The subject of economics is currently at the forefront of everyone’s minds, and you are in a position to enlighten us about many troubling things. In a nutshell, what’s your prognosis for the American economy and the world?
I think there are turbulent times ahead. Our economy has become overheated due to a combination of excessively expansionary policies and bad luck in terms of the availability of goods and bottlenecks. That’s why we have a high inflation rate. Bringing it down is not likely to be easy, and it will probably involve significant disruption. So I think the risks are some combination of stagflationary forces, the slowing of growth and an increase in unemployment on the one hand, and continued inflation at rates that make people uncomfortable. Just what that combination will be is difficult to predict, but my best guess is that within two years the economy will go into recession, and I’m not sure if that will be sufficient to bring inflation all the way down.
I think that with big problems in the Chinese economy coming from Covid, the collapse of real estate interests, much greater state involvement in the technology sector and very slow population growth—in fact, a shrinking workforce—we’re heading for a difficult period in the global economy as well. I believe it’s going to take all the skills policymakers have to navigate this situation.
There are various reasons for the inflation we’re currently seeing. I would imagine that some of it can be controlled by the Fed, but some of it can’t. What you’re saying about stagflation falls into the latter category, including such things as supply issues. Do you think we’re stuck in a place where the Fed can’t get a handle on what’s happening?
It’s important to recognize that even aside from supply factors, monetary policy isn’t a precise tool. It’s an instrument that acts with substantial and variable lag. The Fed’s challenge is a bit like a person staying in an old hotel who is trying to adjust the shower to the right temperature, even though there’s a 15-second lag between the time they turn on the faucet and the temperature of the water actually changes. It’s very easy to freeze or scald yourself in that situation, and it’s very easy for the Fed to make a mistake. In fact, history teaches us that soft landings of overheated economies tend to represent the triumph of hope over experience. That’s a substantial source of my anxiety, which is compounded by all the difficulties with the supply side of the economy. No one knows what’s going to happen with Ukraine or with global oil prices. Put all that together, and I think that you have grounds for substantial concern.
Right now, the Fed seems to be most concerned about inflation. They’re going to try to medicate the issue, but as happens with most medications, there will be side effects. Do you think those side effects may end up being worse than the original illness?
That might be true in the short run, but if the original illness would otherwise be chronic and accelerating, the right thing to do is to live with the side effects, because if you let the disease fester it will be even more painful to cure later. I fear that that is the right way to think about the issues associated with inflation. In other words, if we don’t focus on containing it, it is likely to become entrenched. That is the lesson we learned in the 1960s and ’70s. If we had acted sooner to contain inflation rather than making a series of excuses in terms of oil and heat prices and a variety of other things, we would have contained it at a substantially lower cost than we did with the recession of the early 1980s.
Has there ever been a real soft landing, or is a recession always inevitable?
My reading is that in relevant history we don’t have soft landings, although there would be a debate about how to interpret what took place after the Second World War and the experiences during the Korean War. For a variety of reasons, I don’t think those contexts are particularly applicable to the moment. The more relevant universe of experience is the lifetimes of those who are alive today, and in the US and other countries we don’t find lots of evidence of soft landings.
You seem to support what the Fed is doing. Do you have a scholarly perspective that is different from theirs?
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