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Serving Northern St. Louis County, Minnesota

Is the Fed blowing it?

With higher interest rates, the Fed may be fighting the wrong war


It’s often said that generals prefer to fight the last war, which is another way of noting that we tend to address circumstances in the present based on how we responded to similar circumstances in the past.
That certainly appears to be happening with the Federal Reserve’s current fight against inflation, which risks toppling the U.S. and global economy into recession to address inflationary pressures that look pretty mild by comparison to the 1970s and early ‘80s, when inflation topped out at 14 percent.
Many economic experts from across the political spectrum are starting to point out the obvious, namely that higher interest rates may not be the most effective approach to handling the current inflationary cycle. Now that the election season is over, it at least might be possible for policymakers and the public to start having a more intelligent discussion about the nature of our current inflation, and how to address it.
While higher interest rates can suppress some forms of demand (just ask a realtor these days), they have little impact on most routine consumer spending, so they can’t really help address the rising cost of energy and food, which are the primary drivers of inflation right now.
At the same time, rising interest rates can actually make inflation worse, both directly and indirectly. If interest rates rise, the cost of housing goes up and that has a direct impact on prospective homebuyers or renters. If higher interest rates prompt an oil producer in Texas or North Dakota to shutter plans for a new round of drilling or fracking, or convince a manufacturer now isn’t the time to start production of a product that’s been in short supply, it could help to exacerbate the current supply shortages that are contributing to inflation.
We know that the demand side remains robust, which is one reason that employment has remained strong even in the face of higher prices. This isn’t the stagflation we experienced in the 1970s. The economy would be growing even faster today if we had more goods and services to sell and more workers available to hire.
This really is a supply side issue, one that’s been exacerbated by the effects of COVID, the war in Ukraine, and the effects of climate change. Water shortages are impacting both food production and food shipments, all around the world. It may well be that food prices will never come back down because we can expect more and worsening climate related shocks for decades to come.
Higher interest rates won’t make the rain fall or prompt a Russian pullback from Ukraine, and most certainly won’t free up supply chain glitches. They will, however, send the stock market tanking and, eventually, will start throwing millions of lower-income Americans out of work.
There is a serious equity issue involved here. When the Fed pushes up interest rates, the impact falls hardest on those near the bottom of the economic ladder. They’re the first to face layoffs when a recession hits and they’re hit the hardest, by far, due to rising prices.
Those at the top might notice their paper losses in the stock market, but they’re the ones who are most likely benefitting from the string of record corporate profits that have gone hand-in-hand with the current run of inflation.
If the Biden administration and Congress want to address inflation, they should tell the Fed to ease off the blunt instrument of higher interest rates and work the economic policy side by fixing the broken markets in this country. Industry consolidation, particularly in the food industry, is allowing companies to jack up prices simply because they can, without fear that a competitor will go after market share by undercutting them. When you shop at the supermarket, it may look like there are any number of different brands of chicken, or eggs, or cereal, but it’s largely a mirage. Most of those brands are owned by a tiny handful of huge conglomerates, which control so much of the market that they can set prices wherever they like.
It’s the same with big chain restaurants, which have been jacking up the price of burgers and burritos far beyond their own increases in production costs. Virtually all the big food companies have been posting record profits, and it’s all coming out of the pockets of average consumers.
We see exactly the same with the big oil companies, who have little interest in ramping up production when they recognize they can make more money by coasting on current capacity and keeping supplies tight.
And all those profits are going straight to shareholders. As usual, the rich get richer.
Inflation may be overtaxing most of our wallets, but for those at the top, the cushion keeps getting cushier.