High inflation in the United States basically reflects two forces.
On the one hand, there are many disruptions: rising oil and food prices (exacerbated by the Russian invasion of Ukraine), tangled supply chains, and so on. These factors are the reason inflation is on the rise everywhere, not just in America. For example, here is Great Britain:
On the other hand, the US economy is very hot, with a widespread labor shortage. You can see this overheating in a lot of data, but it is also visible to the naked eye. Here’s what I saw on the streets of New Jersey the other day (don’t worry, my wife was driving):
So far, at least, there is no sign of a third possible factor: inflation driven by entrenched expectations of inflation, in which companies raise prices because they believe other assets will raise prices. But this factor could emerge if inflation remains high, so caution requires that we try to rein in prices now. And while the disruptions will fade over time (there are already hints of improvement in supply chains), it pains me to say that we can’t safely let the economy continue to run so hot.
The reason this pains me is that there are a lot of very good things in a tight job market where it is easy to find work. A dynamic job market is particularly important for young people: recent graduates who have the misfortune of entering a weak market can suffer long-term damage to their career prospects.
Unfortunately, we need some calm. What I’m not sure people understand is the extent to which policies and events have already set the stage for the big cooling.
It starts with the Federal Reserve, which is under widespread attack for being around the curve. It is true that so far the Fed has raised short-term interest rates – which are the ones it controls directly – by only a paltry 0.25 points.
But short-term interest rates are not directly important to the economy. For example, a company considering borrowing to pay for a software upgrade that will be out of date in two years doesn’t care much about the interest rate it has to pay. Monetary policy acts primarily through the effect of interest rates on long-term investments, particularly in housing, which in turn means that what matters are long-term interest rates.
And long-term rates reflect not only what the Fed has already done, but also what it should do. The Fed’s pivot to fighting inflation has already pushed long rates up, especially mortgage interest rates:
This in itself will slow construction and cool the economy substantially.
Then there is the fiscal policy. A year ago, the American Rescue Plan provided families with a lot of financial aid: one-time incentive payments, improved unemployment benefits, and an expanded child tax credit. All this is now over; the last part of that expense, the child tax credit, expired earlier this year. Like it or not (and mostly not), this cut in federal aid risks undermining consumer spending.
Finally, Vladimir Putin’s decision to raise food and fuel prices – OK, he was actually trying to conquer a neighboring democracy, but the price hike has been his main result so far – is already weighing on family budgets, leading to probably to a reduction in spending on other things.
One might wonder if rising oil prices will really be a drag on the US economy. After all, we are more or less self-sufficient in oil:
And we are a net exporter of food. So why should rising oil and food prices make America poorer? The answer is that on average they don’t; while they make many Americans poorer, they also make other Americans richer. But it’s a good bet that those who have gotten poorer will cut their spending more than those who have gotten richer will increase it. In particular, while oil companies have suddenly become much more profitable, the disastrous excesses of the shale bubble have made them reluctant to increase investment and production.
To put it all together: Politics and events are seriously holding back the rapid expansion the US economy has experienced since the recession of the pandemic. So I’m far less worried than many observers that the Fed is behind the curve in response to an overheated economy. If anything, I am beginning to worry that the Fed may find itself behind the curve as the economy cools faster than its board members seem to expect: will the unemployment rate really only be 3.5% by the end of this year?
And yes, I am aware that to say that the economy is cooling because we are hitting the brakes is a mixed bag of metaphors. Face.
Some people are very worried.
Have your shipping costs peaked?
The war of Russia resulted in a massive flight of capital from … China.
The head of the National Republican Senatorial Committee denounces his own words as “democratic talking points”.