Whether the Fed can succeed in taming inflation and do so without precipitating a recession remains to be seen but is highly unlikely.
The focus of the U.S. media and economists for the past several months has been increasingly on inflation. In recent weeks, however, U.S. policymakers awoke as well to the realization that inflation is chronic, firmly embedded, and growing threat to the immediate future of the U.S. economy.
A qualitative ‘threshold of awareness’ was reached this past week when the U.S. central bank, the Federal Reserve, accelerated its pace of rate hikes by 75 basis points—purportedly to bring the rate of price hikes under control. Whether the Fed can succeed in taming inflation and do so without precipitating a recession remains to be seen but is highly unlikely. Taming inflation without provoking a recession is thus the central economic question for the remainder of 2022.
Clearly some think this is possible—i.e. that further rate hikes will moderate the pace of inflation without driving the real economy into recession and result in what is called a ‘soft landing’. Clearly the Fed and the Biden administration believe that will happen. But a growing chorus of even mainstream economists and bank research departments don’t think so. Almost daily new forecasts by global banks and analysts appear indicating recession is more than 50-50 likely—and arriving sooner in late 2022 than in 2023.
This article concludes unequivocally that today’s Fed monetary policy of escalating interest rates is not capable of reducing inflation while avoiding recession—any more than similar Fed rate hikes in 1980-81 did. And this time rate hikes will not need to rise as high as in 1980-81 before they trip the economy into another bona fide recession.
As of June 2022 the Fed raised its benchmark federal funds interest rate to a high end range of 1.75%. It plans to double that at least by the end of 2022, to a 3.5% to 4% range. But the U.S. economy is already nearly stagnant and signs are growing it is becoming even weaker. As this writer has argued since the fall of 2021, a Fed rate to 4% or more will almost certainly mean a ‘hard landing’, i.e. recession. Moreover, it will not reduce inflation that much either. Prices will not slow appreciably until the U.S. is actually well into a recession. That means a condition called stagflation, a contracting real economy amidst rising prices and an economic scenario not seen in the U.S. since the late 1970s. Stagflation has already arrived if one considers the almost flat U.S. economy in the first half of 2022; and it will deepen once recession begins in the second half.
To understand why inflation won’t abate much in 2022, and why recession will occur sometime before the current year’s end, it is necessary first to understand the Anatomy of Inflation (i.e. structure and evolution) that has emerged over the past year. That anatomy, or structure, of inflation shows its current causes are not responsive to Fed rate hikes in either the short or even intermediate term of the next twelve months.
It is necessary to understand why monetary policy in the form of Fed rate hikes will not dampen inflation much before recession occurs—as well as why those same rate hikes will have a greater effect on precipitating a recession long before the Fed can bring the inflation rate down to its long run historic target of only 2%.
The Anatomy of U.S. Inflation: 2021-22
After rising moderately around 4% annual rate when the U.S. economy first opened in the spring of 2021, it is important to note the pace of consumer prices remained virtually steady for the following four months throughout the summer of 2020, at around 5.5%. (Bureau of Labor Statistics New Release, May 11, 2022, Chart 2). That pace began to rise steadily every month only after late August 2021.
Beginning last September 2021 U.S. Inflation not only began accelerating but has since become embedded and chronic. Even U.S. policy elites can no longer deny it. Earlier in 2022 Treasury Secretary Janet Yellen opined publicly that U.S. inflation would be ‘short lived and temporary’. In June she then recanted and apologized for the inaccurate prediction. And this past week admitted that inflation is now ‘locked in’ for the remainder of 2022.
What then are the reasons and evidence inflation has become permanent and chronic—at least until recession sets in?
There’s no doubt that Demand, due to the reopening of the U.S. economy after the worst of Covid in March-April 2021 contributed to the emergence of inflation last spring-summer 2021. But excess Demand is not the primary explanation for it. Demand for goods and services rose during April-May 2021 as workers returned to their jobs and wage incomes grew. However, the record shows after rising modestly in April-May 2021, consumer prices leveled off throughout the summer of 2021, June to August 2021, at just over 5%. It remained steady thereafter at that level for those months as the economy continued to re-open.
