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Last week the Federal Reserve took its most aggressive step yet to curb inflation by raising interest rates by three-quarters of a percentage point, the largest increase since 1994. On Wall Street, the news further disturbed what were already troubled economic waters: By the time of the announcement, the S&P 500, on the decline for much of the year, had lost more than 20 percent of its value since its most recent peak on Jan. 3, crossing the threshold into bear market territory.
A relatively rare occurrence, a bear market is widely seen as an indicator of recession, as one has followed the other in nine of 12 downturns since World War II. Is a recession on the horizon, and if it is, how serious could it prove? Here’s what people are saying.
How a recession could happen
For the most part, the Times reporter Jeanna Smialek explains, economists have blamed the most rapid inflationary burst in four decades on a few main causes:
Consumer demand remains at highly elevated levels, buoyed by savings accrued earlier in the pandemic, thanks to government relief and reduced economic activity, as well as by more recent wage increases. (Last week, it bears noting, the Federal Reserve chair, Jerome Powell, said that “wages are not principally responsible for the inflation that we’re seeing.”)
Suppliers continue to struggle to keep up with consumer demand, constrained by pandemic-induced factory shutdowns, global shipping delays, reduced production and, more recently, lockdowns in China, the war in Ukraine and the attendant sanctions on Russian fossil fuels.
Amid the supply crunch, people have started shifting some of their spending back to services from goods — a reversal of earlier pandemic trends — causing prices to rise in those sectors as well.
Some Democratic politicians have accused corporations with concentrated market power of “greedflation,” or increasing their prices well beyond the level needed to keep their profit margins from eroding. Some new research supports the explanation, my colleague Peter Coy writes, but as The Times’s Lydia DePillis has reported, experts disagree about how much weight to give it and whether the underlying phenomenon is even undesirable in the first place.
The Fed hopes that raising interest rates will drive down inflation by making debt of all kinds more expensive. “By raising rates, the Fed is trying to make you slow down your spending,” Kathy Jones, the chief fixed-income strategist at the Schwab Center for Financial Research, told The Times. “That happens when the cost of money goes up for a car loan or mortgage or something else you want to spend money on. At some point, you’re going to pull back.”
But if the economy slows down too quickly, it could start to contract. For the nine instances since 1961 when the Fed raised rates to combat inflation, recessions followed all but one, according to research from the investment bank Piper Sandler. In a June survey of 49 U.S. macroeconomic experts conducted by The Financial Timesand the University of Chicago’s Initiative on Global Markets, nearly 70 percent said a recession was likely in 2023.
Some think that risk isn’t worth running: If prices are rising owing in large part to inadequate supply, reducing people’s purchasing power could be an inefficient and needlessly painful way to bring them down. Interest raises, after all, cannot produce more gas that would lower its cost at the pump, nor can they alleviate the housing shortage that is driving up rents.
“What the Fed can do is discourage new housing construction (housing starts fell 14 percent in May), in the long run making housing more expensive, not less,” J.W. Mason, a professor of economics at John Jay College, writes in Barron’s. “What the Fed can do is shift bargaining power in the labor market from workers to employers, causing wages to fall even further short of the cost of living. What the Fed can do, if it pushes hard enough, is tip the economy into recession.”
A return to stagflation?
The last time consumer prices were climbing this quickly in the United States, in 1982, the country had just come out of an economic period defined by high, persistent inflation, weak growth and elevated unemployment. In a foreword to a recent World Bank report, the group’s president, David Malpass, said the risk that the nasty and rare combination of stagflation might return was “considerable.”
“Subdued growth will likely persist throughout the decade because of weak investment in most of the world,” he wrote. “With inflation now running at multidecade highs in many countries and supply expected to grow slowly, there is a risk that inflation will remain higher for longer than currently anticipated.”
The U.S. economy, however, is in a very different place than it was in the 1970s, the Times columnist Paul Krugman argues. Whereas inflation was deeply entrenched at the beginning of the 1980s, “the public now expects high inflation for the near term but a return to normal inflation after that,” he writes. “Financial markets, where you can extract implied inflation expectations from the spread between yields on bonds that are and aren’t indexed to consumer prices, are telling the same story: inflation today but not so much tomorrow.”
