Interest rate hikes are not a solution to supply shocks

How is raising interest rates supposed to solve the problem of grain production in the middle of a war zone in Ukraine? How is this supposed to end containment of industrial production – heavy cities in China who sees increasing cases of COVID? How is it supposed to clear ship backlogs outside US ports?

These are the questions left unanswered as Federal Reserve Chairman Jerome Powell, whom liberal prodigies once praised for his unwavering dedication to full employment, steps back and signals aggressive rate hikes for the rest of the year. Interest rates are now expected to rise in half-point increments for the next two Fed meetings and at a more subdued but sustained level indefinitely thereafter, in a bid to counter the rise. of inflation.

We should make it clear what Powell wants to do. The credit crunch by increasing the cost of money is intended to curb investment. Lower investment would lead to fewer jobs. Fewer jobs would lead to poorer people. Poorer people would lead to a reduction in aggregate demand. And this reduction in aggregate demand would lead, according to this concept, to a slowdown in inflation. In other words, the Fed wants to throw people out of work to reduce inflation, and for that to really succeed, the growing number of unemployed would have to register in the millions. For all the talk of “soft landings” and the precise management of monetary tools, these controls are much more direct than Powell would like to admit, and they point in the direction of recession as a strategy to fight against the crisis. inflation that the Fed will follow.

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Powell’s work, although just beginning, is already having an impact. Mortgage rates, one of the most common interest rates we interact with, are now directed in a straight line, affecting housing affordability and employment stability in the real estate sector. The goal may not explicitly be to slow down home buying, but that will be the effect.

My initial questions target the premise of Powell’s plan. What if it puts people out of work and pushes the economy into recession, but delays in shipments and shortages of goods persist, keeping inflation high regardless Requirement ? Since some of the supply shortages are in basic necessities, demand cannot be squashed enough to make much of a difference without mass deprivation.

The fact is that the instruments of the Federal Reserve may not be well suited to the current circumstances of supply shocks, a lingering pandemic and a war waged over the source of several essential commodities. Yet action is demanded and the only action that can happen quickly is hitting the economy with a club.

Policymakers who wanted to do something useful about inflation would start with diplomacy. Although Russia and Ukraine are relatively small economies on a global scale, the war has always inflation driven and damaged supply chains, regardless of interest rate policy. The longer Putin’s war rages, the higher the price of increasingly scarce commodities will rise. Stopping it is a Herculean task, but engaging diplomatically to help end hostilities, while a distant prospect, beats the more available prospect of slowing the economy and hoping for the best.

Shipping companies and Dockers almost immediately refused to move the Russian cargo, causing a chaotic rerouting of flights and container ships. Containers bound for Russia are stuck in the wrong place, while other ports are experiencing shortages. The devastation itself has taken Ukraine off the export map and combined with Russian sanctions that have restricted key supplies of platinum, aluminum, steel and organic products like corn, wheat, and sunflowers. Ships and their crews in Ukrainian ports were blocked in the Black Sea, disturbing the delicate dance seafarers and containers, and rising insurance costs impacting the shipping industry. “More ships are stranded around the world than at any time since World War II,” historians have said. Recount The Wall Street Journal.

Policymakers who wanted to do something useful about inflation would start with diplomacy.

Fighting the pandemic, with other actions such as those recently released by the Biden administration federal ventilation guidelines, would be another more useful initiative than raising interest rates. Lockdowns in Chinese industrial cities like Shenyang reduce the supply of produced goods, which increases the costs that importers are willing to pay to get the meager supplies out of the country. With the BA.2 variant increasing case rates worldwide, the likelihood of additional slowdowns is high.

As declining manufacturing output and the Chinese Lunar New Year gave U.S. West Coast ports a chance to regroup and squeeze through a backlog that dates back to last fall, diverting cargo amid exasperation with delays a delays moved to East Coast, where 63 container ships were waiting offshore last Friday. It’s like squeezing one end of a balloon to inflate the other side. Treat with summary profit taking of shipping companiesas the Biden administration attempted, is more effective in combating rising costs, not to mention a more sensible policy goal than trying to impoverish the working class.

On top of all that, as our friends at Groundwork Collaborative have been hammering, companies took the opportunity to hide behind inflation expectations to raise prices so as to increase their profit margins. Recognizing and fighting windfall profits makes more sense than driving interest rates up to a level that puts people out of work.

What will be the impact of interest rates on shortage of critical equipment for two years need to make more semiconductor chips? To the extent that it reduces investment because it costs more to make capital expenditures, it is counterproductive. What will be the impact of interest rates on stubborn refusal US shale companies to thwart their Wall Street investors and drill more to increase the world’s oil supply? And how will interest rates impact looming supply-side challenges, such as climate change, cyber attacksa potential work stoppage in ports on the west coast, or random container ships running aground?

The only normal-sounding person on this issue these days is the one Fed Chairman Biden hopeful didn’t choose in his last round of nominations, AFL-CIO Chief Economist Bill Spriggs (who, in all transparency, is a Perspective crew member). Like Spriggs told NPR last week, a policy of raising interest rates “does not solve the problem that causes inflation”. He cited the fall in car production, responsible for around a quarter of the current rise in inflation, which is only getting worse as European automakers depend on Ukrainian parts to power their factories. He also cited soaring oil and wheat prices due to the war, noting that increases in the cost of grain will inevitably be factored into meat since that is what cows and pigs are fed. “It’s a series of supply shocks,” Spriggs said.

As Economist Josh Mason pointed out, the logic of what the Fed is doing syncs with forcing students to repay their loans and cutting off enhanced Medicaid payments to states. “You might object that these measures would deprive vulnerable people of income and discourage socially useful spending,” Mason writes. “Which is true. But it’s different from rate hikes, how?” In other words, the austerity mindset and the pressure for monetary tightening differ only in that that the Austerians are more honest about their goals.

The dangers of adopting this mindset are obvious. Because COVID preparedness was left out of the omnibus spending bill, the Biden administration says it has no money to raise more COVID tests or one booster of the fourth vaccine, which as BA.2 becomes more prevalent around the world and we move further and further away from the last booster injection, could leave Americans vulnerable. At a time when so many policymakers are concerned about an “overheating economy” and its alleged effect on inflation, the greatest challenge facing the country for the fate of millions of potential victims of the pandemic is that states States have not spent enough to prepare for the surge.

Policy makers are not powerless to coping with current conditions, although it will take time. But the emphasis on immediate action through the default tools of fighting inflation leads us down a counterproductive path of poisoning the patient to cure their disease. If the slowing economy was helping to increase needed supply inventory, that would be one thing. Cutting people off from their livelihoods for no reason other than to say you “did something” is downright sadistic.

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