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Ask An Economist: How to lower inflation
US inflation is now at a 40-year high. So, what are we going to do about it?
That depends on where you think the problem is coming from, American economist and University of Chicago professor Austan Goolsbee says on GZERO World with Ian Bremmer.
If inflation is being driven by too much stimulus, like some economists such as Larry Summers believe, Goolsbee believes the Federal Reserve is doing the right thing by raising interest rates to cool demand. But if inflation is mostly due to the war in Ukraine or supply chain disruptions, rate hikes might result in stagflation.
"I think if we get a couple [...] more months like the ones we just saw [...] they're gonna be consulting the ghost of Paul Volcker," Golsbee says, referring to the former Fed chair who in the early 1980s triggered two recessions by upping interest rates to double digits in order to tame inflation.
What about risking more unemployment, like Summers has suggested? That would mean "a lot of pain for millions of people."
Watch the GZERO World episode: Explaining inflation & what's next for the US economy
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Podcast: Making sense of global inflation, looming recession, & economists who disagree
Listen: Did US inflation come from supply, or did it come from demand? On the GZERO World podcast, Ian Bremmer speaks with economist and University of Chicago professor Austan Goolsbee about the causes of the current high levels of inflation in the US and around the world. If inflation is being driven by too much stimulus, as economists like Larry Summers believe, Goolsbee believes the Federal Reserve is doing the right thing by raising interest rates to cool demand. But if inflation is mostly due to the war in Ukraine or supply chain disruptions, rate hikes might result in stagflation.
Goolsbee, who served as an adviser under President Obama, also shares his thoughts on why some economic trends from the last two years - like making more products domestically and remote work - may be short-lived "pandemic blips," whether the Biden administration gave out too much stimulus for the recovery, and why Americans feel glum about the economy - yet still have cash in their pockets.
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What We’re Watching: Global stagflation warning, food fight at the UN, China in Cambodia
World Bank issues stark stagflation warning
The war in Ukraine has frustrated attempts to revive the pandemic-battered global economy, creating an endless loop of bad news. That trend continued Tuesday when the World Bank slashed its global growth forecast to 2.9% – down from a January prediction of 4.1%. (It was 5.7% in 2021.) What’s more, the body warned that “subdued growth” will likely continue throughout the decade and could give rise to 1970s-style stagflation – the double whammy of a stagnant economy coupled with double-digit inflation. But the impacts of the lingering global economic crisis won’t be felt equally. The World Bank says that while wealthy countries like the US and China will experience slower-than-usual growth, developing countries will be hardest hit as borrowing costs rise. This is already playing out: Cash-strapped Sri Lanka was recently forced to default on its sovereign debt for the first time. Crucially, the World Bank also warned that the deepening food crisis could cause social upheaval in import-reliant countries in the near-term.
Ukraine update: Food fight at the UN
As the battle for Eastern Ukraine rages, with “stalemate not an option,” according to Ukrainian President Volodymyr Zelensky, tensions have also flared over the global food crisis worsened by the conflict. Millions of tons of Ukrainian and Russian grains and oilseeds remain shut in by the war, causing global shortages and price hikes that are hitting lower-income countries the hardest. At the UN on Tuesday, the European Council president said Russia is using food as a “stealth weapon” against the developing world, prompting Moscow’s ambassador to storm out of the hall. Moscow says Western sanctions are to blame for the food shortages. But while financial sanctions have made some importers wary of touching Russian cargo, there are no sanctions on Russian food or grain exports. Russia’s decision to selectively halt its own fertilizer exports has contributed to price hikes as well. Russian Foreign Minister Sergei Lavrov, meanwhile, is in Ankara, Turkey, where he will meet with his Turkish counterpart on Wednesday to discuss the grain exports from Ukraine that have been stalled by the fighting.
Is China building a base in Cambodia?
