Judging by one set of statistics, the US economy is currently booming, as it continues to make a strong recovery from the pandemic-induced recession. Employment is rising by almost a half million jobs a month, and is limited only by the shortage of workers looking for jobs. Consumers continue to freely spend the Biden stimulus payments they received last year. Businesses are investing, and wages are rising at the fastest pace in decades. The economy has regained 90% of the jobs it lost during the first weeks of the pandemic. The nationwide jobless rate has fallen to 3.6%, near a half-century low.
But many believe that this booming economy bears the seeds of its own destruction. Soaring consumer and industrial demand, combined with pandemic-induced shipping delays and supply chain issues, have created worldwide shortages for all kinds of manufactured goods and commodities. They have sparked a consumer and industrial bidding war fueling the highest rate of domestic inflation in 40 years.
The Biden administration’s war on America’s fossil fuel industry has slowed the recovery of domestic oil production following the pandemic, driving up the price for oil, natural gas, and gas at the pump. The end of Russian oil imports into the US, following the invasion of Ukraine, has further increased domestic energy prices, and they are quickly working their way through the rest of the economy, increasing costs for any product or commodity that has to be shipped, to household electricity and heating bills. Furthermore, it appears that $4-a-gallon prices for gas at the pump, or more, are here to stay for the foreseeable future.
The war in Ukraine has led to more international shipping delays and the threat of worldwide grain shortages later this year. A recent resurgence of Covid infections causing a lockdown in a major industrial area in China has created new supply chain issues. Together, they have ruined hopes by the Biden administration for significant relief from the current rate of inflation in time to prevent voter resentment of the high prices from turning the upcoming November midterm election into a disaster for Democrats.
THE FEDERAL RESERVE WAS ASLEEP AT THE SWITCH
Until just a few months ago, economists in the Biden administration and the Federal Reserve had persistently underestimated the problem of rising prices. They insisted upon calling it “transitory,” until the persistent rise in the inflation rate became too obvious to continue denying it. There is now a belated consensus that the Fed waited far too long before deciding to end its zero-interest rate policies aimed at stimulating the recovery from the pandemic.
Even according to the Fed’s own preferred inflation gauge, known as the personal consumption expenditures price index, inflation is now out of control. The index is expected to rise to 4.7% during the final quarter of this year, more than double the Fed’s 2% target rate.
Last month, the Fed raised its key federal funds interest rate by a quarter of a percentage point, the first increase since 2018. The minutes of the Federal Reserve’s March meeting also show that “many” of its governors would have preferred a bigger rate hike at that time, if not for the uncertainty created by Russia’s invasion of Ukraine.
A blunt statement by Fed governor Lael Brainard revealing a major shift in policy recently shocked the financial markets. “It is of paramount importance to get inflation down,” she declared. “The committee will continue tightening monetary policy methodically through a series of interest rate increases and by starting to reduce the balance sheet at a rapid pace as soon as our May meeting.”
Some economists, including William Dudley, a former president of the Federal Reserve Bank of New York, say that because of the Fed’s delay, a recession in the near future is “virtually inevitable.” They contend that if the Fed had begun raising interest rates slowly last year, thereby lightly “tapping the brakes” on economic growth, it might have been able to bring inflation under control without too much pain. But now, they say, the economy is growing so rapidly that the only way the Fed can get prices under control is to “slam on the brakes” with big interest hikes, causing a recession.
The latest Bloomberg survey of forecasts by 72 economists predicts that the consumer price index will increase by an average of 5.7% during the final quarter of this year, up from the 4.5% estimated a month ago. The economists also increased their odds on the economy going into a recession next year from 20% in March to 27.5%.
THE FEDERAL RESERVE’S DIFFICULT CHALLENGE
By driving up market prices for major commodities like wheat, corn, natural gas, and oil, the war in Ukraine has demonstrated how fragile global supply chains can be. The persistence of those supply chain interruptions has further complicated the Federal Reserve’s already difficult task of trying to reduce inflation without tipping the economy into a recession.
