation towards 2%, recognizing that sometimes you will undershoot and sometimes you will overshoot. Trying to hit a precise medium-term price level target is self-defeating.

[This story was first published here: https://www.annunziatadesai.com/blog, where you can find more of my blogs and subscribe to the mailing list]

July’s jobs data came in better than expected, and stock sold off. From the markets’ perspective, if a company performs better than expected, it’s good news, but if the economy as a whole does, it’s bad news. Fallacy of composition.

The financial press has a logical explanation: stronger jobs data imply the Federal Reserve will have to raise interest rates even more, making a recession more likely.

I think this gets the logic backwards. If you are worried about a recession, the latest data are very good news. The economy added over half a million jobs in July, and June data were revised upwards, raising the 3-month moving average to about 440k.

The unemployment rate is at 50-year low. Job openings came down a bit in June but remain extremely high, supporting the continued uptrend in hirings.

Across the economy, employers kept hiring even though interest rates have risen , and even though media headlines keep warning we are — or soon will be — in recession.

The Fed had already indicated it will keep raising rates through the end of this year and into the next. A stronger economy has a much better chance of withstanding higher interest rates while the Fed assesses what happens to inflation as exogenous shocks on energy and other commodities fade out (hopefully).

Maybe markets are worried the Fed will tighten too much. The latest data showed wage growth still runs above 5%, so high inflation is not just driven by supply shocks — and the Fed has said it will need to cool the labor market to bring inflation under control. But surely a stronger economy can also hold up better against tougher monetary tightening.

Look at it the other way around: if the labor market were already crumbling, with interest rates still very low in absolute terms (and very negative in real terms, given that inflation is running at 9%), we should be much more worried that a recession is imminent.

A more likely explanation is that markets are worried about higher interest rates per se, not about a recession. Worried we might see the end of this comfortable era of ample liquidity and extremely low interest rates.

But that era was never sustainable. It was certainly not compatible with robust economic growth and rising living standards — at best with a dismal depressing “secular stagnation” scenario. We should be happy to leave it behind.

The next step should be to stop obsessing about demand stimulus and refocus on the supply side of the economy. One disappointing element of the July jobs report was the stagnation in the labor force participation rate. For stronger long term growth we will need to pull more people back into the labor market and to support continued investment and innovation. You know, the kind of factors that allow an economy to grow even without negative interest rates and quantitative easing…

[This story was first published here: https://www.annunziatadesai.com/blog, where you can find more of my blogs and subscribe to the mailing list]