STANFORD – The nomination of new members to the US Federal Reserve Board offers an opportunity for Americans – and Congress – to reflect on the world’s most important central bank and where it is going.

The obvious question to ask first is how the Fed blew its main mandate, which is to ensure price stability. That the Fed was totally surprised by today’s inflation indicates a fundamental failure. Surely, some institutional soul searching is called for.

Yet, while interest-rate policies get headlines, the Fed is now most consequential as a financial regulator. Another big question, then, is whether it will use its awesome power to advance climate or social policies. For example, it could deny credit to fossil-fuel companies, demand that banks lend only to companies with certified net-zero emissions plans, or steer credit to favored alternatives. It also could decide that it will start regulating explicitly in the name of equality or racial justice, by telling banks where and to whom to lend, whom to hire and fire, and so forth.

But before considering where the Fed’s regulation will or should go, we first need to account for the Fed’s grand failure. In 2008, the US government made a consequential decision: Financial institutions could continue to get the money they use to make risky investments largely by selling run-prone short-term debt, but a new army of regulators would judge the riskiness of the institutions’ assets. The hope was that regulators would not miss any more subprime-mortgage-size elephants on banks’ balance sheets. Yet in the ensuing decade of detailed regulation and regular scenario-based “stress tests,” the Fed’s regulatory army did not once consider, “What if there is a pandemic?”

When a pandemic did arrive in early 2020, the Fed repudiated the “never again” promises of 2008, this time intervening on an even larger scale. That March, the dealer banks proved unable to intermediate the market for plain-vanilla US Treasury securities. So, the Fed propped up the market. Critics had long pointed to problems with the Fed’s liquidity rules, and fixing these markets would have been simple, but obvious reforms had languished. Later, there was a run on money market funds. The Fed bailed out money market funds once again. There is nothing simpler to fix than money-market runs, but the fix never happened.

The Fed also funded new municipal-bond issues and propped up corporate bond prices, essentially offering a whatever-it-takes guarantee. In 2008, the Fed and the Department of the Treasury had balked at the idea of raising the market price of all mortgages under the Troubled Assets Relief Program. Yet in 2020, the “Powell put” had established an explicit floor for corporate bond prices – and more.

The predictable rejoinder to this critique will be: So what? The COVID-19 lockdowns might well have triggered a financial crisis. The flood of bailouts worked, so much so that our problem today is inflation. We do not need to worry about systemic risk, because the Fed and the Treasury will just put out any new fires with oceans of new money.

The problem, of course, is the incentives these policies have created. Why bother keeping cash or balance-sheet space to buy on the dip, provide liquidity, or treat a “fire sale” as a “buying opportunity?” The Fed will just front-run you and take away the profit. If you are a company, why issue stock when you can just borrow, knowing that the government will prop up your debt or bail you out, as it did for the airlines? If you are an investor, why hesitate to buy shaky debt, knowing that its value will be guaranteed by another “whatever-it-takes” commitment from the Fed in bad times?

No wonder America is awash in debt. Everyone assumes that taxpayers will take on losses in the next downturn. Student loans, government pensions, and mortgages have piled up, all waiting their turn for Uncle Sam’s bailout. But each crisis requires larger and larger transfusions. Bond investors eventually will refuse to hand over more wealth for bailouts, and people will not want to hold trillions in newly printed cash. When the bailout that everyone expects fails to materialize, we will wake up in a town on fire – and the firehouse has burned down.

In 2008, regulators and legislators at least had the sense to recognize moral hazard, and to worry that investors gain in good times while taxpayers cover losses in bad times. But the 2020 blowout has been greeted only with self-congratulation.

The same Fed that missed the subprime-mortgage risks in 2008, the pandemic in 2020, and that now wishes to stress-test “climate risks,” will surely miss the next war, pandemic, sovereign default, or other major disruptive event. Fed regulators aren’t even asking the latter questions. And while they issue word salads about “interconnections,” “strategic interactions,” “network effects,” and “credit cycles,” they still have not defined what “systemic” risk even is, other than a catch-all term to grant regulators all-encompassing power.

