By Jack McPherrin | The Heartland Institute
To combat the highest inflation rate during the height of “stagflation” in 1981, the Federal Reserve on Wednesday announced yet another increase to the central bank’s overnight interest rate, hiking it 75 basis points. Overall, the Fed has gradually increased interest rates from near 0 to between 2.25 and 2.50 percent in just four months, the fastest tightening of monetary policy since the Fed’s attempt to battle stagflation in the early 1980s.
If the United States were simply experiencing a sustained period of inflation caused by booming consumption and investment activity, this might constitute an effective approach. Yet, this inflationary period has been caused by excessive money printing at the hands of the Fed and substantial government spending throughout the COVID-19 pandemic, rather than any sort of natural phenomenon.
Moreover, despite what Federal Reserve Chairman Jerome Powell and Biden administration officials are promoting, the United States is in the midst of a recession, which will only get worse if economic activity continues to be suppressed by high interest rates.
It is likely the Biden administration is pushing the idea that America is not in a recession to salvage a modicum of political viability, with congressional mid-terms quickly approaching. Unfortunately, the casualties of this naked political posturing will be American citizens’ wallets, not to mention the entire U.S. macroeconomy.
A recession is defined as a period of sustained economic downturn, which has historically been indicated by two consecutive quarters of negative GDP growth. As anticipated, Thursday morning’s second quarter report from the Commerce Department shows a reduction in real GDP by 0.9 percent, hot on the heels of a reduction of 1.6 percent in the first quarter.
Biden administration officials, from National Economic Council Director Brian Deese, to Council of Economic Advisors member Jared Berstein, to Treasury Secretary Janet Yellen, have attempted to throw wool over the eyes of the American people by explaining that this traditional definition of a recession is faulty. Powell echoed the party line after announcing his latest interest rate hike: “I do not think the U.S. is currently in a recession. It doesn’t make sense that the U.S. would be in a recession.”
So, basically, because Powell does not personally believe the numbers right before his eyes, the U.S. central bank has continued down the path of dropping napalm on economic production. I am reminded of George Orwell’s 1984, “The party told you to reject the evidence of your eyes and ears. It was their final, most essential command.”
Powell and the Biden administration have pointed to the National Bureau of Economic Research (NBER) as the final arbiter of whether the economy is in a recession; the NBER defines a recession as “a significant decline in economic activity that is spread across the economy and lasts more than a few months.” The NBER measures this sustained economic decline with four primary indicators: real income, real spending, industrial production, and employment. Each of these indicators ostensibly remains in healthy territory.
First, though the unemployment rate remains robust – which has been indicated by Powell, Yellen, and others to be a reason a recession cannot be possible – the U.S. labor market is far from healthy. The unemployment rate does not include the vast number of individuals who have voluntarily left the labor force since before the pandemic. The labor force participation rate sits at 62.2 percent, compared to 63.4 percent in February 2020, and 11.3 million jobs remain open compared to 6.9 million pre-pandemic.
Second, if these individuals insist upon operating from NBER’s framework, what do they think will happen to income, spending, and production after pronounced hikes in interest rates? These three measures are clearly already decreasing, considering that GDP intrinsically takes them into account by aggregating consumer, business, and government spending.
The Fed is basically operating under the Phillips Curve assumption that inflation and the unemployment rate are inversely correlated. Essentially, by raising interest rates, Powell hopes to inhibit spending and investment through increasing the cost to borrow for consumers and businesses. This would theoretically trickle down to labor markets, with businesses laying off employees due to their higher operating costs, and those unemployed individuals no longer spending at the level they did when they had a stable income. This would ultimately lead to increased unemployment and decreased inflation.
Unfortunately, both prices and unemployment have been systematically altered from their natural equilibrium based upon unprecedented government spending throughout the COVID-19 pandemic, and the vast disincentive to work afflicting much of the population – which is likely a significant contributor to declining GDP.
The Fed is reacting to a problem it has created through excessive money printing. And, raising interest rates will plunge the economy further into the troughs of a deep recession.
Perhaps, as an alternative, it would be wise to simply reduce government spending and intervention, allowing markets to equilibrate naturally rather than through artificial manipulation. It would be more beneficial to limit the scope of entitlement programs, cease the giant transfer payments represented by student loan moratoriums, and end discussion of spending hundreds of billions more dollars on green-energy initiatives.
The White House and the Federal Reserve must come to terms with the fact that our economy is in free-fall, and that they are largely responsible for this mess. If they continue to ignore reality and push their false narrative, we will find ourselves in a situation similar or worse to the height of stagflation, with the American people paying the ultimate price.