opinion | Larry Summers: How do we rein in inflation? Policymakers need to do their job.


The United States now faces as complex a set of macroeconomic challenges as it did at any time in 75 years.

This does not mean that he is facing his darkest economic moment. Our current situation includes strengths such as low unemployment, which is not by any measure as serious as the 2009 financial crisis or the inflation of the 1970s. What stands out, however, is the number of serious and interrelated problems that require attention.

Consider the links in this series of macroeconomic challenges:

First, an economy that even progressives like Paul Krugman admit is too hot, is running at a core inflation rate of close to 7 percent and has not yet fallen – with The last monthly number exceeds The last quarterly figure, which in turn exceeds the last annual figure.

Second, the combination of the negative effects of inflation and the negative effects of necessary anti-inflation policies led to a consensus expecting a recession starting in 2023. Federal Reserve’s latest forecast The suggestion that inflation could be lowered to 2 per cent without the unemployment rate rising above 4.4 per cent is simply unreasonable as an expectation.

Third, the Fed raised interest rates in a way that markets would not have thought highly improbable just a year ago. Markets are in shock, with the potential for normal trading in the Treasury market to collapse, an event that if unchecked will have major repercussions for other markets.

Fourth, the global economy everywhere is facing challenges due to rising US interest rates and the dollar exchange rate at record levels against some major currencies. The fallout from the war in Ukraine has been devastating to many economies. A weak and closed global economy is detrimental to our exporters and markets and seriously involves vital national security interests.

And all of this while we’re still finding our way toward COVID-19, which cases will likely spike this winter. Estimated more than a million workers They were pulled out of business due to the prolonged coronavirus. Moreover, the effects of the virus appear to be slowing productivity growth in the United States, with productivity In fact, it has been declining so far this year.

Each of these issues can be all-consuming in normal times. How should policymakers respond to bringing them all together?

Inflation first and foremost

The policy objective should at least be clear. Most importantly, the maximum number of Americans who want to work are able to work at the highest income possible, now and in the future. Other matters – from the level of government debt to the functioning of financial markets to business incentives to inflation – matter not for their own good but because of their effects over time on employment and income.

In other words: macroeconomic policy questions are not about values ​​but about judgments about the ultimate effects of different actions. Paul Volcker, as Chairman of the Federal Reserve in the early 1980s, was famous for taming out-of-control inflation at the expense of severe stagnation. But he did so not because he cared less about unemployment or worker incomes than his predecessors did, but because he rightly recognized that delays in containing inflation would only lead to more pain in the future.

This principle can be seen in the current job market. Even with job opportunities Rising to unprecedented heights The labor shortage has empowered workers, and the real income of Americans has fallen dramatically. Unless inflation falls, workers will not see meaningful increases in their purchasing power – and many will continue to doubt the government’s ability to carry out essential tasks.

That is why it is essential that the Federal Reserve does not hesitate. Chairman Jerome H. Powell has pledged to impose sufficiently restrictive monetary policy to bring inflation back within the Fed’s 2 per cent target range. The more confident workers, businesses, and markets have that the Fed will follow through, the less painful the process will be.

From this perspective, the Biden administration (unlike some in Congress) was right to avoid putting public pressure on the Federal Reserve. Such pressure should be seen as counterproductive even by those most alarmed about the risks posed by aggressive Fed action. The pressure is unlikely to drive interest rates down in the short term – the Fed is likely to tighten its backbone to avoid looking as if it were succumbing to political pressures – while markets will react to it with higher risk premiums and rising inflation expectations. Pressure on the Fed can only hurt the economy.

The idea that the economy has overheated, and therefore monetary policy must be constrained, is finally becoming widely accepted even by aides of the “transient team”. But those who argued early on that inflation would be short-lived are now moving from two valid points – that monetary policy is lagging and recession risks are rising – to the problematic conclusion that the Federal Reserve has done enough to contain inflation and the risks of excessive deflation with More stress.

Of course, the Fed will have to judge carefully when it is confident that the economy is on its way back to permanent price stability. private sector housing Some other data that inflation is likely to subside in 2023 is encouraging but does not provide a basis for this confidence yet.

However, it is a fundamental fallacy to say that since inflation expectations appear contained, the Fed can relax. The outlook was only contained because the Fed’s tightening was much more aggressive than expected. Today’s forecast is conditioned on the assumption that interest rates will rise by approximately two percentage points from current levels.

Those who think the Fed is about to do enough, need to explain their point. If they believe that interest rates above 4 per cent, in an economy with core inflation of 7 per cent, will lead to a recession serious enough to bring inflation below the Fed’s 2 per cent target, they need to explain why. I find it silly. Perhaps the argument is that preventing a recession so deep is so important that it is worth giving up on the federal inflation target. But proponents of this view need to explain how, if inflation remains well above 2 per cent, we can avoid continued erosion in real wages going forward.

For more than a decade, from 1966 to 1979, policymakers failed to do what was necessary to contain inflation because they underestimated the direct consequences of restrictive policy. History remembers them poorly. Conversely, I am not aware of any instance in which history has concluded that a Federal Reserve that was excessively focused on inflation or insufficiently aware of policy lag ended up causing significant, avoidable economic distress.

The broader policy challenge

While restrictive monetary policy is necessary to contain inflation, it does suffer from some toxic side effects. It is likely to increase over time. They are calling for political responses.

First, rather than waiting for crises in the Treasury and other markets, policymakers must take steps now to ensure liquidity is supported and that poorly crafted regulatory policies do not prevent financial institutions from holding government securities. The fact that the banking system came off well through Covid-19 is in part a homage to the regulatory changes put in place after the Great Recession. The next crisis is likely to come from the non-bank financial system. This should be the immediate objective of increasing organizational interest.

In addition, intense global cooperation was necessary in moments such as the Latin American debt crisis of the 1980s and the Great Recession. Now is the time to put in place debt restructuring mechanisms, financial support for emerging markets, and increase the capacity of the International Monetary Fund and the multilateral development banks to meet the emergency needs of the hardest-hit countries.

Finally, the inflation crisis should not be lost. The bright spot in the dismal inflationary period of the 1970s was the collaboration of Stephen J. Breyer (then an advisor to the Senate Judiciary Committee), Senator Edward M. Kennedy (D-Mass.) and the Carter administration on airline liberalization. In this era, high inflation should be a catalyst for regulatory changes — from addressing Jones Act increases in freight costs, to strategic tariffs, to rules mandating oil and gas transport by truck rather than pipelines, to punitive zoning restrictions — that will both lower prices and makes the economy work better.

Restoring price stability at the lowest possible cost is by no means sufficient to maximize US economic performance, but it is necessary. Only with a foundation of price stability can we meet the profound challenges of accelerating growth, involving all Americans in prosperity and maintaining American leadership at a dangerous global moment. Policy makers should not hesitate.

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