Regulators will never be able to foresee risks, artfully calibrate financial institutions’ assets, or ensure that immense debts can always be paid. We need to reverse the basic premise of a financial system in which the government always guarantees mountains of debt in bad times, and we need to do it before the firehouse is put to the test.

Better regulation can bridge partisan divides. The left is correct that big banks are inefficient oligopolies that serve most Americans poorly. But it has the cause wrong. An immense regulatory compliance burden is a major barrier to market entry.

Calls for “more” regulation are meaningless. Regulations are either smart or dumb, effective or ineffective, full of undesired consequences or well designed. We need better regulation. We need more capital, not many more thousands of pages of rules. Capital provides a buffer against all shocks, and it does not require regulators to be clairvoyant. The Fed has scandalously blocked narrow-banking enterprises and payments providers that could help serve many Americans’ financial needs.

Before turning to healing the planet and righting injustice, the Fed should be held to account for how badly it is doing on the basic task of protecting the financial system.

FRANKFURT – Our fiat money regime requires an institutional anchor that credibly and decisively ensures a stable price level and long-term confidence in the euro. Credibility is a central bank’s greatest asset, because it underwrites confidence in the purchasing power of money. And credibility, in turn, rests on the central bank’s independence from political influence, and on its commitment to monetary stability.

Viewed in this light, the European Central Bank has been in dangerous waters for several years. It has jeopardized its political independence and compromised its primary objective. Actions that are clearly intended to anticipate political pressure leave no doubt that it has exceeded its mandate.

For example, during the euro sovereign debt crisis that began in late 2009, the ECB actively participated in the restructuring of Europe’s Economic and Monetary Union (EMU). With its Security Markets Program, it abandoned important monetary-policy principles, including the ban on monetary financing of government debt and the requirement of a single monetary policy for the eurozone. The ECB also took a leading role in rescuing EU member states hit hard by the crisis, even though this was the respective national governments’ responsibility. The boundaries between monetary and fiscal policy thus were deliberately blurred, leading to close coordination between the two.

With then-ECB President Mario Draghi’s unilateral commitment to “do whatever it takes to preserve the euro,” the ECB set itself up as lender of last resort for the eurozone. The attempt to attach conditions to this role in the ECB’s “outright monetary transactions” program failed. Indeed, the program was never activated, and has since been replaced by the Asset Purchase Program and the Pandemic Emergency Purchase Program.

By purchasing government debt, the ECB has fundamentally distorted bond markets, arguing that it is trying to prevent market fragmentation. But now that risk premiums have leveled out and market access with favorable conditions has been secured for all eurozone member states, governments have an incentive to increase their already exorbitantly high public debt levels. Highly indebted states such as Italy and France presumably will rely on this safeguard indefinitely.

Worse, the ECB’s operations exceeding the limits of EU treaties and statutes have intensified during Christine Lagarde’s presidency. Invoking “secondary objectives,” the ECB has committed itself to promoting a “green transformation.” The ECB wants to help improve financing conditions for “green” projects and ensure that the collateral and bonds it accepts are environmentally “sustainable.”

Until 2021, the ECB’s growing politicization did not trigger any major conflict over its core mandate of ensuring price stability. But with higher inflation becoming more apparent, the situation has changed. To be sure, leading ECB representatives still dismiss today’s inflation as temporary. No one disputes the fact that some factors influencing inflation are temporary. But the problem is that other factors may persist longer than projected.

Hence, it is becoming increasingly clear that inflation will gain momentum without monetary-policy countermeasures, auguring the end of the era of price stability. That puts the ECB in a difficult position because it will simultaneously be confronted with several acute problems of its own making.