The surge in prices at a faster pace only began in the late summer, around August-September. That price escalation coincided with rising problems in Supply chains—both in the form of global imports to the U.S. as well as domestic U.S. supply issues associated with goods transport, warehousing, and skilled labor access. In short, as the U.S. economy attempted to reopen global supply chains were still broken and, domestically, U.S. Product and Labor markets were severely wounded by the impact of Covid events of March 2020 through March 2021.
Conservative politicians, business interests, and their wing of the mainstream media nonetheless claimed at the time—and mostly still maintain today—that it was the too generous, excess income support from the American Relief Plan (ARP) social safety net programs passed by Congress in March 2021, and their predecessor programs a year before, that was responsible for excess Demand in mid-2021 and thus the escalating inflation that followed after September of that year.
But even U.S. government data don’t support that view. The ARP authorized only $800 billion spending in the entire next twelve months. The 3rd quarter—the first full quarter when ARP program spending hit the economy and when prices began their accelerations around August—saw probably no more than $200 billion from ARP programs entering the economy. The supplemental income checks had already been distributed and mostly spent in the 2nd quarter. What remained in the 3rd of any magnitude were supplemental unemployment benefits, modest rental assistance, and the child care subsidies for median and low income families introduced that July. $200 billion injection was probably high as well. Certainly not all the $200 billion income injected was actually spent that quarter. (As economists admit, consumers’ marginal propensity to spend added income is always less than ‘one’—i.e. they don’t immediately spend it all). $150 billion or so was probably actually spent. That $150 billion compares to a 3rd quarter overall GDP of more than $5 trillion! There’s no way an economy that size could result in the price acceleration that began at that time from an injection of $150 billion on more than $5 trillion.
Moreover, $150 billion may be too high an estimate as well. Much of the ARP stimulus was cut off significantly by early September, the last month of the 3rd quarter: for example, supplemental unemployment benefits provided previously for 10 million workers was ended, along with rental assistance, the Payroll Protection Plan grants for small businesses, and other lesser injections.
In short, to the extent Demand contributed to the rise in prices in both the 2nd and 3rd quarters, that Demand effect is explainable far more by the continued reopening of the economy rather than attributable to the income support programs of the American Rescue Plan that amounted to no more than $100-$150 billion throughout the entire 3rd quarter when prices began to accelerate. So much for arguments that workers were too flush with income from jobs they were returning to and the government over-generous ARP income programs! The data just don’t support the view it was Demand and government spending Demand in particular that was responsible for the onset of escalating prices last September 2021.
The more likely explanation behind escalating prices in late summer 2021 was global supply chain bottlenecks, especially involving goods imports from Asia and China in particular. In August-September it was mostly goods prices driving inflation. Consumer spending on services again was just emerging. A problem with Supply chains was corporations around the world had shuttered their operations during the worst of Covid, allowing workers and suppliers to drift away. When the economy began to reopen in the summer of 2021, many of these workers and suppliers were not available. That was especially true with global container and other shipping companies. There just weren’t enough ships available to deliver goods from Asia to North America. What shipping was available was initially dedicated to transport between Asia countries first. In addition, USA West Coast ports had a similar problem: the ports were short of traditional workers and transport. Not only port workers but independent truckers that carried the freight from the Los Angeles port, for example, to inland central warehouses. And from those mega-warehouses to regional warehouses from which goods are then distributed to companies’ storage and stores. Like the trucker shortage, there was an insufficient return of workers to warehouses as well. A similar, somewhat lesser labor shortage problem existed with railway workers. In other words, domestic U.S. supply chains were still broken—along with global supply.
As inflation rose and the public was increasingly aware of it, corporations with monopolistic power (i.e. where four or five or fewer companies produced 80% or more of the product or service in the economy) manipulated and took advantage of that public awareness of rising inflation in order to raise their prices—even when their respective industry was not experiencing supply chain issues.
A good example is the U.S. oil corporations that didn’t have a supply problem at all at the time and still don’t. U.S. oil corps were capable then, as now, of raising their output of oil in the U.S. (i.e. supply) by at least 2 million more barrels/day. They chose instead to leave that oil in the ground, not to expand production at U.S. refineries, and refused to reopen many of the drilling wells they had capped during the worst of the preceding 2020-21.
