Americans are obsessively following the Federal Reserve’s interest rate adjustments in hopes of figuring out if the future will be inflation, recession, or some combination (stagflation). “Fed likely to boost interest rates by three-quarters of a point this week” (CNBC) is an example.
What if nobody other than the government borrowed money for any reason and, therefore, the Fed’s interest rate became irrelevant to ordinary subjects. Could we still have inflation? Two economists say “yes” in “The Real Cause Of Inflation Is Insane Deficit Spending” (February 2022):
But proponents of MMT do get one thing correct — the Fed can create money to service the debt and avoid a default. But in real terms, meaning adjusting for inflation, this assertion is false. Creating money to service the debt devalues the currency. Investors then receive a lower real return on their holdings of federal debt.
(see also this 1983 paper from the Minneapolis Fed)
In the old days, inflation came down when the Fed raised rates. Therefore, unless our deficits are larger than in the old days, the interest rate hikes should work to tame inflation (maybe by damaging the economy). “U.S. deficit will shrink to $1T this year before soaring, federal forecasters say” (Politico):
While the nation’s shortfall has substantially declined following last year’s $2.8 trillion deficit, the Congressional Budget Office estimates the gap between spending and revenue will grow starting in 2024, reaching more than 6 percent of GDP a decade from now. The U.S. has only run greater deficits than that six times since 1946, CBO noted.
We’re actually in uncharted territory when it comes to deficit spending.
Another reason that inflation came down when the Fed raised rates is that people weren’t able to pay as much for houses, nearly always bought with borrowed money. But the current headline inflation rate has been cooked so that it doesn’t include the actual prices paid for houses or mortgages (those 1980s headlines were too alarming under the old formula!). The inflation rate won’t move until the fictitious “owners’ equivalent rent” changes.
Some prices that are part of the price index will obviously fall if the Fed causes a recession with high interest rates. Used cars, perhaps. But, given the huge deficits indulged in by Congress, will high rates and a recession be enough to push headline inflation down to the 2 percent level that the Fed claims to be targeting? Consider that if there is a recession, the welfare state will automatically kick in to increase spending on housing subsidies, taxpayer-funded health care (more people eligible for Medicaid), SNAP/EBT, Obamaphone, and free home broadband. Congress also likely won’t be able to resist massive new spending initiatives to combat the recession, just as they spent massively to combat the economic impact of the coronapanic shutdowns ordered by government.
- “President Biden orders 100-percent federal reimbursement for city’s Covid hotels” (January 22, 2021), in which taxpayers in Louisiana and Mississippi were forced to pay for San Francisco’s generosity in providing 2+ years of hotel rooms for the unhoused. If there is a housing “emergency” declared due to an interest rate rise, presumably the same executive order mechanism could be used to increase the federal deficit by spending on hotels.
- The $12 sandwich here in San Diego is temporarily $14 (up 17%):
- Below, sign at a South Florida car dealer, June 9, 2022