First, the ECB’s monetary financing of new sovereign debt has created a money overhang, and now robust demand is running up against the supply constraints caused by the pandemic. The result is higher prices, which are likely to become endemic through subsequent wage increases. The ECB must take seriously the risk of a wage-price spiral, even if there are few hints of this happening at present.

Second, it is becoming increasingly clear that the “green transformation” will not be possible without a surge of inflation. Ideally, fossil-fuel energy sources should become more expensive to the same extent that renewable energy becomes cheaper through the expansion of the relevant capacities and infrastructure. The change in relative prices should alter the structure of demand while the overall price level remains stable. In fact, production capacities for brown energy have fallen faster than new capacities for green energy could be created. As a result, fossil-fuel energy prices have risen without renewables prices falling accordingly to compensate.

Owing to the ECB’s open displays of activism and demonstrated willingness to coordinate monetary, economic, financial, and climate policies, it now faces a serious predicament. Because its core mandate is to ensure price stability, it needs to be ready for a monetary-policy turnaround.

That would mean consistently taking steps to dampen demand by reducing the money overhang (selling off the government bonds that have piled up on its balance sheet) and raising interest rates more quickly (contrary to its previous communications). Such tightening would create serious problems for highly indebted eurozone members, not only in financing new debt but also in refinancing maturing debt. Declining tax revenues and rising unemployment as the economy cools would exacerbate the problem further. The future of some countries’ EMU membership would quickly be called into question again.

But if the ECB tolerates rising inflation, it will lose credibility, owing to growing doubts about its willingness or ability to keep the value of money stable. Rising inflation expectations would lead to increasing inflation dynamics and exchange-rate depreciation, which would further increase inflationary pressures.

Like Shakespeare’s Hamlet, the ECB is faced with a quandary. Should it consistently stick to its mandate and risk another acid test for the EMU, or should it accept higher inflation, lose credibility, and seal the fate of the euro as a soft currency?

In the play, Hamlet never can decide. That is why it is a tragedy that ends in disaster.

STANFORD – This month, the world’s major central banks shifted gears and announced plans to tighten monetary policy. But there was one notable exception: the European Central Bank, which says it does not intend to raise interest rates in 2022, even though it is well aware of today’s inflation risks.

By contrast, the US Federal Reserve now expects to raise its policy rate three times in 2022, and the Bank of England has already increased its main policy rate by 15 basis points. Moreover, to keep an earlier promise that it would not raise rates until it had unwound its balance sheet, the Fed will accelerate the wind-down of its monthly asset purchases.

Does this mean that the ECB is “soft on inflation,” occupying a dovish outlier position among the world’s major central banks? Is Germany’s bestselling tabloid, Bild, justified in bestowing on ECB President Christine Lagarde the mocking sobriquet “Madame Inflation”?

No and no. While Bild may accurately reflect the traditional German view that inflation counts for everything in ECB monetary policy, that perspective is hopelessly outdated in the Europe of 2022.

Lagarde understands that withdrawing monetary stimulus after a crisis can be a fraught task. Raising interest rates too fast could tear apart the currency union by pushing up borrowing costs and stifling the recoveries of heavily indebted member states like Italy, Spain, and Greece. Economists call this “fragmentation risk.” Fragmentation of the currency area is a chronic issue for the eurozone, because, unlike the Fed and the BOE, which both are backed by a single fiscal authority, the ECB operates with 19 independent fiscal authorities.

This may have been uppermost in Lagarde’s mind at her December press conference, where she explained that gradualism is necessary to avoid a “brutal transition” to a more restrictive monetary policy. Not surprisingly, that statement provoked a churlish response from the traditionally hawkish outgoing Bundesbank president, Jens Weidmann. Similarly, Christian Lindner, the new German finance minister, says there are growing fears in Berlin that the ECB’s sensitivity to heavily indebted member states’ borrowing costs would lead it to withdraw stimulus too slowly.

