alt Hacker NewsIs the theory still sound for raising rates to control inflation under these circumstances? Not completely unsound, but I think less effective when inflation is driven by energy prices, than when the inflation is driven more by financialization.
Replies
It's a great question. The Fed cannot print more oil, and so any efforts to reduce energy inflation with interest rates is going to be futile. Fiscal policy must step in (Congress) to both stabilize the oil market and accelerate our transition off of oil (which would prevent energy inflation in the future, EVs, batteries, enough sunlight hits the Earth every 30 minutes to power humanity for a year, etc, etc).
Fundamentally, due to structural demographics, we have arrived at a capital shortage period after a long capital surplus period [1]; there will be, for long into the future, more projects chasing a shrinking supply of capital. This will continue to push interest rates up, which will also drive asset prices down (real estate, private equity, etc) [2].
Tangentially, about a year ago, I predicted that the Fed could beat on the economy all it wants with higher rates and this would not cause mass unemployment, because the world is rapidly aging and how fast workers are retiring out of the labor force [3]. This thesis appears to have been proven accurate, but more time is required to make the thesis more durable.
[1] https://www.apollo.com/wealth/insights-news/insights/daily-s...
There are two big levers the government has to control inflation: monetary policy and fiscal policy.
Monetary policy is where the central bank changes rates. This is effective to a point. It defuses a lot of zero-interest nonsense but the primary idea was to cool the business sector by making borrowing more expensive. Thing is, we don't really do that anymore. We don't borrow a bunch of money to build a factory to make widgets. No, we simply financialize everything. Yes, we have a ton of AI debt now but (IMHO) it's not productive output. The big product and promise of AI is labor displacement. That's going to destroy the economy.
Private equity technically borrows money but usually only temporarily. The target gets bought, restructured, a loan is taken out against the assets to pay back to investors and the corpse is spun out before the debt explodes. The problem? The market seems to be wising up to this bargain and these husks need to be kept on the books longer than desired. PE firms are having to borrow to refinance. That's another house of cards in all of this.
But what really fuels PE and all of this? Real estate. Hoarding land has become the best performing asset.
So the second lever the government has is fiscal policy, specifically taxation. Prior to the pandemic, a lot of companies were afraid to raising prices too much as they'd lose market share. An energy crisis triggered a fundamental change in corporate attitudes to raising prices and we've had a ton of raising prices simply to maintain profits or in anticipation of inflation. Pepsi now is in deep trouble because they've discovered that people don't want to pay $8 for corn chips and Walmart's generic brand is $5 and probably made by the same factory.
In the wake of the pandemic some countries introduced a windfall profits tax. Basically, predatory price-raising should be punished with at least a form of wealth redistribution. These measures were few and far between however.
As an example, because of 2020 energy crisis (caused by Trump) and Russia's invasion of Ukraine, Europe has been in a deep energy crisis for years with no end in sight. Many European governments have tried to protect consumers by subsidizing electricity. Well, these energy providers are making record profits. Why aren't they taxing the back end to pay for those subsidies? Instead, we just have a massive wealth transfer from European governments to (often private) utilities and gas producers.
But fiscal policy, particularly in the US, never gets discussed int his way. We could solve so many problems by simply having a 50% corporate tax rate. The standard objection is "they'll move overseas". Well, you can't move land overseas, particularly mines and oil wells. And the IRS is capable of tackling transfer pricing and profit shifting. Well, they would be if they weren't deliberately starved by successive governments. And if all else fails, punish companies for moving overseas with tariffs. That's what they're actually for.
So, back to your question, no, I don't think the theory is sound because we have a malignant tumor at the heart of our economy, which is land-hoarding.
It's not sound no, and never really was given how doggedly the policy has been stuck to. The policy amounts to handing out wadges of cash to people with money, then ignoring that bit and hoping the hardship suffered by those that need to borrow will offset the activity of the people with interest income. At best, it's weak sauce compared to actual fiscal policy.
[dead]
The Fed can control inflation through demand destruction. Tank the economy and throw enough people out of work so people buy less and inflation goes down.
It's like chemotherapy: it works, but it destroys so much of the rest of your body in the meantime that sometimes you wonder if the pain is worth the gain.
Trump & Congress have access to much less painful means to lower inflation, but they've refused to act.