VSThe unwavering determination of central banks to raise interest rates is truly remarkable. In the name of controlling inflation, they have deliberately set themselves on the path to causing a recession – or making it worse if one happens anyway. Moreover, they openly acknowledge the pain their policies will cause, even if they fail to emphasize that it is the poor and marginalized, not their friends on Wall Street, who will bear the brunt. And in the United States, that pain will disproportionately affect people of color.
As a new Roosevelt Institute report I co-authored shows, the benefits of further reducing interest rate-induced inflation will be small, compared to what would have happened anyway. Inflation already seems to be slowing down. It may be moderating more slowly than optimists hoped a year ago – before Russia’s war in Ukraine – but it is moderating nonetheless, and for the same reasons the optimists described. For example, high automobile prices, caused by a shortage of computer chips, would decrease as bottlenecks are resolved. This has happened and car stocks have indeed increased.
Optimists also expected oil prices to decline rather than continue to rise; this is also precisely what happened. In fact, the falling cost of renewable energy means that the long-term price of oil will fall even lower than the current price. It is a pity that we did not switch to renewable energies sooner. We would have been much better insulated from the vagaries of fossil fuel prices and much less vulnerable to the whims of oil state dictators such as Russian President Vladimir Putin and Saudi Arabia’s own leader Crown Prince Mohammed bin Salman (better known as MBS). We should be grateful that both men failed in their apparent attempt to influence the US midterm elections in 2022 by drastically cutting oil production in early October.
Another reason for optimism has to do with profit margins – the amount by which prices exceed costs. While margins have grown slowly with the increased monopolization of the US economy, they have skyrocketed since the onset of the Covid-19 crisis. As the economy emerges more fully from the pandemic (and hopefully from the war), they should decline, moderating inflation. Yes, salaries have temporarily increased faster than in the pre-pandemic period, but that’s a good thing. There has been a huge secular rise in inequality, which the recent fall in the real (inflation-adjusted) wages of workers has only made worse.
The Roosevelt report also drops the argument that current inflation is due to pandemic overspending, and that rolling it back requires a long period of high unemployment. Demand-induced inflation occurs when aggregate demand exceeds potential aggregate supply. But that, for the most part, did not happen. Instead, the pandemic has given rise to numerous sectoral supply constraints and demand shifts which, together with the adjustment asymmetries, have become the main drivers of price growth.
Consider, for example, that there are fewer Americans today than expected before the pandemic. Not only have Trump-era Covid-19 policies contributed to the loss of over a million people in the United States (and that’s just the official figure), but immigration has also declined, in due to new restrictions and a generally less welcoming and more xenophobic environment. . The driver of rising rents was therefore not a sharp increase in the need for housing, but rather the widespread shift to remote working, which changed where people (especially knowledge workers) wanted to live. . As many professionals have moved, rents and housing costs have risen in some areas and fallen in others. But rents where demand has risen have risen more than those where demand has fallen have fallen; thus, the shift in demand contributed to overall inflation.
Let us return to the great political question which concerns us. Will higher interest rates increase the supply of chips for cars, or the supply of oil (by somehow persuading MBS to supply more)? Are they going to lower the price of food, other than by reducing world incomes so much that people are going to reduce their diet? Of course not. On the contrary, higher interest rates make it even more difficult to mobilize investments that can alleviate supply shortages. And as the Roosevelt Report and my previous Brookings Institution report with Anton Korinek show, there are many other ways higher interest rates can exacerbate inflationary pressures.
Well-directed fiscal policies and other more precise measures are more likely to bring current inflation under control than blunt and potentially counterproductive monetary policies. The appropriate response to high food prices, for example, is to reverse a decades-old agricultural price support policy that pays farmers not to produce, when they should be encouraged to produce more.
Similarly, the appropriate response to rising prices resulting from excessive market power is better enforcement of antitrust laws, and the way to respond to rising rents for poor households is to encourage investment in new housing, while higher interest rates do the opposite. If there were a labor shortage (the standard sign of which is an increase in real wages – the opposite of what we see now), the response would have to be through increased childcare provision , favorable immigration policies and measures to raise wages and improve working conditions. .
After more than a decade of ultra-low interest rates, it makes sense to “normalize” them. But raising interest rates beyond that, in a quixotic attempt to get inflation under control quickly, won’t just be painful now; it will leave lasting scars, especially on those least able to bear the brunt of these ill-conceived policies. In contrast, most of the fiscal and other responses described here would result in long-term social benefits, even if inflation turns out to be more subdued than expected.
Psychologist Abraham Maslow said, “To a man with a hammer, everything looks like a nail.” Just because the US Federal Reserve has a hammer doesn’t mean it should crush the economy.
Joseph E Stiglitz is a Nobel Laureate in Economics, University Professor at Columbia University and former Chief Economist of the World Bank.
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