In a way, Lindner is right. Lagarde indeed is in no rush to tighten monetary policy, because of her concern for keeping the currency union intact as the stimulus is scaled down. Like a responsible medical professional, she does not want to rush the process of weaning an addict off a powerful drug. And make no mistake, the ECB’s stimulus policies have had a potent effect on the economy, which in turn has become dependent on them.

Always politically savvy, Lagarde understands that in a region that has created a €750 billion ($850 billion) recovery fund to keep the currency union together, a monetary policy that threatens to split the union would not sit well with the public. A “cold turkey” approach would be as reckless politically as it would be economically.

The biggest potential source of fragmentation risk today is Italy, with its €2.6 trillion in public debt and a long history of political instability. Managing these conditions requires very careful handling. So far, investors seem pleased with Italian Prime Minister Mario Draghi’s leadership. But they fear that political instability will return if Draghi chooses to pursue the presidency (generally a more ceremonial role) following Sergio Mattarella’s imminent departure from that office.

Financial markets already quaked after Draghi’s end-of-year press conference earlier this month, when he suggested that his stay in office might be ending soon. But investors should relax, because there is only a small chance of Draghi becoming Italy’s next president. Most likely, his hint at the press conference was a tactic to gainsay two of Italy’s largest trade unions, the Italian General Confederation of Labour (CGIL) and the Italian Labor Union (UIL), following their call for a general strike just days ahead of a parliamentary vote to approve a crucial budget law. The wily former ECB president-turned-politician knows that sometimes there is nothing like threatening to quit to get one’s way.

It should go without saying that Lagarde’s effort to manage the eurozone’s fragmentation risk will be a lot easier if her predecessor at the helm of the ECB remains in his current post until his term expires in 2023. In my view, he will do just that. But some additional encouragement from Brussels and Berlin could go a long way toward ensuring that Draghi remains in his post – and that the European recovery stays on track.

NEW DELHI – The question of how best to control inflation is back on the economic policy agenda, and opinion is divided about how to address it. The mainstream view emphasizes the need for tighter monetary policies and regards higher interest rates and reduced liquidity provision as justified, even if they dampen the fragile economic recovery now underway in many countries. Others argue that today’s inflation is transitory, reflecting temporary supply bottlenecks and labor-market shifts, and will soon correct itself.

In rich countries, policymakers still rely mainly on macroeconomic tools to tackle inflation. But one set of price increases is different from the others: food-price inflation. Not only does this phenomenon have a much greater direct impact on people’s lives, especially in developing economies; it also reflects more complex causes, and addressing it effectively requires a completely different set of strategies. Unfortunately, governments are not discussing them sufficiently.

This neglect is deeply troubling. At the end of 2021, the United Nations Food and Agriculture Organization’s (FAO) food price index was at its highest level in a decade and close to its previous peak of June 2011, when many were warning of a global food crisis. Moreover, last year’s increase was sudden: from 2015 to 2020, food prices had been relatively low and stable, but soared by an average of 28% in 2021.

Much of this surge was driven by cereals, with maize and wheat prices increasing by 44% and 31%, respectively. But prices of other food items also shot up: prices for vegetable oil hit a record high during the year, sugar was up by 38%, and price increases for meat and dairy products, though lower, were still in the double digits.

Food-price inflation currently exceeds the increase in the overall price index, and is even more alarming given the significant decline in workers’ wage incomes during the COVID-19 pandemic – especially in low- and middle-income countries. This lethal combination of more expensive food and lower incomes is fueling catastrophic increases in hunger and malnutrition.

There are many possible reasons for the spike in food prices. Some are systemic. Supply-chain problems – especially regarding transportation – have been a major factor driving price increases for a wide range of commodities. Thus, grain prices rose rapidly in 2021, despite record global output of nearly 2.8 billion tons.

Energy prices also are important in determining the cost of producing and transporting food. The large increase in oil prices in 2021 obviously affected the food prices faced by consumers.

