A fairly remarkable thing happened earlier this week. Federal Reserve chair Jerome Powell admitted to Congress that his planned interest rate hikes wouldn’t do anything about the two biggest drivers of this inflation crisis — but he was willing to risk a recession and go ahead with them anyway.
Asked point-blank by several Senate Banking Committee members whether his rate hikes would lower the price of gas or food, Powell repeatedly made clear they wouldn’t.
“We know that our tools can’t affect certain aspects of inflation and that would include certainly energy inflation and food inflation,” Powell told the committee. Later, Powell acknowledged that “increasing commodity prices are clearly connected to the war in Ukraine,” before admitting that “we don’t think that we have the answer to higher oil prices due to the global oil situation.”
Unfortunately, these are the exact things that are fueling US inflation woes. The most recent consumer price index for this past May, which saw the biggest twelve-month price rise since 1981, showed that energy and food prices over the past year had jumped by 34.6 and 10.1 percent, respectively. These numbers far outstrip the 6 percent rise for all items excluding food and energy.
Meanwhile, a recent study from the Federal Reserve Bank of San Francisco concluded that demand — or, in other words, the extra money that was put into people’s pockets thanks to higher wages and government support during the pandemic — was responsible for a third of today’s inflation. This stands in contrast with the effects of supply shocks caused by the pandemic, Moscow’s invasion of Ukraine, and the recent lockdown in China, which account for almost 50 percent.
Former Fed vice chair Alan Blinder warned in April that the price rises for food and energy push everything else to become more expensive “because food and energy prices seep into virtually all other prices.” Even typically right-leaning voices like the International Monetary Fund and Wall Street Journal point to these global supply shocks as the leading drivers of inflation.
Yet Powell is determined to go ahead with the rate hikes even though they won’t do anything about this. As he put it, “We’re focused on the part of it that we can address and that is, there’s a job to do on demand here.” The idea here is that by raising interest rates, the cost of borrowing will rise, leading businesses to downsize and ordinary people to spend more money on paying off debt than on actually buying things or paying for services.
With fewer jobs available, workers lose leverage and are forced to accept lower wages. At the same time, money will be redirected toward servicing various debts — whether mortgages, credit cards, or car loans. This will result in curbing excessive demand — but demand is only one part of the inflation story.
The problem — besides the fact that this doesn’t touch the other, bigger part of that story — is that this strategy also comes with a risk of triggering a recession. Asked about this, Powell repeatedly resorted to lawyerly answers. “It is not our intended outcome at all, but it is certainly a possibility,” he told the committee, adding that “the events of the last few months around the world have made it more difficult for us to achieve what we want” — namely, low inflation and a strong jobs market.
Powell’s careful phrasing elsewhere wasn’t any more reassuring. “I do not see the likelihood a recession as particularly elevated right now,” he said, before adding the qualifying statement that “no one is very good at forecasting recessions very far out, no one has been able to do that regularly.” He insisted that “we are not trying to provoke and do not think we will need to provoke a recession.” But when asked if the Fed was as committed to curbing inflation “no matter what,” as it was under Paul Volcker, he only answered that “we are strongly, strongly committed to restoring price stability.”
“Reaching the standard that Volcker left at the Fed would be a high reach, but one that anybody there should try to get there, wouldn’t it?” asked Senator Richard Shelby (R-AL). “Yes,” Powell replied.
This is particularly ominous, since Volcker is best known for tackling the similarly supply shock–driven inflation of the 1970s by engineering a recession that sent the unemployment rate soaring to 11 percent. There’s even a chance we could end up looking at something even worse, such as “stagflation” — a recession and skyrocketing inflation happening at the same time. This is a distinct possibility if the Fed’s rate hikes do end up leading to an economic contraction while prices continue to rise because food and energy prices are unaffected by the hikes. Or as Senator Elizabeth Warren (D-MA) put it to Powell: “You know what is worse than high inflation and low unemployment? High inflation and a recession with millions of people out of work.”
Powell also confirmed rising fears that the rate hikes could actually add to inflation. The American Prospect’s David Dayen recently warned that by constraining business investment, the hikes may end up limiting firms’ ability to solve supply chain problems. When Warren asked him if this would dampen business investment, Powell simply replied, “I think the idea is to moderate demand so it can be in better balance with supply.” Powell likewise acknowledged the Fed was powerless to deal with the inflationary by-products of corporate concentration. And he similarly ducked and weaved when Senator Chris Van Hollen (D-MD) pointed out that curbing investment would mean fewer houses being built, ensuring continued high housing costs.
“What you will see, or many forecasts call for the increase in housing prices to slow pretty significantly,” Powell replied. Of course, smaller house price increases are an entirely different thing to overall lower house prices.
None of this means that a recession or the worst-case scenario of stagflation are inevitable. But few commentators seem convinced Powell will be able to carry out the “soft landing” he’s talking about. And clearly Powell himself is less than confident. According to the Wall Street Journal’s Jon Sindreu, of the twelve times since 1950 that the Fed has tightened monetary policy the way Powell wants to, nine have ended in a recession. But this maybe isn’t as much of a concern for the wealthy former executive of a massive private equity firm.
If this is how things go again, the prevailing narrative that will be on offer is that all this economic chaos is thanks to the supposedly big-government, ultraliberal approach Joe Biden took to the economy. Don’t let this fool you. If we are hit by a recession or stagflation, it’ll be a political choice — and those responsible will have already admitted their guilt.