For the past several months, the Federal Reserve has used a traditional toolkit to attempt to rein in the high inflation that was unleashed by the pandemic and worsened by Russia’s attack on Ukraine.
The traditional response to inflation model, which economists have used for decades, states that inflation is caused by excessive demand. To rein in this demand and reduce inflation, one must raise the cost to borrow. The Federal Reserve has increased the interest rate and, consequently, the cost of borrowing to finance new investments and to obtain mortgages from banks. A 30-year mortgage for a buyer with excellent credit could be approved in the summer 2021 at a 2.75 per cent interest rate. Last week, those mortgages headed north of 6 percent. For a family with, say, a $400,000 mortgage, that’s a difference of roughly $14,000 per year. Millions of people defer home purchases, not surprising. Between last summer, when mortgage rates were at their lowest point, and now the demand for mortgages has declined by nearly a third.
The idea is pretty straightforward: If it costs more — perhaps a lot more — to borrow, people will defer purchases. Companies that have fewer employees will have less need for new cars, fewer home purchases, and fewer big-spending credit card purchases. This leads to a shift in the labor market away of worker-power. It also makes it harder for employees in a soft labor marketplace to negotiate higher wages. This particular circle, it is argued, will quickly reduce inflation.
This theory is exemplified by the an economic graph known as the Phillips CurveAccording to, a little bit more short-term consumer pain and a willingness for longer periods of unemployment should do the trick to stop inflation. Proponents of this model argue that workers’ short-term pain is more than compensated for by the longer-term gains that come with stable prices.
However, this current bout is not normal, according to progressive economists like Joseph Stieglitz and Dean BakerThis was what the model had predicted. As interest rates rise, housing need is actually decreasing, as the model predicts. But the broader labor market remains tight — in part because so many Americans dropped out of the job market during the pandemic, either out of fear of exposure, because they couldn’t find child care, or in many instances, because they ended up suffering debilitating effects from long COVID. Despite the fact that inflation was at its peak in June and July, there was no sign of it slowing down. the recently released numbers for AugustThe stock market plunged last week due to the fact that inflation is at a higher level than expected (the Federal Reserve targets inflation in the 2 percent range).
Other major industrial democracies are also posting similar bad inflation numbers: The inflation rate in U.K. is slightly higher than in the U.S.It could be as high as $1.5 billion, according to some models. 18 percent by year’s end, although these worst-case scenarios are likely to have been muted somewhat by Prime Minister Liz Truss’s recent announcement that the government would cap energy prices. In the EUThe inflation rate is over 9 percent. In CanadaIt is just below 8 percent. In AustraliaInflation hovers around 6 percent. And even more! JapanThe country has extremely low levels of inflation, due in part, to decades of stagnant economic growth and in part, to the government subsidizing a wide variety of consumer products. However, inflation indicators have risen in recent months, although price increases remain far less problematic than in other wealthy countries.
This stubborn persistence of inflation globally oughtn’t to be surprising: the traditional model assumes inflation is triggered by excess demand, and thus can be curbed by reining in demand. But the last couple years of supply chain disruptions have shown that when an unpredicted but catastrophic “black swan event” such as a pandemic holds the world in its grip, prices around the world get driven up by a cascading series of glitches that make it harder both to produce goods and then to ship the finished product to stores and to consumers.
Why, for instance, is the average consumer paying more for cars? Not because there’s suddenly been a spike in the number of drivers on the road, but because at every level of the supply chain — from rubber and steel to semiconductors — there are shortages or delivery bottlenecks. A globalized economy makes it vulnerable for consumers in import-heavy economies like the U.S. to price spikes due to supply shortages in China.
This is why we need to raise interest rates ad nauseamThis is a very inefficient way to address the problem. The unaffordability to borrow money will eventually reduce demand, but it won’t stop inflation. But before it does that, it’s likely to cause a huge amount of pain. And that hurt won’t be evenly distributed.
Because the labor market is tight, those at the top of economic ladder, those with higher marketable skills and higher education qualifications are more likely to be able largely to offset the loss of purchasing power caused by inflation. They can negotiate wage increases, starting bonus, and other compensation.
Inflation will be most severe for poorer residents. They have less money saved and less power to negotiate wage rises. They also have poorer credit, which means they will pay disproportionately higher interest rates when borrowing.
Low-income residents are in dire straits in poorer countries, mostly in the global South. Governments in these countries lack the political clout to intervene on the energy and food markets to lower costs or cushion the blow to the poorer through price subsidies for food, energy, and other commodities. Inflation, which is being triggered by the twinned disruptions of war and pandemic, is high in large parts of the globe. Argentina’s inflation is roughly 80 percent, Lebanon’s 116 percent, Sri Lanka’s increased from 5.7 percent a year ago to over 60 percent today, etc.
The head of the United Nations World Food Programme warned last week that up to 345 million people worldwide — or roughly 50 times the number known to have died from COVID so far — could face starvationAs food prices rise and food shortages increase, so do their costs. This is the result of a doubling global food insecurity in 2020. About 50 million people already suffer from severe malnutrition. This number will only increase with the recent devastating flooding in Pakistan and the displacement of tens to millions of people from their homes. According to UN estimates, 70 million people have been pushed closer to starvation by the conflict in Ukraine and the disruptions to global markets for grain, soy, and other staples.
The UN’s stark warning ought to have generated headlines around the world; instead, it simply became a side story.
But, even while economics writers around the world fixate on spiraling inflation in economic powerhouses such as the U.S., the U.K. and the EU bloc, while ignoring even worse inflation — and the damage it causes — in poor countries, there are underlying similarities. To be poor anywhere on Earth means to bear adisproportionate burden of the failure of one-size-fits all policies. To be poor means to suffer the inflation spirals; but, to also be poor is to experience the shock-and–awe policy responses that are designed to bring inflation under control.
However, there are other options available to tackle inflation in a fairer way. The Center for American Progress published a last week. reportThe authors discuss how the supply chain can be strengthened to reduce disruptions and rein in prices. The authors suggested that COVID vaccine distribution should be increased, as well as expanding the child-care system to allow parents to return to work. They also recommended increasing immigration levels in countries like the U.S. to fill the jobs left vacant by the contracting workforce. They also recommended going after price-gouging trustees.
The authors concluded that the Fed’s approach, looking to gently tamp down demand without sinking the economy into a deep recession, was unlikely to work to knock excess inflation out of the economy. They warned that if the Fed keeps raising interest rates, eventually the landing could be extremely hard and painful — in other words, this strategy risks crashing both the housing and the job markets, which would hurt poor Americans the most. Better, they argued, to craft an economic policy that “addresses the supply issues brought into high relief during this recovery.”
Because of the Fed’s outsized influence on global economic policy, the rest of the world is likely to follow where the U.S. goes on interest rates. Raising interest rates moderately may make sense as one tool among many to tackle this rather unique inflationary moment, but raising them immoderately — and excluding more unorthodox supply side anti-inflation interventions — risks doing long-term damage to those at the bottom of the economy. This is a grave threat to the U.S. poor and those living in less-affluent countries around the world. It could lead to persistently high inflation, rising unemployment, and more difficult accessing loans for homes and businesses. That’s the sort of lose-lose proposition that could create cascading problems for decades to come.