Months before much of the economic establishment took the prospect of perilously high inflation seriously, Jason Furman made a prescient warning against overstimulating the economy with too much pandemic aid. Now, with prices rising at the fastest pace in 41 years, the Federal Reserve has raised interest rates by half a percentage point — the largest hike since the turn of the millennium. Furman, a Harvard economist who was a close adviser to Barack Obama, thinks the Fed will have to keep moving quickly in order to get the problem under control, with inflation rising higher than even he thought it would. I spoke with Furman about the Fed’s move, the implications for Democrats this November, and whether a recession is inevitable.
The last time we spoke, about six months ago, inflation was at 5.4 percent. Now it’s 8.5 percent. Briefly, how did we get here?
Inflation has gone higher for two reasons. One is the underlying momentum in the economy and the much stronger labor market, and the second is bad luck related to Putin’s invasion of Ukraine. At this point, the Fed can’t afford to ignore the underlying trend. And it also can’t afford to ignore the bad luck.
Was the half-point hike the right thing to do?
The Fed got behind the curve, but it is catching up quickly and trying to get interest rates up to a normal level or at least a neutral level. It may have to go further than that, but for now, I think it’s almost a no-brainer that they need to move as fast as they can — and they’re moving very fast. Fed chair Jay Powell was clear: He’s not going to let up even if the unemployment rate starts to rise. It’s a decently hawkish stance, an appropriately hawkish stance.
The big fear with these rate increases is that the Fed is going to trigger a recession. Do you see that as a danger?
Not in the next year, for two reasons. One is they’re just raising rates to neutral. I don’t think that raising interest rates to 2 percent or 3 percent is a cause for recession. And two, monetary policy affects the economy with a lag of about a year. A year and a half or two and a half years from now, that’s where I think it’s possible that the Fed’s going to move so far so fast that it risks a recession. But for the next year, I’m not that worried. I’m more worried that it’s not going to be enough to control inflation. I’m more worried that inflation is going to persist than I am about recession.
What’s fueling that worry that inflation is not close to being controlled?
It’s because even though part of the inflation we’re seeing is transitory — I don’t think we’re going to see food and energy prices stay this high — the underlying signal keeps rising. We’ve seen strong wage growth feed into strong price growth and strong price growth feed into strong wage growth. I don’t see an end to that process with unemployment as low as it is today.
How scary is this? Does it seem like a crisis or more of an anomaly?
I wouldn’t use the word crisis. But we now have a chronic problem with inflation, and we could be grappling with it for years. There’s two things happening simultaneously: The underlying trend of inflation has been getting worse as labor markets have gotten tighter, and the psychology of inflation has been feeding on itself.
And then layered on top of that there are the temporary factors like the Russian invasion of Ukraine. We’ve had a combination of what I think was a predictable increase in inflation with a sort of unpredictable set of events that have made it even worse. No one expected 8.5 percent inflation. I don’t think that would have been a reasonable thing to have thought. One point or more of our inflation, really, is Putin’s invasion of Ukraine.
Could we have permanently high inflation? What would that look like for our society?
I think the rate will come down from 8.5 percent. I just don’t think it’ll go all the way down to 2. It would take a pretty substantial recession for that.
As for what it means, it depends a lot on what’s winning the race: wages or prices. Right now, prices are winning, and workers are falling further and further behind. That could change, and it could be that we have high inflation but even faster wage growth. That would be a different story, but that’s not where we are yet.
Are you saying that a recession is the only way to get inflation under control?
It’s hard to imagine how we get back to 2 or even 3 percent without a recession. There are very few examples in history. Powell has pointed to so-called soft landings, but in almost none of them did the inflation rate come down very much. In cases where the inflation rate came down a lot, they’re almost all hard landings. The most recent one was the 2008 financial crisis. The more canonical example would be the early ’80s, when a recession brought inflation down.
The good news is that we’re still only a year in to high inflation, and so there may be time to avoid it getting overly built into expectations and into the economy. By the late ’70s, we were a decade into inflation — so this came a lot faster than what we’ve seen in the past.
How do you see the political dynamic? We can expect it to crush the Democrats, right?
People hate inflation. They especially hate inflation when it shows up in gas prices. They’re livid. And you know, I don’t see it coming down quickly enough to provide a lot of relief before the election. If voters are mad about inflation, they’ll take it out on Democrats. That’s just what they do. And it’s not all fair. Some of the inflation is oil, which is a global market; some of it is the Fed, which is acting independently. But, you know, if you’re the incumbent, rightly or wrongly, you sort of own everything.
Just how much pain are workers feeling? Can you quantify it?
Inflation-adjusted wages are falling at the fastest pace in 40 years. So for most workers, this is the worst inflation-adjusted pay they’ve experienced in their entire careers.
Is there anything the White House can do, or is it pretty much all on the Fed?
The two main solutions to inflation are time and the Fed. The White House has done some good things — trying to improve the operation of ports and supply chains, getting more truck drivers on the roads. The biggest thing the White House could do that it has not done is lifting the Trump tariffs on China. That would lower the inflation rate by anywhere from 0.3 to 1.3 points.
You’re not really going to see much impact from the Fed on the actual economy for months — that generally takes about a year from when they act. You’re talking about toward the end of this year, beginning of next year, that the Fed’s going to start making a difference.
Is there anything else you’re concerned about?
Asset prices remain very, very high. House prices are very high. Stock prices are very high. Could they come down? Could they come down quickly? I’m not ready to predict a crash or anything like that. But one has to be nervous when stock prices are trading at a level that’s the highest level they ever have other than just prior to the bubble bursting.
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