In addition, more frequent extreme weather events make crop output more volatile and reduce yields. Some have argued that prices of agricultural commodities as disparate as Brazilian coffee, Belgian potatoes, and Canadian yellow peas (now widely used by the food industry to produce plant-based meat substitutes) rose sharply last year after weather events induced by climate change undermined output.

In March 2021, the FAO warned that increasingly frequent climate-related disasters were affecting agricultural supplies. Droughts are the single greatest threat, accounting for more than one-third of crop and livestock losses in low- and lower-middle-income countries. But floods, storms, pests, diseases, and wildfires have also become more intense and widespread, as was evident last year.

We can expect much more climate-related pressure on food production in the coming years, with developing regions in Asia and Africa likely to be hit hardest. The threats to food production from climate risk underscore the need for greater international cooperation to tackle global warming and its consequences. Sadly, such collaboration seems unlikely.

But some of the other factors contributing to food price increases are the direct result of policy and regulatory changes. These include the significant increase in stockpiling by governments and consumers, driven by fears that new waves of the COVID-19 pandemic will put further pressure on food supplies. The expectation of future food price increases then becomes self-fulfilling, owing to higher current demand.

Last November, the FAO estimated that the global food import bill in 2021 would be the highest ever, at more than $1.75 trillion, a 14% increase from 2020 and 12% higher than the FAO’s forecast just a few months earlier. This is bad news for lower-income economies, which may have more pressing food import requirements than other countries but could be squeezed out of global markets because of increased demand.

The other important factor is financial speculation in food markets, which has recently experienced a revival. Food commodities became an asset class after financial deregulation in the United States in the early 2000s, and there is significant evidence that this played a major role in the destabilizing food-price volatility of 2007-09. In recent years, these commodities had become less attractive to investors, but that changed during the pandemic.

Despite high volatility, long positions in major food commodity markets were significant and positive for most of 2021, suggesting that financial investors were expecting prices to increase. The volume of such investments grew substantially last year, enabled by persistent regulatory loopholes and the availability of cheap credit to financial institutions.

Unlike some of the more systemic forces affecting food supply and prices in the medium term, policymakers could easily address the issues of stockpiling and speculation. But that requires governments to accept that these are problems, and to muster the will to address them. Until they do, food-price inflation will continue to hit the world’s poor the hardest.

CAMBRIDGE – The specter of inflation is once again stalking the world, after a long period of dormancy during which policymakers were more likely to be preoccupied by price deflation. Now, old debates have resurfaced on how best to restore price stability.

Should policymakers step on the monetary and fiscal brakes, by reducing spending and raising interest rates – the orthodox approach to fighting inflation? Should they instead move in the opposite direction by lowering interest rates, a route followed by Turkey’s central bank under the direction of President Recep Tayyip Erdoğan? Or should policymakers perhaps try to intervene more directly, through price controls or by clamping down on large firms with price-setting power, as some economists and historians in the United States have argued.

If you have a knee-jerk reaction to these policies – immediately endorsing one remedy while rejecting others out of hand – think again. Economics is not a science with fixed rules. Varying conditions call for different policies. The only valid answer to policy questions in economics is: “It depends.”

Orthodox remedies for inflation often have costly side effects (such as bankruptcies and rising unemployment) and have not always produced the desired effects quickly enough. Price controls have sometimes worked, during wartime for example.

Moreover, when high inflation is driven predominantly by expectations rather than “fundamentals,” temporary wage-price controls can help coordinate price-setters to move to a low-inflation equilibrium. Such “heterodox” programs were successful during the 1980s in Israel and in a number of Latin American countries.

Even the idea that lower interest rates reduce inflation is not necessarily outlandish. There is a school of thought within economics – dismissed by most mainstream economists today – which associates inflation with cost-push factors, such as high interest rates (which boost the costs of working capital).

