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Reviews |  Beware of the dangers of sado-monetarism

Sado-monetarism is experiencing a moment. And one of the biggest risks facing the US economy right now is that it will have too much influence over politics.

Incidentally, this term was coined by William Keegan to describe the economic policies of Margaret Thatcher. But sado-monetarist has come to mean a person who always seems to demand higher interest rates and fiscal austerity, regardless of the state of the economy.

And these people have just had a good year: the inflation they always warned against has finally materialized. In 2021, US policymakers, like many economists, myself included, grossly underestimated inflation risks – as they themselves admit. This candor, by the way, is itself refreshing and welcome. In the 2010s, very few of those who incorrectly predicted runaway inflation admitted to being wrong.

More importantly, policy makers act to fix their mistakes. Budget deficits are plunging. The Federal Reserve has started raising the interest rates it controls, and longer-term rates that matter to the real economy — particularly mortgage rates and corporate borrowing costs — have soared. . These policies pretty much guarantee a slowdown in the US economy, which could be severe enough to qualify as a mild recession.

But there is a chorus of loud voices insisting that the Fed must tighten even more – in fact, that it must lead the American economy into a prolonged period of high unemployment, something like the great crisis of the beginning of the 1980s. And there is a real danger that the Fed will be intimidated into overreacting.

So let’s talk about why calls for even more aggressive Fed action are misguided.

First, how did inflation get so high? Much of the story involves shocks such as rising oil and food prices, disruption of supply chains, etc., that are beyond the control of policymakers – that is, policymakers other than Vladimir Putin, whose invasion of Ukraine severely damaged the global economy. These non-political shocks explain why inflation has risen almost everywhere – for example, UK inflation just hit 9.1%.

Unfortunately, that’s not the whole story. In the United States, at least, inflation is not confined to a few troubled sectors; even measures that exclude extreme price changes show that inflation is well above the Fed’s 2% target, although well below the numbers you can see in the headlines. And the scale of inflation suggests that the combination of large federal spending last year and easy money has caused the economy to overheat – that we suffer from a classic case of too much money chasing too little. Goods.

As I said, however, policymakers have already taken strong steps to calm the economy. So why isn’t that enough?

The answer I keep hearing is that tough policy is needed to restore the Fed’s credibility. And to be fair, there are good reasons to believe that credibility is an important factor in controlling inflation. What we don’t have are good reasons to believe that credibility has been lost.

Economists have long accepted the idea that persistent inflation can be self sustaining. In 1980, for example, almost everyone expected high inflation to continue indefinitely – and these expectations were reflected, among other things, in big wage deals that gave inflation a lot of momentum. . Thus, Paul Volcker, the chairman of the Fed at the time, had to impose a severe and prolonged recession to break the inflationary cycle.

But other than the sado-monetarists themselves, who currently expects inflation to stay persistently high (instead of staying high for, say, next year)?

Not the financial markets. On Wednesday, the five-year breakeven inflation rate — a measure derived from the spread between US government bonds that are and are not inflation-protected — was just 2.74%. And part of that reflects expectations of near-term price increases that investors don’t expect to see continue; markets expect inflation to subside.

What about the general public? Last month, economists at the Federal Reserve Bank of New York, who conduct regular surveys of consumer expectations, noted that consumers apparently expected inflation “to fade over the next few years. and that five-year expectations had been “remarkably stable”.

A few weeks ago, another survey from the University of Michigan showed a rise in long-term inflation expectations, which had previously been flat. But the New York Fed’s numbers didn’t show the same bump. And as anyone who works with economic data can tell you, you shouldn’t make too much of a month, especially if other numbers don’t tell the same story.

To be clear, I’m not saying any of these predictions are necessarily right. What they tell us, instead, is that persistent inflation expectations are not entrenched as they were in 1980. So it doesn’t seem like we need harsh Volcker-type policies that punish inflation. economy until morale improves.

Inflation is a real problem, and tightening the Fed has to do it. But it will be tragic if the Fed listens to people who actually demand a much deeper collapse than the economy seems to need.

nytimes Gt

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