Not long ago, many people were predicting a long, hot summer of inflation. To their surprise — and, for some Republicans, dismay — that isn’t happening. Overall consumer prices were flat in July, and nowcasts — estimates based on preliminary data — suggest that inflation will remain low in August.
However, I don’t know any economists who believe that inflation has been beaten. Much of the recent good news is the result of falling gas prices, which won’t continue. It’s true that we’ll probably get another round of good news from falling food prices: The Food and Agriculture Organization’s index of global food prices plunged in July, and the effect will probably show up in supermarket aisles in a few months.
In fact, beef is already getting cheaper.
Still, the Federal Reserve has learned from much experience not to let policy be driven by movements in volatile food and energy prices, and underlying inflation still looks high. So the Fed isn’t about to pivot; it will keep raising interest rates to cool off the economy, which is highly likely to lead to at least some rise in unemployment and quite possibly a recession.
In pursuing this strategy, the Fed is following policy orthodoxy. But are there less painful, heterodox strategies we could be following instead?
I’d like to believe that there are, and heterodoxy sometimes works. Unfortunately, I can’t see it working under current U.S. conditions.
What do I mean by heterodox policy? Broadly speaking, there are two ways to bring inflation down without putting the economy through a painful squeeze. One is what we used to call incomes policy: direct government intervention, whether through controls or moral suasion, to limit price increases. The other is policy to hold prices down by expanding supply.
Do incomes policies ever work? Yes. The classic example is Israel in the 1980s, a nation that experienced very high inflation, then brought inflation way down.
This achievement was made possible in large part through a package that included a temporary wage freeze and price ceilings. And Israel managed to go cold turkey on inflation without experiencing a severe recession.
But nothing like that seems possible in modern America. For one thing, Israel in the 1980s was the kind of place where you could get most of the major economic players together in a single room; labor federation Histadrut represented about 80% of the workforce.
Beyond that, Israel’s ‘80s inflation probably reflected, in large part, self-fulfilling expectations of inflation. When that’s your problem, there’s a strong case for a timeout to break the cycle. But that isn’t what’s happening in the United States now, where long-term inflation expectations have stayed remarkably subdued.
So what is our problem? Probably just a classic case of too much money chasing too few goods, leading to a very hot economy — one in which there are far more job vacancies than there are people seeking work.
And any attempt to suppress the inflation caused by this hot economy with controls would almost surely be blown apart instantly by market forces.
Does this mean that Congress and the president should ignore the possibility that some companies are taking advantage of an inflationary background to exploit their monopoly power? No, a bit of naming and shaming wouldn’t do any harm and might accelerate the process of disinflation. But we’ll still need Fed tightening — reducing the amount of money chasing the limited supply of goods.
Unless, that is, we can increase the supply of goods. Can’t we reduce inflation by, say, investing in infrastructure, thereby increasing the United States’ productive capacity? In principle, yes. And we are, in fact, doing that. Last year’s infrastructure law and the just-enacted Inflation Reduction Act are, to an important degree, investment bills that will eventually make the U.S. more productive and hence limit inflation — more, I think, than many people realize.
But these benefits, aside from being uncertain in size, will take years to materialize. And the Fed believes — correctly, I think — that it’s operating on a clock. So far, expectations of inflation have stayed anchored, but we can’t count on that happy condition persisting if inflation stays high for an extended period. The Fed, therefore, needs to take action to reduce underlying inflation fairly quickly.
So orthodoxy — reducing inflation by engineering a slowdown — it is. It’s still unclear whether this slowdown will be severe enough to be labeled a recession, but it will be painful for consumers even if it isn’t. There are many good things to be said about a hot economy and tight labor markets, and we’ll miss them when they’re gone. But there don’t seem to be any realistic alternatives.
Paul Krugman, winner of the Nobel Memorial Prize in Economic Science, is a columnist for The New York Times.