The inflation-producing effects of high interest rates is called the “Cavallo effect,” after former Argentine finance minister Domingo Cavallo, who discussed it in his 1977 Harvard doctoral thesis. (Ironically, Cavallo would resort to a very different inflation-fighting strategy – based on a fixed exchange rate and full currency convertibility – when he assumed office in perennially high-inflation Argentina during the 1990s.) The theory has even received some empirical support in particular cases.

That is why ridiculing currently unfashionable ideas on inflation as “science denial” akin to rejecting COVID-19 vaccines, as some prominent economists have done, is so misplaced. In fact, when a particular claim about the real world appears inconsistent with existing theories, this is often an invitation for a young, smart economist to demonstrate that the claim can indeed be justified, under certain specific conditions. The true science of economics is contextual, not universal.

What might a contextual approach to inflation imply today?

Current inflation in the US and many other advanced economies differs significantly from the inflation of the late 1970s. It is neither chronic (so far), nor driven by wage-price spirals and backward indexation.

Inflationary pressure seems to derive largely from a transitory set of factors, such as the pandemic-related reallocation of spending from services to goods, and supply-chain and other disruptions to production. While expansionary monetary and fiscal policies have boosted incomes, these policies, too, are temporary. The alternative would have been a dramatic collapse in employment and living standards.

Under current circumstances, then, policymakers in developed countries should not over-react to the spike in inflation. As the historian Adam Tooze has argued, transitory inflation calls for a restrained response, whether through regulation or monetary policy.

The best argument against price controls is not that they are “incompatible with science” but that nothing so radical needs to be considered for now. The same caution would apply to orthodox policy as well: central banks should be patient before raising interest rates.

What about Erdoğan’s continued insistence that high inflation is the result rather than the cause of high interest rates? The validity of his argument has always been in doubt, given that Turkey’s macroeconomic imbalances are legion and have been building up for quite some time.

Even when an argument cannot be settled beforehand, facts eventually allow us to distinguish among theories that do and do not make sense in a given place. In Turkey’s case, the evidence that has accumulated since policymakers embarked on Erdoğan’s experiment speaks loudly and clearly.

In particular, despite the lowering of the Turkish central bank’s policy rate – the interest rate that the monetary authorities control directly – market interest rates have continued to rise. Depositors and savers have demanded higher rates, driving up the price of credit for borrowers.

This undermines the argument that lower policy rates could effectively reduce production costs for firms. It indicates that the rise in interest rates reflects more fundamental problems with the economy, uncertainty about the conduct of economic policy, and higher inflation expectations for the future.

Sometimes, as in Turkey’s case, the orthodox economic argument is indeed the correct one. Experiments that depart from conventional policy can be costly. But this does not mean that there are universal rules in economics or that the prevailing view among mainstream economists should determine policy. Otherwise, some of the most important policy innovations in history – think of the New Deal in the US or industrial policy in post-World War II East Asia – would never have occurred.

In fact, today’s dominant monetary policy framework, inflation targeting, is itself a product of the peculiar political and economic circumstances that prevailed in New Zealand during the 1980s. It sat uncomfortably with the theory of monetary policy of the time.

Economists should be humble when they recommend (or dismiss) various inflation-fighting strategies. And while policymakers must pay attention to economic evidence and arguments, they should be skeptical when the economists who advise them display excessive confidence.

CAMBRIDGE – In 2008, as the global financial crisis was ravaging economies everywhere, Queen Elizabeth II, visiting the London School of Economics, famously asked, “Why did nobody see it coming?” The high inflation of 2021 – especially in the United States, where the year-on-year increase in consumer prices reached a four-decade high of 7% in December – should prompt the same question.

Inflation is not nearly as bad as a financial crisis, particularly when price increases coincide with a rapid improvement in the economy. And whereas financial crises may be inherently unpredictable, forecasting inflation is a staple of macroeconomic modeling.

Why, then, did almost everyone get the US inflation story so wrong last year? A survey of 36 private-sector forecasters in May revealed a median inflation forecast of 2.3% for 2021 (measured by the core personal consumption expenditures price index, the US Federal Reserve’s de facto target gauge). As a whole, the group put a 0.5% chance on inflation exceeding 4% last year – but, by the core PCE measure, it looks set to be 4.5%.