In early May, the Federal Reserve is expected to start reducing the $9 trillion worth of securities on its balance sheet to reduce the available money supply in financial markets. At the same time, it is expected to hike its key interest rate by half a percentage point, possibly followed by a similar interest rate increase in June as well.
There are currently two main schools of thought within the economic community about whether it is still possible to bring down inflation without plunging the economy into recession. New York Times economic columnist Paul Krugman is on one side of the debate, and President Obama’s former chief economic advisor, Larry Summers, as well as Harvard economist Jason Furman, are on the other.
Krugman no longer believes that the current spike in inflation is transitory. He now predicts that “rising prices will get worse before they get better… There’s still a lot of inflation in the pipeline.” But he also believes that Federal Reserve policy makers can bring inflation under control without having to raise interest rates so high as to induce a recession, as former Fed Chairman Paul Volcker did to end a more severe bout of inflation 40 years ago.
Krugman argues that such extreme measures are unnecessary today because inflationary expectations among consumers and business leaders are not yet as ingrained today as they were then. He also admits that the necessary hike in interest rates will result in some increase in the unemployment rate, but not a “full-on recession.”
AN EARLY WARNING WAS IGNORED
Summers, who also served as Secretary of the Treasury during the Obama administration, was one the first economists to predict that Biden’s $1.9 trillion Covid relief package passed by Congress last year would trigger a surge in inflation. More recently, he has written that the Federal Reserve’s current policy “is likely to lead to stagflation, with … unemployment and inflation both averaging over 5% over the next few years — and ultimately to a major recession.”
In an interview with New York Times writer Ezra Klein, Summers was highly skeptical of the Fed’s prediction that “the unemployment rate is going to fall to 3.5%, remain at 3.5% for three years, and that while that’s happening inflation is going to fall from its current north of 6% level to the neighborhood of 2%. Nothing like that has ever happened in the last, roughly, 60 years,” he said. “It is hard to see the [Federal Reserve’s] forecast as anything other than — to use an old political term — rosy scenario economics,” Summers added.
He believes that inflation can’t be brought under control unless the Fed increases interest rates above the rate of inflation, and keeps them there until the rate of inflation slows sufficiently. Inevitably, such high interest rates would dramatically reduce the current rapid rate of growth. It would make a “soft landing” for the US economy very difficult, and more likely plunge the country into a recession.
Other economists argue that the current economic recovery is robust enough to withstand the rise in interest rates necessary to stop rising inflation without bringing growth to a complete halt. For example, Aneta Markowska, chief economist for the Jefferies investment bank, told the New York Times, “I just don’t see what would cause businesses to do a complete 180 and go from ‘We need to hire all these people and we can’t find them’ to ‘We have to lay people off.’”
While some of these predictions are alarming, they all should be taken with more than a grain of salt, because we are in uncharted economic waters. There is no recent parallel for the shock to the economy created by the pandemic, and even before the pandemic, economists have in recent years compiled a very poor record for accurately predicting recessions.
LINGERING SUPPLY CHAIN PROBLEMS
In addition, the supply chain problems which developed last year as the economy recovered from the pandemic have lingered far longer than economists had expected.
For example, the domestic new and used car markets continue to suffer from a severe lack of cars to sell due to a variety of supply chain issues, which range from a chronic shortage of computer chips, to unexpected shutdowns at auto parts factories around the world, to shipping issues such as the recent truckers’ strike in Canada.
Corina Diehl, who operates a car dealership in the Pittsburgh area, recently told a New York Times reporter, “If I could get 100 Toyotas today, I would sell 100 Toyotas today.” Instead, she said, she’s lucky to have three, and, “it’s the same with every brand I have.”
As a result, the relatively few new cars that are now available are often being sold by dealerships at well above their list prices, and popular recent model used cars, instead of depreciating in value, are now selling for more than their owners originally paid for them. These vehicle shortages, and the rising prices they have generated, are expected to continue into 2023.
