Interview with Emi Nakamura: All Things Macro

Noah Smith serves as interlocutor in an insightful interview with Emi Nakamura (“Interview: Emi Nakamura, macroeconomist,” Noahpinion, February 21, 2022).

The interview isn’t overlong and should probably be read in full. But here are a couple of tastes:

On Why Inflation Has Risen

The recent increase in inflation is much more than historical experience would have predicted (which is about an increase in inflation of 1/3% for every 1% decrease in unemployment). I think several factors have been important. 

First, after a long hiatus from playing a major role in inflation, supply shocks are back! The most dramatic of these is the disruptions to the labor market. US labor force participation is down by roughly 1.5%, and so far the decline is pretty persistent. And the shocks to labor supply go far beyond that: many workers are out sick, or quarantined (or are at risk of this). … There have also been other important supply shocks: it’s more expensive to operate a daycare or a factory than it used to be due to safety restrictions due to COVID. It used to be hard to come up with good examples of negative supply shocks in teaching undergraduate economics classes, but COVID certainly counts as one!

Second, there has been a historic shift in demand from services to goods. In the Great Recession, the fraction of expenditures spent on goods fell. The opposite happened during COVID: the fraction of spending on goods rose pretty dramatically. This is another tectonic shift in the economy that I think is putting enormous pressure on supply chains among other things. Many more people are working from home, and they all need computers, and the semi-conductors needed to build those computers. All those goods have to be shipped to the United States and to people’s houses. This is a supply “pressure” but not really a “supply shock” because its ultimate cause is an increase in demand (at least for certain kinds of goods). But a recent Jackson Hole paper points out that secular shifts in demand can lead to the same inflationary pressures as supply shocks. …

Third, there has been a very rapid recovery and a lot of government support for spending. Households have a huge buildup in savings, and spending this down is no doubt contributing to demand.  …

One graph that strikes me as interesting in assessing the role of these different factors is this one. This graph shows the inflation rate for the shelter and non-shelter components of the CPI [Consumer Price Index] along with the unemployment rate. I graphed these series back to 1990 because that’s roughly when long-run inflation expectations started to stabilize in the US. Here you see very clearly the fact that the shelter component of the CPI is quite cyclical, whereas the non-shelter component is much more volatile (for example, the big commodity-driven fluctuations in 2008). Even during the COVID period, the shelter component of the CPI has a reasonably stable relationship versus the unemployment rate whereas the non-shelter component has increased pretty dramatically. It’s important to recognize that the shelter component of the CPI in the US is based on rental costs: so this isn’t exposed to either supply chains or labor market shortages. So one interpretation of this graph is that it suggests a big role for the first two factors I emphasized, as opposed to only conventional aggregate demand factors. However, some are predicting a big catch-up in rent inflation soon, and perhaps some of these patterns also have to do with demand shifts related to housing. We have to be humble in extrapolating past relationships to the present given the fundamental shifts that COVID has imposed on the economy.

One thing that hasn’t contributed much to inflation so far is an unhinging of longer run inflation expectations. Both survey and market-based measures of longer run inflation expectations look pretty stable … There has been a notable uptick in longer run inflation expectations in the very recent past, but so far it is small. It’s one of the Fed’s primary goals these days to keep it that way. 

Question Assumptions

When I was an undergraduate at Princeton, I remember sitting in the office of one of my advisors, Bo Honore, and pondering the sign he had on the wall: “Question Assumptions.” When I came for my job interview at Berkeley a few years ago, I was sitting in the office of the department chair at the time, Jim Powell. I looked up and saw exactly the same sign: “Question Assumptions.” After recovering from the deja vu, I learned that the sign was acquired from a counterculture hippie when Bo and Jim were strolling around downtown Berkeley. I’m pretty sure the sign wasn’t originally intended as research advice for aspiring economists, but I still think of this as some of the best advice I’ve gotten, and some of the best advice to pass on.

The interview also includes some discussion of how Nakamura thinks about doing empirical macroeconomics, and in particular the role of using microeconomic data to help discipline and guide macroeconomic models. Some of the discussion draws up on an article by Nakamura and Jón Steinsson in the Summer 2018 issue of the Journal of Economic Perspectives,  “Identification in Macroeconomics.”