The View | How the US can manage inflation – and stem the obliteration of the middle class

Contrary to those advocating austerity, inflation peaked on its own, rather than due to the Fed’s intervention, in mid-2022

Using budget cuts to engineer a recession and tame inflation would adversely affect the middle class. There are ways, however, for policymakers to empower the middle class and disempower bankers

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Shoppers at a grocery store in Washington on February 15. A key indicator of US inflation cooled in June to the lowest annual rate in over two years, although this remains above the central bank’s target, according to government data released on July 28. Photo: AFP

Published: 3:43pm, 10 Aug 2023Updated: 4:41pm, 10 Aug 2023

Back in 2021 and early 2022, a posse of prominent economists – including Lawrence H. Summers, Jason Furman and Kenneth Rogoff, all of Harvard University – criticised the Biden administration’s fiscal and investment programme, and pressured the US Federal Reserve to raise interest rates. Their argument was that inflation, fuelled by federal spending, would prove “persistent”, requiring a sustained shift to austerity. Unemployment, sadly, would have to rise to at least 6.5 per cent for several years, according to one study touted by Furman.

While this trio – and many like-minded commentators – failed to sway the White House or Congress, they were in tune with Fed chair Jerome Powell and his colleagues, who began hiking interest rates in early 2022 and have kept at it.

The Fed’s rapid monetary-policy tightening soon prompted progressives, led by Senator Elizabeth Warren, to fear that it will trigger a recession, mass unemployment, and – though they didn’t say it – a Republican victory in 2024.

But the macroeconomic situation today has confounded both positions. Contrary to those advocating austerity, inflation peaked on its own in mid-2022, owing partly to sales from the US Strategic Petroleum Reserve. There was no persistence, no surge from the 2021 fiscal stimulus, and no wage-driven inflation from low unemployment.

There also has been no recession, unemployment has not risen, and higher interest rates have not deterred business investment. A recession remains possible, but so far there are very few warning signs.

These happy circumstances have led some observers to congratulate Powell and the Fed on achieving a “soft landing”. But there is no way that rate hikes beginning early last year could have knocked back inflation by July of the same year. The Fed’s policy tightening has been irrelevant to the inflation slowdown so far.