Deja Vu

By Matthew Gutierrez and Shawn O'Malley, edited by Robert Leonard · February 07, 2023

Welcome back, readers, 2021 is off to a hot start — err, 2023. It does feel like 2021 again, though. The Nasdaq is up almost 16% year-to-date, while Bitcoin is up 40% over that same period, and we're only seven days into February 

Meme stocks are also back, with the company that's seemingly always teetering on bankruptcy but may finally be going under, Bed Bath & Beyond, surging 92% yesterday in frenzied trading. 

 That is, until it collapsed today, falling about 50% on fears that the company is in a "death spiral," hoping to use last-ditch share issuances to save itself. 

In another blast from the past, Zoom's stock rallied nearly 10% today, though only on news of mass layoffs.

2023 is looking like some weird blend of 2021 and 2022 so far: Erratic market behavior meeting harsh economic realities.

Here's the year-to-date performance:

MARKETS

*All prices as of market close at 4pm EST

Today, we'll discuss two items in the news: 

• The latest musings from the Fed's leadership 
• Worries over the consequences of deepfake tech
• Plus, our main story on a new way to understand inflation

 All this, and more, in just 5 minutes to read.

IN THE NEWS

?? Powell: 'Disinflationary Process Has Begun' (Yahoo)

Explained:

• The inflation-Fed story isn't going away anytime soon: Federal Reserve Chair Jerome Powell said Tuesday the "disinflationary process" in the U.S. economy has begun, but additional rate hikes will likely be necessary to bring inflation back to its 2% target. 
• Powell said this process will "take quite a bit of time, and is not going to be smooth," adding: "We will likely need to do additional rate increases."
• Powell said the strong labor market "shows you why we think (disinflation) will be a process that takes a significant period of time." He said it's "good" that inflation is falling in tandem with a strong labor market. 

Why it matters:

• Investors can often use Powell's comments to support both a hawkish and dovish stance. What's clear from his remarks is that Friday's strong jobs report likely won't change the Fed's approach to future rate increases, as he said there's still work to do.
• Last week, the Fed raised interest rates by another 0.25%, the second straight meeting it slowed its pace of interest rate hikes. In December, the central bank raised rates by 0.50%. In each of the prior four meetings, the Fed had raised rates by 0.75%. 
• Asked about the timeline for taming inflation to the 2% target, Powell said the process would likely take into 2024. Some commentators have suggested the Fed's current 2% target ought to be raised, but Powell said this remains a firm target for the foreseeable future. 

 ??Worries Mount Over 'Deepfake' Tech (NYT)

Explained:

• Amid the widespread talk of ChatGPT, there's growing concern of "deepfake" technology, which has progressed rapidly over the last decade. It has the ability to create talking digital puppets, and the A.I. software is sometimes used to distort public figures or spread misinformation. This is a new chapter in information warfare. 
• A video last year falsely showed Volodymyr Zelensky, the president of Ukraine, announcing a surrender. But the software can create characters out of whole cloth, going beyond editing software, blurring the line between fact and fiction. 
• A British A.I. company called Synthesia makes software for creating deepfake avatars. The software, which costs as little as $30 a month, produces videos in minutes that could otherwise take several days and would require hiring a video production crew and human actors. 

Why it matters:

• Leaders at Synthesia and elsewhere are calling on policymakers to set clearer rules about how the A.I. tools could be used. Identifying disinformation is expected to only become more difficult as the A.I. improves. Experts say deepfake technology will become sophisticated enough to "build a Hollywood film on a laptop without the need for anything else."
• Disinformation peddlers will continue experimenting with A.I. software to produce increasingly convincing media that's hard to detect and verify. Few governments have approved regulations, often because of free-speech concerns. 
• While the technology can be used for enormously helpful studies and creations, it can incite violence. The Department of Homeland Security has identified risks including cyberbullying, blackmail, stock manipulation, fraud, and political instability. 

CHART OF THE DAY

MAIN STORY: A NEW WAY TO UNDERSTAND INFLATION

Studying inflation

While it comes as little relief to your bank account, the last two years of inflationary shocks have provided researchers with incredible case studies for understanding how higher prices can ripple through modern, advanced economies.

Academics will study this period, hoping to garner insights that may help policymakers better navigate uncertain economic environments. 

One economics professor, Isabella Weber of UMass Amherst, has already done much of this intellectual heavy lifting in a recent study that offers a third approach to understanding inflation.

