The inflexibility with which central banks are determined to raise interest rates is remarkable. In the name of controlling inflation, they are willing to cause a recession or aggravate it if it occurred on its own. Furthermore, they openly acknowledge that their policies will cause suffering, although they do not say that the worst part will be borne by poor and marginalized people (and in America, people of color), not their friends on Wall Street.
As a new report from the Roosevelt Institute, which I co-authored, shows, any benefit from the further reduction in inflation as a result of higher interest rates will be minimal compared to what is foreseeable in any case. There are already signs that inflation is subsiding. Perhaps not as fast as the optimists expected a year ago (before the Russian invasion of the Ukraine), but it is indeed moderating, and for the same reasons that the optimists detailed at the time. For example, they predicted that the price of automobiles would drop as soon as the semiconductor shortage was resolved. This is what happened, and, in fact, car manufacturers’ inventories are increasing.
Optimists also expected oil prices to decline, rather than continue to rise; once again, that’s exactly what happened. In fact, the cheapening of renewable energy sources means that the price of oil in the long term will fall even below the current level. It’s a shame we haven’t moved to renewables sooner. We would have been much better insulated from fossil fuel price swings and much less vulnerable to the whims of petrodictators like Russian President Vladimir Putin and Saudi leader, the warmongering and journalist-killer Crown Prince Mohamed bin Salman (whom everyone calls MBS). It is to be thankful that both men failed in their apparent attempt to influence last November’s mid-term elections in the United States, appealing for a notable reduction in oil production in early October.
There is yet another reason for optimism, and it has to do with corporate profit margins (the difference between prices and costs). These had been increasing slowly as a result of the growing monopolization of the US economy, but since the start of the covid-19 crisis they have skyrocketed. As the economy comes out of the pandemic (and, hopefully, the war), those margins are expected to decline, moderating inflation. It is true that wages have been growing faster than before the pandemic for some time, but that is a good thing after the huge secular increase in inequality that has taken place, compounded by the recent decline in the (deflated) real wages of workers.
The Roosevelt Institute report also refutes the argument that current inflation is due to overspending during the pandemic and that bringing it down requires a long period of high unemployment. Demand inflation occurs when aggregate demand exceeds potential aggregate supply. But, in general, it is not what has happened. Instead, the pandemic led to numerous sectoral supply constraints and demand shifts, which (in combination with asymmetric adjustments) were the main drivers of price increases.
For example, today the US population is lower than the pre-pandemic projections. Trump-era policies for covid-19 not only contributed to the loss of more than a million people in the United States (and that’s just the official figure), but also reduced immigration, due to the presence of new restrictions and a less welcoming and more xenophobic environment. What caused rents to rise was not that there was a large increase in demand for housing, but rather that the spread of telecommuting led to changes in preferences (particularly among knowledge workers) regarding location of residence. With the relocation of many professionals, the cost of renting or buying a home increased in some areas and decreased in others. But the increase in the former was greater than the decrease in the latter; so demand shifts contributed to headline inflation figures.
Let us return to the main question at hand. Will higher interest rates increase the supply of semiconductors for cars, or oil (as if they will somehow convince MBS to produce more)? Will they lower the price of food (except for causing a global drop in income of such magnitude that people have to adjust their diets)? Of course not. Conversely, raising interest rates will make it even more difficult to mobilize investment that can ease supply constraints. And as the Roosevelt Institute report and an earlier one I wrote with Anton Korinek for the Brookings Institution show, there are many other ways that rising money prices can add to inflationary pressures.
It is more likely to control this inflation with well-targeted fiscal policies and other more specific measures than with indiscriminate and potentially counterproductive monetary policies. The appropriate response to high food prices, for example, is to reverse the old policy of farm price support whereby farmers are paid not to produce when they should be encouraged to produce more.
Likewise, the appropriate response to price increases derived from excessive market power is to better enforce competition law; and the answer to rising rents for poor families is to encourage investment in new housing, while raising interest rates will have just the opposite effect. If there were labor shortages—a context in which the typical signal is for real wages to rise, the opposite of what we are seeing—the response should include more childcare provision, pro-immigration policies, and wage-boosting measures. and improve working conditions.
After more than a decade of meager interest rates, it makes sense to “normalize” them. But raising rates more than necessary in a quixotic attempt to control inflation in a short time will not only cause suffering now, but will leave lasting scars, especially among those least able to bear the effects of ill-advised policies such as these. . By contrast, most of the fiscal and other responses described here would deliver long-term social benefits, even if inflation ultimately turns out to be lower than anticipated. The phrase of the psychologist Abraham Maslow is well known according to which, “if all you have is a hammer, all problems look like nails to you”. The fact that the US Federal Reserve has a hammer does not mean that it has to go out and destroy the economy with a hammer.
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