In the months preceding the onset of Covid shutdowns in March 2021 U.S. oil corps were producing more than 13 million barrels per day; by fall 2021 they were producing barely 11 million per day (and still are). Nevertheless, U.S. oil corporations raised their prices faster than perhaps any other industry. By the fourth quarter 2021 energy prices were rising at 34.2% annual rate, according to the U.S. GDP accounts (U.S. Bureau of National Economics, NIPA Table 2.3.7).
With prices now surging after September 2021 the important new factor also driving prices was thus neither supply nor demand related. It was price manipulation by U.S. corporations with market power to do so. And it was not just oil corporations, although they were responsible for more than half of the price index surge at the time—and still are. Other food processing corporations, airlines, utilities, and so forth with monopolistic power did so as well. This political (market power) cause, combined with Demand and Supply forces, after August resulted in yet a further surge of prices through the remainder of 2021.
Beginning in 2022 further forces also began to determine the U.S. Anatomy of Inflation:
Commencing March 2022, added and overlaid onto 2021 inflation drivers was U.S. and EU sanctions on Russia commodities, which were especially critical as the global economy was still in the process of trying to reopen and restore and heal Covid shattered global supply chains.
Russia supplies 20% to 30% of many key global commodities—including oil, gas and nuclear fuel processing in the energy sector. But also industrial metals commodities like nickel, palladium, aluminum and other resources required for auto, steel and other goods manufacturing in the U.S. and EU. Also agricultural commodities like 30% of the world’s wheat; 20% of global corn production used in production of animal feed; 75% of critical vegetable oils like sunflowers; and 75% potash fertilizer—to name the more important.
Even before U.S./EU sanctions on these key Russian commodities began affecting actual supply, global financial commodities futures market speculators began driving up commodity inflation in anticipation of the sanctions eventually taking effect. Speculators were quickly followed by global shipping companies that jacked up their prices before actual sanctions. They were joined in turn by shipping insurance companies. All along the commodities supply chain, capitalists in sectors capable of exploiting the coming sanctions-driven shortages began manipulating prices in anticipation. Physical shortages from sanctions thereafter began to have a further impact late in 2nd quarter 2022 as war in Ukraine intensified and sanctions were implemented. The speculators, shippers and insurers thereafter added further price increases to the general sanctions effect.
When U.S. Treasury Secretary Yellen voiced her prediction earlier in 2022 that inflation would be temporary she no doubt did so based on the erroneous assumptions that somehow the global and domestic supply chain problems of late summer 2021 would be resolved in 2022, and corporate price gouging that overlaid supply chain issues would also somehow abate. She clearly did not factor in to her inflation prediction the very significant effect of war and sanctions.
President Biden called the now further escalation of prices in spring 2022 as ‘Putin’s Inflation’. That claim might be laid on shortages of some agricultural products directly disrupted in Ukraine war zones, but can’t be laid on global energy prices which were virtually all from within Russia’s economy not Ukraine’s. Thus to the extent inflation is due to rising energy prices—which accounts for more than half the total price rise at the consumer level—it is more attributable to Biden’s sanctions and thus is ‘Biden’s Inflation’ rather than Putin’s.
By the 2nd quarter 2022 all the above combined forces driving inflation (i.e. moderate Demand, global & domestic broken Supply chains, widespread corporate price gouging, oil, energy & commodities prices) converged to produce an embedded, chronic, and continued rise of inflation.
For the period for which latest prices are available, March-May, consumer prices (CPI Index) have been rising at a steady 8.5% rate while producer prices that eventually feed into consumer prices have been rising at an even faster rate of 10-11% for the three months. Furthermore, pressure on producer prices (that feed into consumer prices) may accelerate even that 10-11% current producer price hike average. For example, the most recent Producer Price Index released for May shows the category of ‘Intermediate’ goods and services prices are rising even faster. Intermediate processed goods (e.g. steel) have been rising at a 21.6% annual rate over the past year, while intermediate unprocessed goods (e.g. natural gas) have risen at a 39.7% annual rate.
