[In the name of taming inflation, central banks have deliberately
set themselves on a path to cause a recession – or to worsen it if
it comes anyway. Worse, todays monetary-policy tightening will leave
long-lasting scars, there are better responses. ]
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ALL PAIN AND NO GAIN FROM HIGHER INTEREST RATES  
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Joseph E. Stiglitz
December 8, 2022
Project Syndicate
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_ In the name of taming inflation, central banks have deliberately
set themselves on a path to cause a recession – or to worsen it if
it comes anyway. Worse, today's monetary-policy tightening will leave
long-lasting scars, there are better responses. _

, Frederic J. Brown/AFP via Getty Images

 

NEW YORK – Central banks’ unwavering determination to increase
interest rates is truly remarkable. In the name of taming inflation,
they have deliberately set themselves on a path to cause a recession
– or to worsen it if it comes anyway. Moreover, they openly
acknowledge the pain their policies will cause, even if they don’t
emphasize that it is the poor and marginalized, not their friends on
Wall Street, who will bear the brunt of it. And in the United States,
this pain will disproportionately befall people of color.

As a new Roosevelt Institute report
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I co-authored shows, any benefits from
the _extra_ interest-rate-driven reduction in inflation will be
minimal, compared to what would have happened anyway. Inflation
already appears to be easing. It may be moderating more slowly than
optimists hoped a year ago – before Russia’s war in Ukraine –
but it is moderating nonetheless, and for the same reasons that
optimists had outlined. For example, high auto prices, caused by a
shortage of computer chips, would come down as the bottlenecks were
resolved. That has been happening, and car inventories have
indeed been rising
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Optimists also expected oil prices to decrease, rather than continuing
to increase; that, too, is precisely what has happened
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of renewables implies that the long-run price of oil will fall even
lower than today’s price. It is a shame that we didn’t move to
renewables earlier. We would have been much better insulated from the
vagaries of fossil-fuel prices, and far less vulnerable to the whims
of petrostate dictators like Russian President Vladimir Putin and
Saudi Arabia’s own war-mongering, journalist-murdering
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Crown Prince Mohammed bin Salman (widely known as MBS). We should be
thankful that both men failed in their apparent attempt to influence
the US 2022 midterm election by sharply cutting oil production
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early October.

Yet another reason for optimism has to do with mark-ups – the amount
by which prices exceed costs. While mark-ups have risen slowly with
the increased monopolization of the US economy, they have soared
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the onset of the COVID-19 crisis. As the economy emerges more fully
from the pandemic (and, one hopes, from the war) they should decrease,
thereby moderating inflation. Yes, wages have been temporarily rising
faster than in the pre-pandemic period, but that is a good thing.
There has been a huge secular increase in inequality, which the recent
decrease in workers’ real (inflation-adjusted) wages has only made
worse.1

The Roosevelt report also dispenses with the argument that today’s
inflation is due to excessive pandemic spending, and that bringing it
back down requires
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long period of high unemployment. Demand-driven inflation occurs when
aggregate demand exceeds potential aggregate supply. But that, for the
most part, has not been happening. Instead, the pandemic gave rise to
numerous _sectoral _supply constraints and demand shifts that –
together with adjustment asymmetries – became the primary drivers of
price growth.

Consider, for example, that there are fewer Americans today than there
were expected to be before the pandemic. Not only did Trump-era
COVID-19 policies contribute to the loss of more than a million people
in the US (and that is just the official figure), but immigration also
declined, owing to new restrictions and a generally less welcoming,
more xenophobic environment. The driver of the increase in rents was
thus not a large increase in the need for housing, but rather the
widespread shift to remote work, which changed where people
(particularly knowledge workers) wanted to live. As many professionals
moved, rents and housing costs increased in some areas and fell in
others. But rents where demand increased rose more than those where
demand fell decreased; thus, the _demand shift _contributed to
overall inflation.

Let us return to the big policy question at hand. Will higher interest
rates increase the supply of chips for cars, or the supply of oil
(somehow persuading MBS to supply more)? Will they lower the price of
food, other than by reducing global incomes so much that people pare
their diets? Of course not. On the contrary, higher interest rates
make it even more difficult to mobilize investments that could
alleviate supply shortages. And as both the Roosevelt report and my
earlier Brookings Institution report
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Anton Korinek show, there are many other ways that higher interest
rates may exacerbate inflationary pressures.

Well-directed fiscal policies and other, more finely tuned measures
have a better chance of taming today’s inflation than do blunt,
potentially counterproductive monetary policies. The appropriate
response to high food prices, for example, is to reverse a decades-old
agricultural price-support policy that pays farmers not to produce
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when they should be encouraged to produce more.

Likewise, the appropriate response to increased prices resulting from
undue market power is better antitrust enforcement, and the way to
respond to poor households’ higher rents is to encourage investment
in new housing, whereas higher interest rates do the opposite. If
there was a labor shortage (the standard sign of which is increased
real wages – the opposite of what we are currently seeing
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should involve increased provision of childcare, pro-immigration
policies, and measures to boost wages and improve working conditions.

After more than a decade of ultra-low interest rates, it makes sense
to “normalize” them. But raising interest rates beyond that, in a
quixotic attempt to tame inflation rapidly, will not only be painful
now; it will leave long-lasting scars, especially on those who are
least able to bear the brunt of these ill-conceived policies. By
contrast, most of the fiscal and other responses described here would
yield long-term social benefits, even if inflation turned out to be
more muted than anticipated.

The psychologist Abraham Maslow famously said
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with a hammer, everything looks like a nail.” Just because the US
Federal Reserve has a hammer, it shouldn’t go around smashing the
economy.

_JOSEPH E. STIGLITZ, a Nobel laureate in economics and University
Professor at Columbia University, is a former chief economist of the
World Bank (1997-2000), chair of the US President’s Council of
Economic Advisers, and co-chair of the High-Level Commission on Carbon
Prices. He is a member of the Independent Commission for the Reform
of International Corporate Taxation and was lead author of the 1995
IPCC Climate Assessment._

_PROJECT SYNDICATE produces and delivers original, high-quality
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leaders, and civic activists from around the world, we provide news
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_Subscribe to Project Syndicate.
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* Economy
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* inflation
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* Federal Reserve Bank
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* Government Spending
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* Ukraine
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