Purging excessive inflation from the economy is worth the price. That price, however, is real.
Purging excessive inflation from the economy is worth the price. That price, however, is real.
A s the governments and central banks of some of the world’s biggest economies gear up to tackle the outbreak of grave inflationary pressures, the rest of us need to recognize that getting inflation back under control is going to be a very difficult and messy business.
For all the assurances by central bankers that they can engineer a soft landing, such an outcome is unlikely. On the contrary, it is far more probable that we will face a difficult and long war against inflation. And like in any war, there will be considerable collateral damage. Making matters worse, the generals leading the campaign are, at best, an irresolute bunch. Some of them have even helped create our present problem by advocating low-interest rates for far too long and deploying quantitative-easing far too often.
Until recently, many Americans had little experience with high inflation. By my calculation, about 52 percent of Americans likely have little to no memory of the inflation that bedeviled the U.S. economy between 1974 and 1983. Nor did they experience the harsh effects of the Federal Reserve’s ultimately successful efforts to control it between 1979 and 1983.
The hard truth that we’re all going to have to relearn is that there are no easy paths to reducing inflation to the annual 2 percent level at which we have become accustomed. Bringing down inflation from its current high level will take much more than fixing supply chains; it ultimately will necessitate reducing demand, too, which will in turn shrink economic growth. We may have a tight labor market now, but slower growth will likely result in fewer jobs and stagnating wages.
Let’s assume that the Federal Reserve’s Open Market Committee does what Chairman Jerome Powell has said it will do in order to re-establish price stability — that is, continue to raise interest rates while reducing its massive balance-sheet holdings of Treasury securities, agency debt, and mortgage-backed securities. One effect will be to make credit steadily harder to obtain.
Businesses and corporations will then face higher financing costs. The consequences will initially be invisible to most of us, but the subsequent effects on growth will be significant over time as companies are forced to cut back on spending.
If the effects of these measures is a recession in the U.S. economy — something that Deutsche Bank is predicting for America in the final quarter of 2023 — our presently low unemployment levels are unlikely to persist. I’ve yet to hear of a recession that doesn’t involve some increase in unemployment. That is the price of reducing the excessive amounts of money sloshing through an economy.
Yet as the Fed seeks to reverse our inflationary spiral, a bigger and more visible group that will be affected is the millions of Americans with mortgages.
Over the past 16 months, interest on the average 30-year fixed-rate mortgage has gone from a record low of 2.65 percent in January 2021 to just over 5 percent now. In short, mortgage rates have doubled as the Fed has sought to temper inflation.
Those whose mortgages consist solely or partly of variable interest rates are already feeling the pinch as they experience increases in what is, for many people, their biggest monthly expense. This pain will be felt among those seeking to buy a house for the first time, too. Higher mortgage rates will make it harder for them to break into an already-tight housing market. Most of these individuals aren’t in a position to put down the type of bigger down payment of a size that would reduce their monthly interest payments.
Further complicating matters is the role played by inflationary expectations. Inflation’s relatively quick take-off since April 2021, plus the sheer size and length of supply disruptions across the globe, means that those who invest in bond markets, for instance, will expect higher inflation to persist. Those expectations will make it more difficult for the Fed’s anti-inflationary measures to have their desired impact. That in turn is likely to produce more squeezing of credit by the Fed and therefore more pain.
All this assumes, of course, that the Fed will stay the course and do what is necessary to slay the inflation dragon before it devours even more of our spending power than it already has.
Whether it does so, however, is an open question. No one today would describe Jerome Powell’s Fed as being dominated by monetary hawks. Even though Powell and others have signaled that they intend to move aggressively against inflation, we also hear some hemming and hawing from other Fed governors about how tough — or not — they are willing to be, and for how long. Given the central bank’s willingness over the past decade to subordinate price stability to the realization of other goals, we have good reason to be concerned about its fortitude.
This possibility should greatly concern us. Few things would be worse than a Fed starting a war against inflation, only to vacillate or back off before finishing the job. An inflation that is only half-defeated is likely to surge back, thereby making people wonder why they had to endure the pain that’s part and parcel of trying to crush inflation in the first place.
We can certainly hope that the Fed errs on the side of getting the inflation contagion out of the U.S. economy as quickly and as prudently as possible. After all, inflation creates deep disorder in the economy. But don’t take my word for it. Here’s how someone with whom I normally disagree described inflation’s insidious effects on economic life:
By a continuing process of inflation, government can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily. . . . As the inflation proceeds and the real value of the currency fluctuates wildly from month to month, all permanent relations between debtors and creditors, which form the ultimate foundation of capitalism, become so utterly disordered as to be almost meaningless; and the process of wealth-getting degenerates into a gamble and a lottery.
John Maynard Keynes was dreadfully wrong about many things. Some of his ideas about stimulating demand have helped let the inflationary genie out of the bottle on numerous occasions. Nevertheless, Keynes understood why inflation is such a problem. Purging excessive inflation from the economy is worth the price. That price, however, is real. The sooner we acknowledge that, the better.