Supply chain and Demand forces of the past year, May 2021 through May 2022, will likely continue driving prices at similar rates through this summer 2022 and likely the rest of the year as well. There appears no end in sight, for example, for the Ukraine war and the Sanctions on Russia which continue to tighten. Price gouging in these commodities impacted by war and sanctions will certainly continue as will the general phenomenon of monopolistic corporations price gouging. Commodity futures financial speculators will continue to speculate; shipping companies continue to manipulate price to their advantage; and insurers continue to hike their rates on bulk commodity shipping worldwide.
In addition, new forces are also emerging this summer 2022 that will contribute still further to chronic inflation throughout the rest of 2022 and possibly even further beyond.
One such new factor is rising Unit Labor Costs for businesses, which many will try to pass through to consumers this summer and beyond. Unit labor costs (ULCs) are determined by productivity change for businesses and/or wages. If wages rise, ULCs rise; similarly if productivity falls, ULCs rise. While wages appear to be moderately rising in nominal terms, productivity is falling precipitously. The most recent data on productivity trends in the U.S. indicate productivity collapsing at the fastest rate since data was first gathered in 1947. That’s because business investment is stalling in the face of growing economic uncertainty about inflation as well as likely recession. Wage rise contribution to rising ULCs is on average modest, as Fed chair Jerome Powell has admitted. Wage pressures are mostly skewed to the high end of the labor force where highly skilled professionals are ‘job hopping’ to realize wage income gains of 18% on average; meanwhile, low paid service workers’ wages are also rising some as many have refused to return to work at the U.S. minimum wage of only $7.25/hr which hasn’t changed since 2009. Service businesses have had to offer more. But the great middle of the U.S. labor force is not experiencing wage gains to any significant extent. Thus the ‘average’ wage hikes, as moderate as they are, do not account for the rising ULCs which businesses will soon, if not already, begin to ‘pass on’ to consumers in higher prices for the remainder of 2022. Treasury Secretary Yellen herself now admits inflation will continue high throughout 2022—no doubt in part reflecting the new forces adding to inflation pressure.
Another emerging factor of growing importance to the continuation of inflation trends throughout 2022 is the now emerging ‘inflationary expectations’ effect. Cited by Fed chair, Jerome Powell, in his most recent press conference following the Fed’s latest interest rate announcement, Powell referred to the recent University of Michigan consumer survey showing inflationary expectations now definitely emerging as well.
As inflation continues to rise, inflationary expectations mean consumers will purchase early, or even items they had not planned to buy, in order to avoid future price hikes. That means another Demand force that adds to the general anatomy of inflation, just as falling productivity and higher ULCs represent an additional Supply force contributing to future price hikes.
In short, now entering the mix of causes in 2022 are inflationary expectations, falling productivity driving up ULCs and cost pass-through to consumers, and the growing pressures on commodity inflation due to the Ukraine war and sanctions on Russia.
When all these emerging 2022 factors are added to the 2021 economy reopening and Supply chain causes of inflation—as well as the continuing corporate price gouging—the broader picture that appears reveals multiple causes of inflation—many of which mutually feed back on the other; some political, some unrelated to market supply or demand, and none of which appear to be moderating significantly. In fact, corporate price gouging, manipulation of commodities markets by speculators, Ukraine war, and sanctions on Russia all represent contributions to inflation that may well accelerate over the next six months.
Stagflation May Have Already Arrived
Stagflation is generally defined as inflation amidst stagnate growth of the real economy. That is already upon us in its first phase: U.S. GDP for the 1st quarter of 2022 recorded a decline of -1.5% while the Atlanta Federal Reserve bank’s ‘shadow’ GDP estimates zero GDP (0.0%) growth for the current April-June 2nd quarter! Should the Atlanta Fed’s forecast prove accurate, that’s stagnation at best. And if the 2nd quarter actually contracts, then it represents a yet deeper phase of Stagflation.
Just as mainstream economists and media debated for months whether current inflation was chronic or temporary, the same pundits now debate whether stagflation will soon occur when in fact it’s actually already arrived. (see Larry Summers’ latest pontification to the business media where he warns of stagflation around the corner when it’s already turned it).
