J. Scott Applewhite/AP Photo
Cecilia Rouse, chair of the Council of Economic Advisers, testifies before the Senate Banking Committee on the state of the economy and inflation, February 17, 2022.
The Prospect’s reporting has established that the prime driver of today’s inflation was the supply chain shock, the 40-year folly of deregulating the several links in the chain, and the excessive offshoring to China combined with COVID disruptions. The culprit was not anti-recession stimulus.
But reshoring production and restoring a coherent logistics system will not be finished this year. In the meantime, inflation is all too real, compounded by Putin’s Ukraine War.
Price increases hurt consumers and workers. They are never good for the government in power.
But there are ways to restrain prices without harming the economy. The first principle is to do no needless damage. That means you, Federal Reserve.
In January, the core inflation rate, excluding more volatile goods like food and energy, was up 6 percent over January 2021. The February numbers are expected to be worse. Though some forecasters, including many at the Federal Reserve and the major Wall Street banks, have been projecting that inflation will subside by fall 2022, the Ukraine War will worsen inflation in the near term.
For more than a decade, the entire economy has been based on the assumption that very low interest rates will continue almost indefinitely. Supposedly, the world is awash in savings, leading to low capital costs.
The reality is more that Fed policy, ever since the slow recovery from the Great Recession, has targeted short-term rates of close to zero. But that will soon end.
A zero-interest-rate economy has affected everything from mortgage rates and consumer loans to stock prices to corporate investment plans. Higher interest rates will adversely affect all of these.
With inflation in the range of 5 to 6 percent for at least the next several months, the Fed will be under pressure to raise rates significantly, and also to sell off some of its $9 trillion portfolio of Treasury and mortgage-backed security bonds. All of this will slow the economy, and a lot more.
For instance, stock prices have been predicated on a world of very low interest rates and parallel low returns on bonds. High stock prices are the reciprocal of low interest rates. Many critics have observed that stock prices, as in 1929 and 2008, are far too high for economic fundamentals. If interest rates rise significantly, the stock market has to tank.
A lot of other Wall Street bets have been premised on very low interest rates as well. Investors have been willing to buy mortgage-backed securities based on a yield of 4 percent or less. But if inflation is running around 5 percent, that’s a negative rate of return; and if the Fed starts dumping its own holdings of mortgage-backed securities onto the market, the value of those securities also has to tank.
If you take a close look at the sources of inflation, most of them are not amenable to the cure of interest rate hikes.
There are those who believe that Fed Chair Jerome Powell has been keeping interest rates low and resisting a rapid sell-off of the Fed’s own bond portfolio less out of concern for the economy as a whole and more to keep Wall Street afloat. The stock market lost ground early last week, but it was up dramatically on Friday—because investors believed that the economic dislocations of the Ukraine War may cause the Fed to be more cautious about raising rates.
Some of the more hawkish people at the Fed have called for several rate hikes of half a point (50 “basis points”) each. With the uncertainty of war, the first of these is likely to be moderated to a quarter point. But higher interest rates are coming. The question is how high and how fast.
Obviously, tighter money will also hurt ordinary people. Everything from auto loans to credit card rates will rise. Consumers have been getting a very good deal on mortgage loans, with 30-year rates of under 4 percent. That’s over, meaning that homeownership will be even further out of reach. Fed overreaction will needlessly raise mortgage costs even higher.
Some workers have been able to negotiate raises, but if prices are rising faster than wages, workers will still be worse off. And Fed actions to cool the economy will take us further away from full employment, undercutting worker bargaining power.
The Fed’s next policy-setting meeting of the Federal Open Market Committee is March 15–16. At its most recent meeting in mid-January, whose minutes were released in mid-February, participants confirmed their belief that inflation would subside in late 2022, though that assumption may have been overtaken by recent events, and the next meeting will be more hawkish.
The Fed’s seven-member Board of Governors, all of whose members sit on the Open Market Committee, is currently down three members, because of the delay in Senate confirmation of President Biden’s three appointees, Sarah Bloom Raskin, Lisa Cook, and Philip Jefferson. All of these are likely to be at the dovish end of the Fed’s spectrum on interest rate policy, in contrast to the more hawkish representatives of the regional Fed banks.
Sen. Ben Ray Luján, whose stroke deprived Senate Democrats of a working majority, was discharged from the hospital to a rehab facility last week, and is expected back in the Senate sometime in March, but not in time for a full-strength Fed to be confirmed by March 15.
If you take a close look at the sources of inflation, most of them are not amenable to the cure of interest rate hikes. Higher rates will do nothing to cause more energy supplies or semiconductors to appear. They will do nothing to restrain higher worldwide grain prices caused by disruptions in Ukrainian exports of wheat. They will do nothing to prevent middlemen in the beef industry, the drug industry, or the ocean shipping cartel from gouging consumers.
To the extent that higher rates slow down the economy without restraining prices, they create a perverse economy reminiscent of 1970s stagflation. The moderately good news here is that Fed chair Powell seems to be more aware of these risks than his predecessor Paul Volcker, who deliberately used sky-high rates in 1979 to slow inflation by creating a deep recession. Even so, the slow drip of several small rate increases, which now looks likely, would weaken the economy while doing little to restrain inflation.
What about President Biden? One thing he can do, and we can expect him to mention this in his State of the Union address, is to use the government’s antitrust authority to go after big companies that are using their market power to impose unjustified price hikes.
One of the most extreme cases of these is the ocean shipping industry, which enjoys antitrust immunity, and has used it to jack up shipping rates and profits, adding to price inflation in the entire range of imports. The government, through the Federal Maritime Commission, has the authority to sue the industry for anti-competitive price-gouging (see David Dayen’s “Biden Wants to Take Down the Ocean Shipping Cartel”).
The administration has already had some success in loosening supply bottlenecks by reshoring production. This can be accelerated if Congress passes a final version of the USICA passed by the Senate and the COMPETES Act approved by the House—without the backdoor provisions in the Senate bill that help China.
In addition, President Biden is expected to call on Congress to pass legislation that will cut costs to consumers. This includes reducing child care and pre-K costs, as well as drug and health insurance costs. Extending the Child Tax Credit would be a terrific anti-inflation offset that puts more money in the pockets of consumers.
In the meantime, Biden could use existing executive authority to set standards on which drugs should not qualify for insurance reimbursement because of their lack of efficacy. In extreme cases of price-gouging, the government already has the authority to put drugs into the public domain.
On the energy front, Biden could redouble efforts to revive the Iran deal that Trump killed, which would bring more Iranian oil onto world markets, and press the Saudis to restore full oil production. For the long run, of course, the remedy for unreliable carbon energy sources is to accelerate our move away from fossil fuels, but that will do little to reduce inflation in 2022.
As painful as it is to admit, in the short run sky-high energy prices are both an economic and a political problem. If we want Biden to double down on a clean-energy path, first he needs to keep his majority in Congress and then get re-elected.
One other thing Biden needs to do is to tie the rising inflation to Putin’s invasion of Ukraine. The sooner this war is over, the sooner the war-related inflation will subside. And the more aid Biden and America’s allies can give to the heroic Ukrainians, the sooner the war will be over.