Ben Bernanke, who presided over the Federal Reserve during the Great Recession (another moment of heightened stagflation fears), agrees. Unlike President Biden, Presidents Johnson and Nixon put a great deal of pressure on the Federal Reserve to refrain from taking any economy-slowing measures that might reduce inflation for fear of blowback from the electorate.
Today, Bernanke argues, the Fed is a much more independent institution with a better understanding of how inflation works and what it can do to control it: “In short, the lessons learned from America’s Great Inflation, by both the Fed and political leaders, make a repeat of that experience highly unlikely.”
What to watch out for
The Federal Reserve’s plan to slow the surge in consumer prices won’t have to cause stagflation or a full-blown recession for average Americans to feel squeezed. Earlier this month, the chief executive of JPMorgan Chase warned that an economic “hurricane” was on the horizon. “We just don’t know if it’s a minor one or Superstorm Sandy,” he said, but “you better brace yourself.” Against what?
Amid a national affordable housing shortage, steeper mortgage rates are likely to drive the cost of homeownership even higher in the near term, pushing people who might otherwise buy into overheated rental markets. And higher rents could in turn sustain high inflation, Lisa Abramowicz notes at Bloomberg.
By increasing the cost of corporate borrowing, interest rate raises slow business growth and drive up unemployment. This week, former Treasury Secretary Larry Summers said that to get inflation under control, the unemployment rate would need to rise above at least 5 percent, from 3.6 percent today. “To state the obvious,” the Washington Post economics reporter Jeff Stein tweeted, “a 5% unemployment rate would mean devastating joblessness for millions of poor American workers.”
With higher unemployment comes reduced leverage for workers in the labor market, which could cause wage growth to slow even as it has failed to keep pace with inflation. “The transition is going to be very difficult,” Seth Carpenter, the global chief economist at Morgan Stanley and a former Fed economist, told The Times. “At least historically, it takes a really long time for inflation to come down, even after the economy slows.”
Some economists say the White House and Congress should be doing more to bring inflation down faster and cushion the blow to average Americans. Michael R. Strain of the American Enterprise Institute, for example, believes that Biden should finally roll back the Trump administration’s tariffs on Chinese goods, which, in combination with other trade liberalization policies, could reduce inflation by as much as 2 percentage points.
While Biden is reportedly considering asking Congress to suspend the federal gas tax to bring down its price by 18.4 cents per gallon, Claudia Sahm, a former Fed economist and contributing Times Opinion writer, argues that it’s a “somewhat gimmicky” idea that doesn’t address the problem at the root. Instead, she believes the administration should write contracts with domestic oil producers with a minimum price guarantee to encourage production, which would lower the price of gas in the near term, while Congress should pass legislation to expedite the renewable energy transition, which would reduce the country’s dependence on fossil fuels in the longer term.
“The Fed cannot print oil or wheat,” Sahm writes. “If the Fed alone fights inflation, people will suffer.”
Do you have a point of view we missed? Email us at firstname.lastname@example.org. Please note your name, age and location in your response, which may be included in the next newsletter.
“If You Must Point Fingers on Inflation, Here’s Where to Point Them” [The New York Times]
“The Fed’s Newfound Aggressiveness Is Concerning” [The New York Times]
“Why a Not-So-Hot Economy Might Be Good News” [The New York Times]
“The World Has a Choice: Work Together or Fall Apart” [The New York Times]
“The Stock Market Is Plummeting. Welcome to the End of the ‘Everything Bubble.’” [The New York Times]
WHAT YOU’RE SAYING
Here’s what readers had to say about the last debate: Will Trump face criminal charges?
Michael, 78, from Florida: “Not bringing charges after such an overt attempt at a coup certainly sends an unwanted future signal. But charging him and failing is not necessarily a wasted effort at quashing future such attempts. For one, it shows a would-be autocrat that he/she will be prosecuted and perhaps not as fortunate. Furthermore, I’m assuming such a prosecution will also ensnare those close around him and in Congress who abetted his effort. While Trump might skate, if many of those accomplices don’t, that sends the desired message downstream. Since no one person can pull such an effort off, anyone seeing such accomplices go down will certainly think twice before considering similar support in the future.”