Richard Drew/AP Photo
A television screen on the floor of the New York Stock Exchange shows the rate decision of the Federal Reserve, March 16, 2022.
How is raising interest rates supposed to solve the problem of producing grain in the middle of a war zone in Ukraine? How is it supposed to end lockdowns of industrial production–heavy cities in China that are seeing rising COVID cases? How is it supposed to clear backlogs of ships outside American ports?
These are the questions going unanswered as Federal Reserve chair Jerome Powell, whom liberal wonks once praised for his unbending dedication to full employment, reverses course and signals aggressive rate hikes for the rest of the year. The expectation now is that interest rates will rise in half-point increments for the next two Fed meetings and at a more moderate but sustained level indefinitely thereafter, in an attempt to counteract rising inflation.
We should say plainly what Powell means to do. Tightening credit by raising the cost of money is intended to dampen investment. Dampened investment would lead to fewer jobs. Fewer jobs would lead to poorer people. Poorer people would lead to a reduction in overall demand. And that reduction in overall demand would, under this concept, lead to a slowdown in inflation. In other words, the Fed wants to throw people out of work to reduce inflation, and for this to actually succeed the increasing number of jobless would have to register in the millions. For all the talk of “soft landings” and precise management of monetary tools, these controls are far blunter than Powell wants to admit, and they point in the direction of recession as the inflation-fighting strategy the Fed will follow.
Powell’s work, though just beginning, is already having an impact. Mortgage rates, one of the most ubiquitous interest rates we interact with, are now headed up in a straight line, affecting housing affordability and the job stability of the real estate industry. The goal may not explicitly be to slow down homebuying—but that will be the effect.
My initial questions target the premise of Powell’s plan. What if he throws people out of work and tips the economy into recession, but delays in shipments and shortages of goods persist, keeping inflation high regardless of demand? Given that some of the supply shortages are in basic necessities, demand can’t be crushed enough to make a big difference without mass privation.
The point is that the Federal Reserve’s instruments may not be well suited to the current circumstances of supply shocks, a lingering pandemic, and a war being waged at the source of several critical commodities. Yet action is demanded and the only action that can happen quickly is hitting the economy with a club.
Policymakers who wanted to do something useful on inflation would start with diplomacy. Despite Russia and Ukraine being relatively small economies globally, war has always driven inflation and damaged supply chains, regardless of interest-rate policy. The longer Putin’s war rages, the more the price for increasingly scarce staples will rise. Getting it to stop is a Herculean task, but engaging diplomatically to help bring an end to hostilities, while a remote prospect, beats the more available prospect of slowing down the economy and hoping for the best.
Shipping companies and dockworkers almost immediately refused to move Russian cargo, causing a chaotic rerouting of flights and container vessels. Containers bound for Russia are stuck in the wrong place, while other ports experience shortages. The devastation itself pulled Ukraine off the export map, and it combined with Russian sanctions that constricted key supplies of platinum, aluminum, steel, and organic products like corn, wheat, and sunflowers. Ships and their crews in Ukrainian ports were stranded in the Black Sea, disrupting the delicate dance of seafarers and containers, and increasing insurance costs that filter through the shipping industry. “More ships are stranded around the globe than at any point since World War II,” historians told The Wall Street Journal.
Policymakers who wanted to do something useful on inflation would start with diplomacy.
Fighting the pandemic, with more such actions as the Biden administration’s recently issued federal ventilation guidelines, would be another more useful initiative than raising interest rates. Lockdowns in Chinese industrial cities like Shenyang reduce the supply of goods produced, raising the costs importers are willing to pay to get whatever meager supplies are available out of the country. With the BA.2 variant increasing case rates worldwide, the likelihood of more slowdowns is high.
While lower manufacturing output and the Chinese Lunar New Year gave U.S. West Coast ports a chance to regroup and get through a backlog that dates back to last fall, diverting cargo amid exasperation with the delays has shifted delays to the East Coast, where 63 container ships were waiting offshore as of last Friday. It’s like squeezing an end of a balloon to make the other side inflate. Dealing with sketchy profit-taking from ocean shipping companies, as the Biden administration has attempted, is more effective in fighting rising costs, not to mention a more sensible policy goal than trying to immiserate working-class people.
On top of all that, as our friends at Groundwork Collaborative have been hammering, companies have used the opportunity to hide behind inflation expectations to jack up prices in ways that raise their profit margins. Recognizing and combating windfall profits makes more sense than driving interest rates to a level that puts people out of a job.
How will interest rates impact the two-year shortage of critical equipment needed to make more semiconductor chips? To the extent that it reduces investment because it costs more to make capital expenditures, it’s counterproductive. How will interest rates impact the stubborn refusal from U.S. shale companies to buck their Wall Street investors and drill more to boost global oil supplies? And how will interest rates impact the looming factors in supply challenges, like climate change, cyber attacks, a potential labor walkout at West Coast ports, or random container ships running aground?
The only normal-sounding person on this issue these days is the one Fed hopeful President Biden didn’t pick in his latest round of nominations, AFL-CIO chief economist Bill Spriggs (who, full disclosure, is a Prospect board member). As Spriggs told NPR last week, a policy of interest rate hikes “doesn’t address the issue that’s causing inflation.” He cited the slump in auto production, responsible for about one-quarter of the current inflation rise, which is only about to get worse, because European car manufacturers rely on Ukrainian parts to feed their factories. He cited oil and wheat prices spiking due to the war as well, noting that increases in the cost of grains will inevitably factor into meat since that’s what cows and hogs are fed. “This is a series of supply shocks,” Spriggs said.
As economist Josh Mason points out, the logic of what the Fed’s doing syncs up with forcing students back into loan payments and cutting off enhanced Medicaid payments to states. “You might object that these measures would deprive vulnerable people of income, and discourage socially useful spending,” Mason writes. “Which is true. But that’s different from rate hikes, how?” In other words, the austerity mindset and the push for monetary tightening is only different in that austerians are more honest about their aims.
The dangers of adopting that mindset are obvious. Because COVID preparedness was left out of the omnibus spending bill, the Biden administration says it has no money to procure more COVID tests or a fourth vaccine booster shot, which as BA.2 increasingly predominates worldwide and we get further and further away from the most recent booster shot could make Americans vulnerable. At a time when so many policymakers are preoccupied with an “overheating economy” and its alleged effect on inflation, the biggest challenge the country faces for the fate of millions of potential pandemic victims is that the U.S. didn’t spend enough to get ready for the surge.
Policymakers are not powerless to deal with current conditions, though it will take some time. But the focus on immediate action through the default tools of inflation fighting is leading us down a counterproductive path of poisoning the patient as a cure for their disease. If slowing the economy would work to raise needed supply stocks, that would be one thing. Cutting people off from their livelihoods for no reason other than saying you “did something” is downright sadistic.
