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SUMMARY
Paul Krugman discusses the recent record low in consumer sentiment as measured by the University of Michigan survey, emphasizing the growing concern over entrenched inflation expectations. He warns that the latest data suggest the U.S. may be entering a period reminiscent of late 1970s stagflation, with potentially severe long-term economic consequences.
MAIN POINTS
- Consumer sentiment has reached a record low according to the University of Michigan survey, reflecting widespread dissatisfaction with prices and economic management.
- Short-term inflation is tolerable, but the real danger arises if inflation becomes entrenched in expectations, influencing how businesses set prices.
- Entrenched inflation expectations historically required severe recessions and high unemployment to reverse, as seen in the early 1980s after the inflation of the 1970s.
- Medium-term inflation expectations, which remained stable during the recent inflation surge, have now risen sharply, indicating a shift toward entrenched inflation.
- The latest Michigan survey shows expected five-year inflation at 3.9%, the highest since the early 1980s, suggesting that inflation is becoming embedded in public expectations.
- Krugman concludes that policy missteps have created conditions similar to late 1970s stagflation, warning of prolonged economic pain ahead.
DETAILED ANALYSIS
Recent data from the University of Michigan survey reveal a significant decline in consumer sentiment, reaching levels lower than those seen during the financial crisis and the stagflation era around 1980. This widespread pessimism is attributed to dissatisfaction with rising prices and perceived poor economic management. While such sentiment is concerning, the more critical issue lies in the shift of inflation expectations among consumers.
Inflation, when short-lived, can be managed without severe consequences, but it becomes a major problem if expectations of persistent inflation become entrenched. This entrenchment affects how businesses and workers set prices and wages, often leading to a self-reinforcing cycle of rising costs. Historically, such situations have required harsh measures, including prolonged periods of high unemployment, to restore price stability, as was the case in the early 1980s following the inflationary pressures of the previous decade.
Krugman notes that during the recent inflation surge of 2021–2022, medium-term inflation expectations remained relatively stable, which suggested that the situation would not require drastic interventions. However, in the past two months, these expectations have risen sharply, with the latest Michigan survey indicating a five-year expected inflation rate of 3.9%. This is the highest reading since the early 1980s and signals that inflation is becoming embedded in the economic outlook of both consumers and, likely, businesses.
The implication is that policy errors, including trade shocks and geopolitical tensions, have contributed to a scenario reminiscent of the late 1970s, raising the prospect of enduring economic hardship as the country grapples with the consequences of entrenched inflation.