The New York Times published a Spencer Bokat-Lindell article on April 14 analyzing whether a recession is the only way to stop inflation.
On Tuesday, news said inflation continued to worsen in March, with consumer prices up 8.5 percent from the same period last year, the sharpest increase since 1981. While the so-called core inflation rate, which excludes the volatile prices of fuel and food, and the temporary surge in Russia's invasion of Ukraine, have indeed begun to decline since February, workers' real wages are still eroding. If expectations of high inflation become entrenched, some economists worry that prices could spiral out of control.
The Fed hopes to avoid this by raising short-term interest rates, which officials expect to rise by 1.9 percentage points by the end of the year.
However, this treatment, even if successful, can have serious side effects. Higher interest rates make all kinds of debt, from mortgages to car and business loans, more expensive, driving inflation down. For the same reason, they can also push up unemployment and trigger a recession. In fact, according to research by investment bank Piper Sandler, all but one of the 9 examples in which the Fed raised interest rates to cope with inflation since 1961 has experienced recessions.
Fed Chairman Jerome Powell, who is no doubt aware of the record, said his goal was to design a "soft landing": a gradual slowdown in economic activity to help contain soaring prices but not jeopardize the recovery. But is the central bank on the right track and can it achieve such a rare achievement? What other factors beyond its control could affect the economic outlook for the United States? Here are some of the thoughts people have.
The Fed can't save us
As The Times columnist Paul Krugman explains, there are roughly two lines of thought about the causes of current inflation. The first view, the "overheaters," blames a wide range of stimulus measures, such as the CARES Act and the U.S. bailout program, for pushing demand beyond the economy's productive capacity. The second view, the "tandem faction," argues that inflation is primarily the result of a shift in consumer spending from services to goods caused by the COVID-19 pandemic, and that it happens precisely at a time when supply chains and labor markets are being disrupted.
As John Cassidy points out in The New Yorker, perhaps the strongest argument against the "overheater" hypothesis is that prices are also rising rapidly in other countries that have responded to pandemics with very different macroeconomic policies. Last month, inflation in the eurozone reached 7.5 percent, much lower than in the United States. "In Europe, they didn't have the big stimulus measures we did, but inflation is almost as high as we are now," said Austan Goolsbee, an economist at the University of Chicago. "It's a global phenomenon. It is not primarily from U.S. stimulus. "
If supply-side disruptions are the primary cause, then rate hikes may prove to be a flawed solution.
Powell has warned that the labor market is strained to "unhealthy levels," citing the fact that there are about 1.8 job openings per person looking for work. But "hikes alone will not increase the supply of workers or alleviate fears of covid-19," Rachel Siegel wrote in The Washington Post. "They can't provide childcare for working parents, change immigration policies or attract early retirees back into the workforce." According to some estimates, there are about 2.6 million of these people. "
Similarly, rate hikes will not unshackle supply chains, reduce gasoline and food costs, or alleviate the housing shortages that are driving rents up. Eric Levitz wrote in a New York magazine article, "The Fed Can't Save Us," that doing so will require land-use reform and public investment in housing, along with federal action to encourage full-scale energy production in the short term and renewable energy production in the long term.
"Given our existing balance of power and a range of institutions, raising interest rates is probably the best anti-inflation tool we have," Levitz wrote. "But that's a crisis in itself. We cannot continue to rely on policy tools that are more familiar than effective. The price of complacency is too fucking high. "
Reason for a hard landing
Perhaps the most prominent member of the overheating school is Larry Summers, a former economic adviser to barack-Oba President Ma, who warned that the country's pandemic stimulus policy carries the risk of "the kind of inflationary pressure we haven't seen in a generation."
Summers still believes that these policies have played a key role in driving prices up. But he argues that if supply-side problems are the main culprit, the Biden administration has limited tools to remedy in the short term, and it has been reluctant to use the tools it has. As a result, in his view, the Fed's obligation to raise interest rates remains unchanged.
He said on a recent podcast by Times columnist Ezra Klein: "Blame inflation on supply, but supply is not an excuse," he said. "It's a reality in an environment that you have to deal with. Therefore, our job is to look for measures of overheating, and when you see measures of overheating, take restraint measures. "
Summers argues that the Fed will need to raise interest rates to 4 or even 5 percent to curb inflation, apparently more aggressively than officials now seem to be considering. He acknowledged that the consequences of such tightening monetary policy could be painful, leading to the kind of hard landing that Powell is seeking to avoid. Summers told Klein: "I don't think we can go back to 2 percent inflation without a recession that's at least mild." "
But if the Fed doesn't control inflation now, some worry it could become a self-regulatory continuation. Jenanna Smialek of The Times wrote: "It would be a troubling sign if consumers and businesses expect prices to rise rapidly year after year. "If companies feel comfortable raising prices and consumers accept these higher costs but demand bigger wages to cover their ever-increasing expenses, that expectation could become a self-actualizing situation."
It's not just Summers who thinks a hard landing is preferable to the long-term effects of runaway inflation. William Dudley, former president of the Federal Reserve Bank of New York, believes that if the Fed started raising interest rates last year, inflation could be contained without causing a recession. But now, he thinks recessions are "almost inevitable."
How a soft landing can happen
As The Times' Ben-Kasselman reports, most economic forecasters still believe that a recession is still unlikely in the short term. First, there are signs that the prices of some commodities, such as used cars, are already falling. This decline may be due to a delayed buildup of inventory by retailers who overbuyed early in the pandemic while consumer demand shifted to services.
Craig Fuller, CEO of Freight Waves, which specializes in supply chain analysis, wrote: "This is all good for consumers, after all, freight prices will fall. The recent shortage of inventory to the current surplus may lead to a discount in prices, rather than an increase. "
Even as inflation continues to weigh on the U.S. economy, many analysts believe the U.S. economy is strong enough to continue to grow, albeit at a slower pace. As Krugman argues, the rise in gasoline and food prices caused by the war in Ukraine, and the Modest Interest Rate Hike by the Federal Reserve, could be enough to slow growth without paralyzing it.
Anita Markowska, chief economist at investment bank Jefferies, agrees. She told The Times: "It's easy to construct a very negative narrative, but when you really look at the scale of all these impacts, I don't think they're enough to push us into recession in the next 12 months." I just don't know what would cause a complete 180-degree shift in businesses, from 'we need to hire all these people, but because we can't find them, it's going to be's going to be 'we have to lay off people'. "
As Insider's Ben Winck explains, one reason for this optimism is that even with inflation, Americans still enjoy a significant buffer of corporate profits and household savings that have accumulated during the pandemic. Citing estimates by Bloomberg economists, he noted that Americans collectively hold about $2.5 trillion in excess savings, of which only about 27 percent will be used to pay for inflation-related costs.
"Well, the Fed's policy drawdown may be just right," Wink wrote. "While Americans don't feel good about the economy, they're still spending heavily and have more savings to take advantage of." Demand for workers is also at historical levels. Higher interest rates will dampen the pace of economic recovery, but, if Powell is right, given the situation, the Fed is heading for an extraordinary soft landing project. "
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