THE RECENT GROWTH RATE WAS UNSUSTAINABLE
Statistically, last year saw the American economy grow at the fastest pace since the mid-1980s, and create a record number of jobs. But those numbers were in comparison to the steep declines artificially created by the pandemic lockdowns, and that high rate of growth was clearly not sustainable.
Because the lockdown made many services unavailable, the pent-up consumer demand was redirected toward the purchase of goods, which overwhelmed the industrial supply chains still recovering from the impact of Covid. In addition, because so many people had gotten used to staying home, once businesses began to reopen, employers could not find enough workers to fill their vacant job positions, even after raising their wage scales. As Fed chairman Jerome Powell put it, the labor market had gotten “tight to an unhealthy level.”
Some liberal economists disagreed, arguing that the hot labor market was good for workers, while admitting that the rapid pace of job growth could not last for very long. In addition, while unemployment for black workers, for example, who had suffered severe job losses during the pandemic, had fallen back to 6.2% in March, they were still losing ground economically, because their wage increases could not keep pace with the rate of inflation for the essentials, such groceries, rent, and gas for their cars.
HAS THE PANDEMIC PERMANENTLY CHANGED THE ECONOMY?
However, British economist Charles Goodhart foresees a different scenario. In an interview with the Wall Street Journal, Goodhart said that, “The coronavirus pandemic will mark the dividing line between the deflationary forces of the last 30 to 40 years and the resurgent inflation of the next two decades.”
The key factor that the other economists have missed, Goodhart believes, is a major demographic shift, both in the West and in China, from the past generation’s labor surplus to the current generation’s labor shortage, due to recent decades of depressed birth rates and a rapidly aging workforce. This labor shortage will create continued pressure forcing up wages and, eventually, prices.
Goodhart also says that the Russian invasion of Ukraine has brought home to business and political leaders alike the geopolitical risk in relying too heavily upon globalized supply chains. He predicts this realization will prompt efforts to move toward more localized, less vulnerable supply and production arrangements. Safer “just in case” inventory strategies will replace the lower cost “just in time” production procedures that were introduced a generation ago by Japanese car manufacturers, which enabled them to take over much of the US car market at that time. The more cautious new inventory strategies will increase the cost of production somewhat, but the loss in efficiency will be counterbalanced by more resilience to the crippling supply chain disruptions that the global economy is currently experiencing.
Goodhart believes that, in the short term, the US economy will not fall into recession. Instead, he expects it to continue running hot, with high growth and low unemployment driving an uncomfortably high-level inflation and interest rates. But he warns that maintaining long-term economic growth while at the same time keeping wages stable to prevent a further rise in inflation will require major gains in the years ahead in the productivity of American industry.
DOES THE BIDEN ADMINISTRATION HAVE A WAY FORWARD?
The Trump administration made a highly successful effort in that direction by reducing corporate taxes and eliminating unnecessary government regulations. But since taking office, President Biden has been trying to reverse those policies. His big spending proposals, coupled with his climate change-inspired war on the domestic fossil fuel industry, launched the current wave of inflation, which started with energy prices and has now spread through almost every segment of the US economy.
Biden has argued, unconvincingly, that his failed “Build Back Better” plan — the multi-trillion-dollar spending package killed by Senator Joe Manchin (D-WV) due to his concern that it would boost inflation — would have eventually addressed some of the bottlenecks in the American economy which have contributed to the supply chain issues. The Biden administration continues to argue that Americans must continue paying record high prices for gas at the pump and other forms of fossil fuel energy for the sake of slowing climate change and hastening the country’s transition to green energy sources.
But the Biden administration has little to offer American families now struggling with prices rising much faster than their paychecks. All the polls now show that a substantial majority of voters are most concerned about the current state of the economy. They are clamoring for immediate relief from the inflation spike, but as long as President Biden maintains his current policies, there is no such relief in sight.