All pain and no gain from central banks’ higher interest rates

Central banks’ unwavering determination to increase interest rates is truly remarkable. In the name of taming inflation, they have deliberately set themselves on a path to cause a recession — or to worsen it if it comes anyway. 

Moreover, they openly acknowledge the pain their policies will cause, even if they don’t emphasise that it is the poor and marginalised, not their friends on Wall Street, who will bear the brunt of it. And in the United States, this pain will disproportionately befall people of colour.

As a new Roosevelt Institute report that I co-authored shows, any benefits from the extra interest-rate-driven reduction in inflation will be minimal, compared with what would have happened anyway.

Inflation already appears to be easing. It may be moderating more slowly than optimists hoped a year ago — before Russia’s war in Ukraine — but it is moderating nonetheless, and for the same reasons that optimists had outlined. For example, high auto prices, caused by a shortage of computer chips, would come down as the bottlenecks were resolved. That has been happening, and car inventories have indeed been rising.

Optimists also expected oil prices to decrease, rather than continuing to increase; that, too, is precisely what has happened. In fact, the declining cost of renewables implies that the long-run price of oil will fall even lower than today’s price.

It is a shame that we didn’t move to renewables earlier. We would have been much better insulated from the vagaries of fossil-fuel prices, and far less vulnerable to the whims of petrostate dictators like Russian President Vladimir Putin and Saudi Arabia’s own war-mongering, journalist-murdering leader, Crown Prince Mohammed bin Salman Al Saud (widely known as MBS).

We should be thankful that both men failed in their apparent attempt to influence the US 2022 midterm election by sharply cutting oil production in early October.

Yet another reason for optimism has to do with mark-ups, the amount by which prices exceed costs. Although mark-ups have risen slowly with the increased monopolisation of the US economy, they have soared since the onset of the Covid-19 crisis.

As the economy emerges more fully from the pandemic (and, one hopes, from the war) they should decrease, thereby moderating inflation. 

Yes, wages have been temporarily rising faster than in the pre-pandemic period, but that is a good thing. There has been a huge secular increase in inequality, which the recent decrease in workers’ real (inflation-adjusted) wages has only made worse.

The Roosevelt report also dispenses with the argument that today’s inflation is due to excessive pandemic spending, and that bringing it back down requires a long period of high unemployment. Demand-driven inflation occurs when aggregate demand exceeds potential aggregate supply.

But that, for the most part, has not been happening. Instead, the pandemic gave rise to numerous sectoral supply constraints and demand shifts that – together with adjustment asymmetries – became the primary drivers of price growth.

Consider, for example, that there are fewer Americans today than there were expected to be before the pandemic. Not only did Trump-era Covid-19 policies contribute to the loss of more than a million people in the US (and that is just the official figure), but immigration also declined, owing to new restrictions and a generally less welcoming, more xenophobic environment.

The driver of the increase in rents was thus not a large increase in the need for housing, but rather the widespread shift to remote work, which changed where people (particularly knowledge workers) wanted to live.

As many professionals moved, rents and housing costs increased in some areas and fell in others. But rents where demand increased rose more than those where demand fell decreased; thus, the demand shift contributed to overall inflation.

Appropriate response