The Fed’s rate-setting Federal Open Market Committee fared no better, with none of its 18 members expecting inflation above 2.5% in 2021. Financial markets appear to have missed this one as well, with bond prices yielding similar predictions. Ditto the International Monetary Fund, the Congressional Budget Office, President Joe Biden’s administration, and even many conservative economists.

Some of this collective error resulted from developments that forecasters did not or could not expect. Fed Chair Jerome Powell, among many others, blamed the Delta variant of the coronavirus for slowing the reopening of the economy and thus driving inflation higher. But Powell and others had earlier argued that the increase in inflation in the spring of 2021 was spurred by an overly rapid reopening as vaccination reduced case numbers. It is unlikely that both of these excuses are correct. The emergence of Delta, like the pandemic in 2020, probably kept inflation lower than it otherwise would have been.

Supply-chain disruptions were another unanticipated development that allegedly blew up inflation forecasts. But while the pandemic has caused some genuine bottlenecks in production networks, most are churning out much more than last year, with both US and global manufacturing output and shipping up sharply.

This brings us to a more important source of forecasting error: not taking our economic models seriously enough. Forecasts based on extrapolation from the recent past are nearly always as good as, or better than, those based on more sophisticated modeling. The exception is when there are economic inputs that are well outside the realm of recent experience. For example, the extraordinary $2.5 trillion in fiscal support for the US economy in 2021, amounting to 11% of GDP, was far larger than any previous fiscal package since World War II.

A simple fiscal multiplier model would have predicted that average output in the last three quarters of 2021 would be 2-5% above pre-pandemic estimates of potential. To think that a stimulus of this magnitude would not cause inflation required believing either that such a huge adjustment was possible within a matter of months, or that fiscal policy is ineffective and does not increase aggregate demand. Both views are implausible.

Economic models also gave us substantial reason to believe that several factors would reduce the US economy’s potential in 2021. These included premature deaths, reduced immigration, foregone capital investment, the costs of hardening the economy to COVID-19, pandemic-induced exits from the workforce, and all of the difficulties of rapidly reassembling an economy that had been torn apart. Such constraints made it very likely that additional demand would push inflation even higher.

A final set of errors arose because our models were missing key inputs or interpretations. To the degree that people relied on economic models, they often used a Phillips curve to predict inflation or changes in inflation based on the unemployment rate. But these frameworks had difficulty reckoning with the fact that the natural rate of unemployment likely rose, at least temporarily, as a result of the COVID-19 crisis.

More important, unemployment is not the only way to measure economic slack. Estimates from before the pandemic show that the “quit rate” and the ratio of unemployed workers to job openings are better predictors of wage and price inflation. These other indicators of slack were already tight at the beginning of 2021 and were very tight by the spring.

In retrospect, the mental model I find most useful for thinking about 2021 is to apply fiscal multipliers to nominal GDP, use them to predict how much of the fiscal stimulus will be spent, and then try to predict real GDP by understanding what the economy’s productive capacity is. The difference between the two is inflation.

Multipliers indicated that total spending in 2021 would go up a lot, while production constraints suggested that output would not increase by as much. The difference was unexpectedly higher inflation.

Where does this leave us in understanding inflation in 2022? Instead of making inertial forecasts that the future will resemble the past, taking our models seriously means accounting for high levels of demand, continued supply constraints, and ever tighter labor markets with rapidly rising nominal wages and higher inflation expectations. Some types of inflation, notably in goods prices, are likely to decline this year, but others, including services inflation, will likely increase.

I therefore expect another year of significant US inflation, maybe not as high as in 2021 but plausibly in the 3-4% range. But the most important forecasting lesson from last year is humility. We should all be adding some large error bands around our expectations and be prepared to update our outlooks as the economic situation unfolds.