At its latest policy meeting, the Federal Reserve’s Open Market Committee voted to raise its benchmark interest rate by 0.75%, the biggest hike since 1994. Expectations are for a similar hike in July.

The reason, of course, is the highest inflation rate in four decades. Fed Chairman Jerome Powell is under intense pressure from the business class and from both political parties to do something about the problem, and so it is.

But there are strong indications that at a minimum it is advancing far too quickly and in doing so runs a significant risk of tipping the economy into the same pit of stagnation it was stuck in for a decade after the Great Recession. This is especially true because the federal government is already doing, through fiscal policy, the job the Fed is trying to do: slowing the economy to crush demand. Amplifying it with rapid interest rate spikes guarantees a deeper recession.

A significant part of the inflation problem is caused by supply disruptions that the Fed cannot address — pandemic disruptions in China, lingering problems caused by decades of weak investment, and most importantly, the war of Russia against Ukraine. Indeed, as economist JW Mason points out to Barrons, Powell himself admitted this at a recent press conference: “Indeed, we are looking at a job that requires a sewing machine, or maybe a fire extinguisher, while Powell only has a hammer. . But as the rest of the press conference made clear, he plans to keep rocking it. Since then, other economists within the Fed itself (at its San Francisco branch) recently concluded that spending could only account for about a third of inflation.

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Moreover, as my colleague David Dayen points out, the Fed hike is likely to worsen the supply situation in the medium term, making investments much more expensive and much less likely to materialize in terms of sales and profits. future. For example, while soaring rents are a big part of the inflation problem, new housing starts are collapsing thanks to skyrocketing mortgage rates.

But the fiscal dimension of the economy has so far gone largely unnoticed. Inflation phobics like Larry Summers attribute the price hike to the large fiscal stimulus from pandemic relief programs. This was probably responsible, as noted, for some of the rise in inflation. But what they tend not to mention is that since that time – the US bailout was passed 15 months ago – the tax and spending balance has gone sharply negative.

As Nasiha Salwati and Louise Sheiner at Brookings point out, “fiscal policy reduced US GDP growth by 3.5 percentage points at an annual rate in the first quarter of 2022.” This is expected to reach an economic slowdown of 4.1% in the second quarter of this year, or almost twice the peak level of austerity after the Great Recession, then slowly drops. The reasons for this are the erasure of pandemic measures and an increase in tax revenue thanks to relatively strong growth.

A significant part of the inflation problem is caused by supply disruptions that the Fed cannot resolve.

In other words, the United States is currently undergoing great austerity. Indeed, President Biden has repeatedly bragged that the government would cut deficits by about $1.5 trillion this fiscal year.

In itself, this austerity will have negative effects on the economy, including job losses and wage cuts, which is not good at all. But it should also significantly ease the pressure on Powell to walk so quickly. With fiscal policy pressing hard on the economic brakes, there’s less reason for him to do the same, especially because the Fed can’t affect half of why inflation happens except in aggravating them. Nor is there any reason for President Biden to listen to advisers who would like to counter the effects of canceling some student loan debt by restarting the remaining student loan repayments. Given that we have had no repayments on these loans for over two years, under the current policy benchmark this would mean even more austerity, in the form of a substantial tax increase on about 30 million people.

There’s also a health insurance price spike looming this fall, as the Affordable Care Act swap subsidies expire. When asked if he was concerned about this serious inflationary action, Senator and Lifetime Emperor Joe Manchin (D-WV) replied, “you gotta start paying down the debt” to fight inflation, and “there’s only so many dollars to spend” to…prevent health insurance rate inflation. The Fed should not be aiding and abetting steel trap logic like this by pushing very hard with its economic leverage in the same direction to halt investment, hiring, consumer spending and the economic activity.

Powell should be doubly cautious because, absent some sort of pandemic-sized crisis, it is impossible to imagine another round of serious fiscal stimulus. Swing-voting Senate Democrats are already allergic to the idea, and the party will likely lose one or both houses of Congress midterm. Indeed, it is easy to imagine a future where there will be no fiscal stimulus for a decade or more (except possibly tax cuts for the rich, which are the worst possible). If Powell increases too fiercely, he will tip the economy into recession, and then he will have no fiscal support to revive growth.

During the era of unchallenged neoliberal hegemony, economists often referred to former Fed Chairman William McChesney Martin, who described the Fed’s role as “a chaperone who ordered the withdrawal of the bowl of punch just when the party was really starting to heat up.” Although Martin’s speech was actually quite nuanced, this slogan has come to mean that the Fed should primarily be on hyper-alert for price hikes and start rising before inflation even begins.

I offer a new party scenario as a hunch pump: the Fed should keep the punch supply at a level that keeps the party going for as long as possible. It wasn’t the Fed that got the party started – it was pandemic relief, associated supply issues and Vladimir Putin – but now it’s largely their responsibility to manage. Too much punch and people will get drunk and crash (inflation), but too little and they’ll get bored and go home (2010s-style recession or stagnation).

If Powell keeps a light touch on interest rates, hopefully the party will rock hard enough to last a good while. If he’s in a hurry, we all go home before we’ve even had a chance to make a good buzz.


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