The next phase of stagflation coming late 2022 and early 2023 will reflect the contraction of the real economy—i.e. a recession. GDP won’t simply stagnate with no growth, but decline. Indeed, recession is already damn close if we are to believe the Atlanta Fed’s 2nd quarter GDP forecast and the various early economic indicators now appearing. Stagflation may already be here, as the 1st quarter U.S. GDP -1.5% contraction is followed by another contraction—not just zero growth—in the current 2nd quarter. Two consecutive quarters of contraction define what’s called a ‘technical recession’. Actual definition of a recession is left to the National Bureau of Economic Analysis, NBER, economists to call. They always wait months after the fact to make their call. But ‘technical recessions’ almost always result in NBER declarations subsequently of actual recession. And the U.S. economy is clearly on the cusp of a technical recession at minimum.
Biden’s Empty Inflation Solutions
Biden’s various solutions to date are more public relations events designed to make it appear something is being done instead of actions that directly address the problem of embedded and chronic U.S. inflation.
Biden’s proposed solutions include getting U.S. oil corporations and other global producers of oil to raise their output; somehow convincing countries who agree with U.S. sanctions in Russia to enforce a ‘cap’ on the price of oil worldwide; reducing tariffs on imports from China to the U.S.; offsetting the price of energy productions for U.S. consumers by lowering the price of other consumer goods; increasing competition among U.S. monopolistic corporations by subsidizing new competitors to enter their industries; introducing a federal gas tax suspension.
Despite Biden’s railing against the oil companies, shipping companies, and other obvious price gougers, it’s been all talk and no action. All his proposals have not been implemented to date. They’ve been either just ideas raised with no actual executive or legislative proposals. Or they’ve already been rejected by Congress. Or, even if implemented, will be ‘gamed’ and absorbed by corporations with little net impact on consumer prices. Or will produce insufficient additional global output of oil, gas, and energy products to dampen energy price escalation much.
Biden’s strategy has been to ‘talk the talk’ without the walk, as the saying goes.
The only actual solution the administration has quietly agreed upon, but dares not admit publicly, is to have the Fed precipitate a recession by means of its record level of rapid interest rate hikes over this summer 2022 now in progress. And as they say, ‘that train has left the station’. It’s a done deal. Biden’s ‘solution’ is to have the Fed precipitate a recession.
Enter the Federal Reserve
The Fed itself has already decided on recession! Moreover, it’s a policy template that’s been employed before.
The origins of the coming recession appear very much like the 1981-82 recession. At that time the Fed also precipitated a recession by aggressively hiking interest rates with the objective of ‘Demand destruction’ as it is called. In other words, then as now, the strategy was to make households’ and workers’ pay by destroying wage incomes by means of layoffs, for what was essentially at the time a Supply caused inflation associated with rising global oil access destruction by OPEC and middle east oil producers.
At 75 basis points Fed rates are already rising at a pace not seen since 1994. !981-82 rate hikes were even more aggressive. However, as this writer has argued, the global economy is more fragile and interconnected today than it was in 1980-81 when the Fed raised rates to 15% and more. Today’s global capitalist economy won’t sustain rate hikes even a third of that 15% before contracting sharply.
It is more likely than not that the Fed will continue raising interest rates at the 75 basis points when it next meets in July, and possibly the same in the subsequent meeting. At 4% for its benchmark federal funds rate (not at 1.75%) the economic damn will crack. It won’t even get to the one-third of 1982 level, the 5%.
Why the economy will slide into recession well before the 5% rate level was discussed by this writer in 2017 in the book, ‘Central Bankers at the End of Their Ropes: Monetary Policy and the Coming Depression’, Clarity Press.
In the sequel to this essay, why the U.S. real economy is quite fragile today is addressed including most recent evidence of a weakening U.S. real economy. Also addressed is why Fed federal funds rate increases to 4% or more will precipitate a serious U.S. recession sooner rather than later, and, not least, why Fed rate hikes of that magnitude will likely have severe negative impacts on financial asset markets as well, provoking serious liquidity and even insolvency crises in the global capitalist financial system.
Should financial asset contraction occur along with a contraction of the real economy, then the 2022 recession will almost certainly deepen in 2023. And in that case the economic crisis will appear more like 2008-10 as well as 1981-82. Or perhaps a merging of the two recession dynamics into one.
Jack Rasmus is author of the recently published book, ‘The Scourge of Neoliberalism: US Economic Policy from Reagan to Trump’, Clarity Press, 2020.
L.A. Progressive, June 21, 2022, https://www.laprogressive.com/