There Is a Painless Way to Fix Inflation

AAt its September meeting, the US Federal Reserve raised its key interest rate again sharply by three quarters of a percent. When asked what the impact of this tightening will be on the broader economy, Chairman Jerome Powell said, “I wish there was a painless way… There isn’t.” Actually, there is a painless way: stop charging interest rates raise.

The Fed is hardly alone in fixing inflation. Inflation is high on the list of concerns for most voters. The Fed’s moves represent a broad consensus that high inflation threatens the stability of the system, undermines living standards, and must be lowered even at the risk of slowing growth and triggering a recession. That’s why Fed Chair Jerome Powell said in a Jackson Hole speech in late August, “While higher interest rates, slower growth and weaker labor market conditions will lower inflation, they will also cause some pain for households and businesses… These are the.” unfortunate cost of reducing inflation. But failure to restore price stability would mean far greater pain.”

The lack of doubt now displayed by the Fed, most economists and many companies about what the problem is and what to do about it is a troubling sign of economic groupthink. In short, the Fed is making an epic mistake. It shouldn’t have done what it did, shouldn’t do what it’s doing, and shouldn’t have done what it intends to do. Past mistakes cannot be undone, but future ones can be avoided. Groupthink gets in the way.

More from ZEIT

Of course there is inflation right now, in the US and in most countries around the world. There is also broad agreement as to what caused this inflation: overspending as the pandemic began to ease in spring 2021; too much pent-up demand due to pandemic lockdowns, which exploded from summer 2021, led to massive bottlenecks in the supply chain and demand for labour; too much easy money from global central banks held up assets like stocks and houses; too little action by the Fed until it was too late; and Russia’s invasion of Ukraine caused oil and gas prices to double or more, along with wheat and corn.

Faced with such a brew, the only remedy now, as longtime inflation hawk Larry Summers has said, is to force a recession with a combination of sharp interest rate hikes and even spending cuts and tax hikes to break the fever.

Also Read :  Fed says inflation concerns remain, will continue raising rates

The belief that this period of inflation is so dangerous that it is worth the price of crushing the strongest labor and wage market in a generation has permeated nearly every central bank and government in the developed world.

The feeling that inflation is destroying wealth and creating conditions for political instability runs deep. The determination to fight rising prices stems from the Great Depression and the belief that unchecked inflation has bred fascism and poisonous nationalism in Germany and elsewhere. The equation that inflation equates to political dissolution and war may be sotto voce today, but it remains ingrained in central banks’ DNA. The experience of “stagflation” in the 1970s and the inability of policymakers in the United States to rein in it led to the appointment of Paul Volcker as Fed chairman. He drastically increased target interest rates to over 20%, triggering a recession that then paved the way for spectacular economic expansion in the 1980s and 1990s.

Today’s thesis that inflation must be brought down is the culmination of nearly a century of central bank orthodoxy. But that leaves a pretty crucial question: Is it true? Must central banks take aggressive action to cool jobs, dampen financial markets and likely trigger a recession? Is it a fact that waiting longer would result in elevated inflation rates becoming uncontrollable and entrenched? And should a strong economic recovery following an unprecedented global pandemic response be quashed because waiting will only delay the pain that may come?

Read more: We are heading towards a stagflation crisis

If you listened to what the Fed and many economists are saying, you would hardly realize that this was a biennium like no other. One might think that today is a normal and unfortunate bout of too much money, too much demand and high wages. That’s not the case. It’s different this time.

In 2020 and 2021, between the two emergency COVID-19 stimulus programs of April 2020 and March 2021 and the expansion of the Federal Reserve’s balance sheet, the US government injected up to $5 trillion into the system. This was matched by trillions of other incentives from other countries around the world. For the first time in living memory, that money went not only directly to businesses and banks, but also to individuals and small businesses to keep them afloat as government-mandated shutdowns froze economic activity and mobility. This level of spending surpassed the entire New Deal.

Also Read :  Truss says British economy ‘needs a reset’ after market sell-off

Then, almost simultaneously, the world opened up from the summer of 2021 when vaccines rolled out, and any remnants of shutdowns were largely lifted by this spring. All of the current high inflation starts at this time and was then exacerbated by Russia’s invasion of Ukraine in late February.

Inflation as a statistic measures price increases from year to year, meaning that up to this month all high inflation is relative to subdued economic activity caused by pandemic shutdowns. Inflation started rising at a rate of 5% in May 2021, rose to 7.5% as markets began to anticipate the devastating energy effects of the Ukraine war, then accelerated to 9.1% before stabilizing in weakened to 8.2% in recent months.

From now on, inflation will be measured on a much higher basis. That means inflation will peak regardless of what the Fed has done and will do. It is well known that interest rate increases have a significant lag, that it takes many months before the effects of these increases are reflected in changing spending patterns and falling prices. The recent slowdown in inflation cannot therefore be attributed primarily to rising interest rates. As the impact of the pandemic stimulus and commodity price shock from the invasion of Ukraine wears off and supply chains slowly ease out of congestion, inflation is easing – of its own accord.

In the fall of 2021, the Fed and Chair Powell appeared ready to consider whether inflation was “temporary,” content to hold off on rate hikes on the reasonable view that the pandemic had created unusual conditions. What proved temporary, however, was the Fed’s willingness to wait and see; It then reversed course and resorted to the above comforting script, lauded by economists and policymakers for realizing the error of its path, and finger-wagging that it had waited too long to act, and foolishly allowed the proverbial inflationary spirit of the bottle.

Now the Fed is poised to force a recession (although the White House strenuously denies we’re in one now, even after six months of weak GDP). A recession means halting the huge rise in wages that has caused the bottom quartiles to post meaningful wage increases for the first time in decades and dampened asset prices from stocks (and therefore pension funds) to houses, in Conviction that this is a necessary medicine .

Also Read :  Youth have ‘prophetic’ role in shaping new economy, Assisi archbishop says

Furthermore, given the oddity of what has happened over the past two years, the Fed could have waited much longer before reverting to the old script. It could and should have seen this stimulus digested before abruptly raising rates, in a way that suggests giving in to public pressure and panicking about its own reputation. Surely an economy posting the first wage increases in decades, exceptionally low unemployment and high demand does not need to be halted and reversed?

The Fed is run by mandarins whose sole purpose is the public good. That’s to be commended, but they can still make destructive mistakes. Rather than give in to pressure from critics who are playing out an old script, the Fed should have stayed the course it stayed in the fall of 2021 to wait and see how temporary inflation would be in the face of a strange and unusual two years. It should then have viewed the Russian invasion of Ukraine as another one-off event distorting oil and commodity prices. She should have realized that the fear that high inflation would take hold and turn inflationary expectations into a self-fulfilling inflationary spiral was just that: a fear. It should have waited to act instead of burning down the village to save it.

It didn’t. Now, with signs of a sharp economic slowdown, as the housing market not only cools but nears freezing, asset prices fall, and public sentiment darkens, the Fed can at least stop what it is doing, halt its rate hikes, and its attempts to slow its pace balance sheet shrink. It doesn’t even have to admit mistakes. As is so often the case, all it can say is that new data suggest a different course. And yet it could only prevent a future in which unemployment rises, wages stagnate, pension funds depreciate and large numbers of people become even more economically insecure in order to satisfy indifferent economic orthodoxies.

Institutions and politicians like to act. Sometimes the best action is no action. There’s still time to stop the onslaught. Retiring from an outdated script will at least avoid further damage. Otherwise we could achieve low inflation at an unacceptable cost.

More must-read stories from TIME

Contact us at [email protected]


Leave a Reply

Your email address will not be published.