Housing Market, Exports Will Slump, Fed Has Hiked Enough

  • Paul Krugman sees a slump in the housing market and a drop in exports that will hit the US economy over time.
  • The Nobel laureate said the Fed has likely raised rates high enough to dampen inflation.
  • Krugman warned of further rate hikes and a stronger dollar could destabilize the financial system.

The US economy is expected to suffer a painful downturn in the housing market and a significant drop in exports, and that likely means the Federal Reserve has already done enough to fight inflation, Paul Krugman said.

The central bank has been raising interest rates rapidly this year in response to the rate of inflation hitting 40-year highs.

Krugman, a Nobel Prize-winning economist, outlined in a recent New York Times column how higher interest rates weigh on demand for housing as they translate into higher interest rates on mortgage loans. This leads to less construction, people in this industry spending less and eventually the general economy slowing down.

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While building permit applications have declined, construction employment hasn’t started to shrink yet — likely because there’s a backlog of housing projects that started before interest rates rose, Krugman said.

As a result, he doesn’t expect higher interest rates anytime soon, which will weigh on property prices and housing demand.

“The broader economic impact of the coming real estate crisis is many months away,” he said.

Krugman also stressed that the US dollar’s rise to a 20-year high this year has made US exports less competitive and imports more affordable, and that this is a headwind for domestic growth.

“Declining exports and rising imports will ultimately be a major economic drag,” he said. “But switching to new suppliers takes time, so that effect won’t really materialize until next year.”

Krugman gave a few other reasons why he sees inflation easing. On the one hand, he pointed to the falling demand for apartments, since rental growth is a key driver of price increases.

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He also noted that transpacific shipping rates have dropped from about $21,000 per container in September 2021 to about $2,300 today. That suggests the supply chain disruptions during the pandemic, which triggered widespread shortages and fueled inflation, are dissipating, he said.

“I would argue that these indicators tell us that the Fed has already done enough to ensure a sharp fall in inflation – but also, all too likely, a recession,” he said.

The Fed’s rate hikes took interest rates from near zero to over 3% in March, and aggressive policy has fueled fears that it has overreacted to inflation and could hurt the US economy.

In his column, Krugman underscored the growing risk of a banking crisis or market collapse, citing the recent UK government bond fiasco as an example of the chaos that rapid rate hikes and a strong dollar could wreak.

“We don’t want financial markets to dictate Fed policy, but that doesn’t mean it should ignore financial risks,” he said.

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The Nobel laureate believes the Fed could go overboard in tackling inflation as its rate hikes have not yet had their full effect and the inflation data it tracks lags behind reality. He doubled this attitude in a Twitter thread on Saturday.

“Regardless of what the inflation and employment data are saying right now; a large reduction in inflationary pressures – and a large drag on output and employment – is already in the pipeline,” he said. “Do you really think we’ve seen anything like the full impact of the financial tightening that’s already happened?”

“I see strong arguments that the Fed has already done enough,” he added. “You want to shoot in front of a moving target, not behind it.”

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