Krugman: Eye on the 3 F's

Fiscal Policy, Food/Fuel, and the Fed.

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High inflation in the United States basically reflects two forces.

On one side, there’s a lot of disruption: rising oil and food prices (made worse by Russia’s invasion of Ukraine), snarled supply chains and so on. These factors are the reason inflation is way up everywhere, not just in America…On the other side, the U.S. economy is running very hot, with widespread labor shortages…So far, at least, there’s no sign of a third possible factor: inflation driven by entrenched expectations of inflation…

It pains me to say that we can’t safely let the economy keep running this hot. The reason this pains me is that there are many very good things about a tight labor market in which jobs are easy to find…

Unfortunately, we do need some cooling off. What I’m not sure people realize is the extent to which policies and events have already set the stage for the big cool-down.

Okay that’s probably about the limit for direct quotes, but he goes on to talk about how there are strong forces already in play that are pushing to cool the economy:

Fiscal Policy: the numerous and generous fiscal stimuli intended to keep the economy afloat during the pandemic have all expired: direct payments to all residents, expanded unemployment benefits, expanded child tax credits … all in the rear view mirror, so fiscal policy at the moment is notably tighter than last year, and that will be reflected more and more in coming months in consumer and worker behavior: less spending, more working.

Inflation in necessities food and fuel caused by the Ukrainian war and other factors, like little spending by US oil companies to expand supply. Extra money paid for food and fuel mean less to spend on other items, for most people, though the owners of food and fuel companies will do fine.

And he notes that the Fed is already raising rates and more importantly has set expectations for ongoing rate increases and the withdrawal of quantitative easing, letting their account of excess bonds draw down as the bonds expire instead of continuing to buy on the open market. These changes, along with the inflationary environment have already led to large changes in interest rates for many loans. I.e. he shows a chart of 15 year mortgage rates rising from ~2.1% middle of last year to 3.6% now.

So, he cautions that while the Fed tightening is needed, they need to be very aware of these other factors in play and be prepared to change stance if the economy begins to cool too quickly, if they want to manage a soft landing.