Western governments are warning that Beijing is set to cut the ribbon on a new naval base in Cambodia this week, despite years of denying it was building military facilities in the Southeast Asian country. If the Washington Post report is true, it would be just the second-known Chinese overseas military base, along with a facility in Djibouti. A Cambodian outpost would enable China to more easily keep an eye on shipping lanes that funnel into the Strait of Malacca, one of the world’s busiest trade passages. But it would also heighten concerns about Beijing’s claims on the South China Sea. China insists that vast swaths of the sea belong to it, despite internationally backed counterclaims by five neighboring countries. Cambodia, like most countries in Southeast Asia, is trying to balance the need for close relations with China against concerns about a popular backlash against Beijing, as well as an interest in preserving good ties with the US.
Will stagflation make a comeback?
America’s fashionistas are super excited these days about 1990s crop tops, baggy outfits, and tattoo chokers, but economists are freaking out over a specter from a different decade: the ’70s. That’s when the US economy sputtered into what's known as “stagflation.”
Stagflation, very simply explained, is the double whammy of a stagnant economy coupled with double-digit inflation. In the mid-’70s it was caused by two oil crises, which doubled the price of crude and triggered recessions in many Western countries well into the early ’80s.
Why now? Six months ago, when COVID-related supply chain disruptions first started pushing up global inflation, there was a heated debate among economists about whether stagflation was looming. The skeptics argued that prices would stop rising when the pandemic ended and things “got back to normal.”
But earlier this year came two unexpected shocks. The first was Russia's war in Ukraine, which has driven the cost of energy, food, and other commodities through the roof. The second was China's zero-COVID policy, which has snarled supply chains even more.
It’s the war, stupid. TIGER — a global index tracking the global economic recovery set up by the Brookings Institution and the Financial Times — warned in its Sunday update that stagflation might affect most economies this year as the war in Ukraine exacerbates a slowdown in the global post-pandemic recovery.
What’s more, on Tuesday the International Monetary Fund will lower its growth forecasts for 143 of the world’s economies, representing a staggering 86% of global GDP.
Barely six months ago, IMF chief Kristalina Georgieva dismissed talk of stagflation when prices were beginning to rise mainly due to pandemic-induced supply chain disruptions. Now, she says that the Russian invasion is a “massive setback for the global recovery” from COVID and admits that “for the first time in many years, inflation has become a clear and present danger.”
How big of a deal is this? Stagflation has often been described as pretty much the worst thing that can happen to an economy outside of a war, a natural disaster or, obviously, a pandemic. If GDP doesn’t grow enough for wages to keep pace with inflation, everyone feels the pinch: purchasing power declines, people lose their jobs, credit and investment dry up, and poverty increases.
Also, recessions tend to have political consequences. US President Joe Biden surely knows that his predecessor Jimmy Carter blames losing his job in part on America’s economic “malaise” at the end of his term. Wherever stagflation hits, expect incumbents to feel the heat from populist insurgents who claim to have the secret sauce for making economic woes go away (spoiler: they likely won’t).
So, should we be worried? As always, economists disagree.
On the one hand, the war and zero-COVID have thrown a wrench into a global recovery that was already limping. The longer the war drags on and the longer Xi Jinping doubles down on his policy to contain the pandemic in China, the more prices will continue to rise and the more supply chains will be impacted by Chinese lockdowns.
Xi might be able to keep China’s economy chugging along with more stimulus spending, but other countries won’t because COVID left their coffers empty. Also, the world’s economy is a lot more interconnected than it was in the ’70s, and since inflation is a global phenomenon, all nations will take a big hit.
On the other hand, it might be too early to determine whether the current economic slowdown will be enough to trigger stagflation in many parts of the world. For instance, the US economy is still doing well and unemployment remains low despite recession fears. (The traditional definition includes high unemployment, but most economists now believe economic stagnation and high inflation are enough.)
"While global inflation is now very high — above 7% in the US, the EU, and the UK — it is still forecasted to lower in the next few months," says Eurasia Group analyst Robert Habib. "For one thing, spending will cool in part because central banks will raise interests rates across the board. For another, supply chain issues will ease as cargo traffic starts to pick up."
Whatever happens, people are definitely curious about stagflation nowadays. Last month, Google searches for the term far exceeded those during the 2008 global financial crisis.
What's your take? Let us know here.