What are the first two ways?

There are many ways to understand the sweeping macroeconomic phenomenon that is inflation, but two primary schools of thought have dominated discussions: Monetarism and New Keynesian Economics.

Before your eyes glaze over, to oversimplify things, Monetarism derives from the famous economist Milton Friedman, who argued: "inflation is always and everywhere a monetary phenomenon, in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output (supply)."

In other words, too much 'money printing' is the driving cause of any significant inflationary outburst.

The New Keynesian approach, a modified outlook of the famous economist John Maynard Keynes' opinions, emphasizes that inflation is principally a result of imbalances between supply and demand throughout the economy, particularly in the utilization of supply-side production capacity, not just the result of money supply growth. 

These thinkers might argue that we would have still seen a rise in inflation to some extent over the past two years, regardless of money supply growth from government spending and lending programs, as supply chains got disrupted by Covid lockdowns, limiting the amount of goods/services available to people locked at home shopping online. 

In econ jargon, our aggregate capacity to meet demand was hugely impaired.

Understanding Keynesian Economics 

Keynes felt that governments could tame the business cycle with counter-cyclical measures that dulled the pain of downturns via increased government spending/lower taxes and lower interest rates. 

On the flip side, governments could cool inflation and slow their economies by raising interest rates or taxes.

If that sounds familiar, well, that's because this framework has become doctrine for policymakers globally. 

As reflected by the Phillips Curve, inflation and employment were thought to almost always have an inverse relationship. The stagflation of the 1970s (stagnating economic growth and high inflation), however, flipped Keynesian theories upside down. 

Policymakers faced a paradox: they could either boost the slowing economy with more spending and loose monetary policies that would risk spiraling inflation out of control, or raise rates and cut spending, which would broadly cool inflation but at the expense of economic growth.

Counter-cyclical policies in both directions were no longer helpful without significant tradeoffs.

What are New Keynesians?

New Keynesians added microeconomic dimensions to the classic Keynesian theories to improve them, namely that prices and wages are "sticky."

For example, we all expect (or at least hope for) pay raises each year, but how many of us have had pay cuts within the same job? It happens, but not as frequently as raises. 

Rather than cutting all workers' salaries by 10%, which is psychologically painful for everyone at the company, many firms choose to cut, say, 10% of their employees' salaries by 100% (layoffs) to save money in a recession. 

Thus, wage levels are generally sticky, because they rise over time but seldom fall.

Despite additions to and blending of these two frameworks (Monetarism and Keynesian Economics), leaders at the Federal Reserve still today would be the first to admit that our collective understanding of inflation is deeply incomplete.

A third way to understand inflation

Isabella Weber's paper hopes to fill in the gaps, offering a new way to ponder inflation. While original (and New) Keynesian and Monetarist models tend to be very big picture, macro-focused, her approach narrows in on how disruptions at the microeconomic level ripple through the economy. 

She says, "what we're trying to do here is to think of prices as an interconnected network where, since one sector's output is another sector's input, and therefore one sector's output prices are the costs for another sector, you can trace price movements across the whole production network" using what she calls "input-output tables."

While the proposition is new to today's economists, Weber explains that input-output tables are rooted in wartime economics. Specifically during World War II, when the Allies were looking to determine which bombing targets would maximize damage to the German economy. 

Intuitively, certain operations are more systemically important than others — targeting a candy shop would not yield the same economic costs as an oil refinery. 

Her study attempts to quantify different industries' impacts on inflation rates, as measured by the Consumer Price Index. 

Takeaways

Rather than seeing inflation as purely a result of too much money printing or as a tradeoff with employment, producing the heavy-handed solutions that governments and central banks employ today (i.e., raising interest rates for the entire economy), her insights may enable policymakers to take a more targeted approach focused on sectors with the greatest ripple-through effects.

She argues, "shocks to specific sectors can matter in that they can unleash processes that actually unsettle the stability of prices overall...We want to know where these points of vulnerability are so that we can react to these shocks before they ripple throughout the whole system."

In other words, the government ought to intervene when critical pockets of the economy come under stress. 

Dive deeper

Weber offers a compelling framework, which will likely serve as the basis for more tailored approaches to addressing inflation in the future. 

You can read her full paper here, or listen to her recent podcast interview on Bloomberg.

SEE YOU NEXT TIME!

That's it for today on We Study Markets! 

 See you later!

All the best,

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