Inflation hurts. Raising interest rates does too

The main problem is inflation. Goods and services are getting much more expensive. US gas prices hit another high on Tuesday — $4.37 a gallon. globally, higher food and energy costs could last for years, according to the World Bank.

The recognized cure for inflation is to raise interest rates. This makes it more expensive for companies and people to borrow money and cuts down on how much they’re spending. The Federal Reserve did that last week and plans to do it again in the months to come.

Inflation affects everyone. The people who can least afford it are hurt the most.

Read this CNN report written by Alicia Wallace about how inflation is squeezing single parents, more than half of whom make less than $15 per hour, according to Oxfam. Wallace talks to parents skipping meals and racking up debt.
Interest rate hikes will hurt too. The entire point of raising rates is to slow down the economy, CNN’s Chris Isidore pointed out back in February, before the Federal Reserve began to raise rates.

Isidore talked to the liberal economist Robert Reich, who opposes rate hikes.

“The people you’re drafting into the fight against inflation when you raise interest rates and slow the economy are the most vulnerable,” said Reich, the former US Labor Secretary under President Bill Clinton and a professor of public policy at the University of California , Berkeley.

“The purpose of raising interest rates is to take the air out of the sails of the economy. If it works, you are, by definition, going to have fewer jobs. Even small increases in interest rates, if they have the desired effect, will cause job losses and wage losses,” he said.

What Matters term of the day: soft landing

The happy medium between inflation and rate hikes that policymakers at the Federal Reserve are aiming for is the “soft landing.” The idea is that inflation would be brought under control but the higher interest rates don’t push the entire economy into recession.

Soft landings rarely workout

Larry Summers is skeptical. He was the Treasury Secretary under former President Bill Clinton and economic adviser to former President Barack Obama, both Democrats, and has turned loudly questioning the Biden administration’s economic policy into a hobby over the past year.

With another Harvard University economist, Alex Domash, Summers studied attempted soft landings.

“The history of engineering soft landings is not encouraging, however. We found that every time the Fed has hit the brakes hard enough to bring down inflation in a meaningful way, the economy has gone into recession,” they wrote in early May.

Summers and Domash argue inflation will stay over 5% for the foreseeable future.

Last week, after announcing the interest rate hike of half a percentage point, Fed Chairman Jerome Powell said that the US economy can handle higher rates. He thinks inflation can be brought more under control.

Who’s in charge here?

In a speech from the White House on Tuesday, President Joe Biden pointed to several steps his administration has already taken to combat inflation — but it drove home the hard point that there’s very little he can actually do.
Encouraging more energy production is a request, while a windfall profits tax on companies using the fog of inflation to pad their profits seems unlikely. One thing Biden could do — ending Trump-era tariffs on China — is still under discussion.

The President, in a country that prides itself on free markets, does not control the economy. And his efforts to un-kink supply chains and bring down gas prices may chip away at price hikes, but they won’t solve anything.

Enter the Federal Reserve

The government agency that does have the power to do something about inflation is the Federal Reserve, which is arguably more immune from politics than the Supreme Court.

Members of its Board of Governors, with some exceptions, are not the subject of long and divisive confirmation battles. They serve 14-year terms and are appointed on a rolling basis, every other year. Other members of the committee that sets rates are appointed for shorter terms. But their control over monetary policy is absolute.

Long time coming

The Fed was slow to realize inflation — kicked off by the pandemic, goosed by continued federal and state stimulus packages, exploited by companies that see an opportunity and exacerbated further by the effect of the war in Ukraine on gas and grain prices.

It was also slow to raise rates after the Great Recession and then again as the world emerged from the pandemic.

“We’ve had decades of easy money, and the bill is now coming due,” said Rana Foroohar, CNN’s global economic analyst. In an appearance on CNN on Tuesday, she argued Fed actions to bring the US out of the Great Recession and the pandemic have compounded.

Helping people might not help the economy

Diane Swonk, the chief economist at Grant Thornton and an advisor to the Fed, told CNN’s Ana Cabrera on Tuesday that actions to directly help Americans deal with inflation — suspending the gas tax, for instance — could be counterproductive because they pour more money into the market.

“Although it’s good politics, because everyone feels the effects of inflation, it’s not the best economics, because it could actually continue inflation out there,” Swonk said.

The economy is in chaos

Read this analysis from CNN’s Christine Romans about how Biden has no silver bullet for inflation.

Romans told me by email it is difficult to read the economy at the moment.

“It’s just chaos trying to decipher what’s happening,” she said, pointing to strong economic indicators (unemployment as well as wage growth) despite obstacles. “Together, it’s a mess of cross-currents.”

Leave a Comment