Politics & Government
Economy continues to defy conventional wisdom
Wesleyan's Zelity says inflation has been driven by both demand- and supply-side components
By Scott Benjamin
With interest rates at a 22-year high you shouldn't the economy be on the verge of a recession?
Surprisingly, the unemployment rate is at 3.8 percent and has been below four percent for the longest stretch in the last 50 years, according to Politfact
Find out what's happening in Brookfieldfor free with the latest updates from Patch.
Yes, inflation surged again in August to 3.8 percent, but is well below the nine percent rate of June 2022.
“The resiliency of the economy does fly in the face of classic economic intuition, which would suggest higher interest rates should cause higher unemployment,” stated Wesleyan University Assistant Economics Professor Balazs Zelity in an e-mail interview with Patch.com.
Find out what's happening in Brookfieldfor free with the latest updates from Patch.
Economist Donald Klepper-Smith of DataCore Partners told Patch.com in July that the odds for a soft landing had improved over the recent months.
Zelity stated, “Unless a previously unknown vulnerability in some sector of the economy is suddenly triggered by continued interest rate increases, a soft landing is likely.”
Klepper-Smith, who chaired former Gov. M. Jodi Rell’s economic team, told Patch.com that the relative strength of the economy is largely due to fiscal and monetary stimulus that resulted from the pandemic.
Zelity wrote, “The COVID recession was quite unique from many perspectives. For one, households increased their savings due to lockdowns and stimulus checks prior to the current period of rising interest rates.”
John Cochrane, a senior fellow at the Herbert Hoover Institute at Stanford University, wrote recently in The Wall Street Journal that the federal government's fiscal policies largely explain the surge in inflation in 2022.
“Our government borrowed about $5 trillion and wrote people checks,” he stated. “Crucially, and unlike in 2008, there was no mention of how the new debt would be repaid, no promise of debt reduction later.”
Wrote Zelity, “In my view, inflation has also been driven by supply-side factors such as factory shutdowns in China, bottlenecks in international shipping, or the war in Ukraine affecting oil and gas supplies.”
“But I do agree that demand-side factors, of which increased federal government spending is an important part, also played a role,” he added. “Another important demand-side factor in my opinion is pent-up demand: the phenomenon of higher-than-normal spending after concerns about COVID eased. Finally, inflation expectations could have played a role as well: if a firm expects its costs to increase over the next quarter, it will raise prices accordingly.”
After raising interest rates over the last year and a half to the highest levels in a generation, where does the Federal Reserve Board go from here?
Nick Timiraos of The Wall Street Journal recently wrote, “Some officials still prefer to err on the side of raising rates too much, reasoning that they can cut them later. Now, though, other officials see risks as more balanced. They worry about raising rates and causing a downturn that turns out to be unnecessary or triggering a new bout of financial turmoil.”
Stated Zelity, “In recent months, the Fed has slowed its pace of interest rate increases. Inflation continues to decrease, and yet the economy remains resilient. The Fed's policy remains effective and is achieving precisely what it is meant to do. The Fed has been more cautious with rate increases because monetary policy works with a lag. That is to say, you will not feel the full effect of today's interest rate increase for many months into the future.”
On another topic, financial investor and columnist Red Jahncke of Greenwich recently wrote that the recent Fitch downgrade of the federal government’s credit rating below AAA is a sign of concern
“Net interest on the [federal] debt is escalating rapidly on a track to hit an unsustainable and crippling $1 trillion in fiscal 2025,” he stated in a CT Examiner column.
Zelity stated, “The deficit grew temporarily to address the COVID recession and is currently being gradually clawed back.”
However, 25 years ago the federal government had a budget surplus – the first in 29 years. On September 30 it will have been 22 years since the last budget surplus.
Zelity wrote, “In my view, the current situation is not too concerning if deficit reduction continues unabated as the US government seems to have no trouble financing its debt. It took five years for the deficit to go back to below 3% of GDP after the Great Recession [in 2008]. For context, the deficit was at 5.4% in 2022 and 14.9% in 2020 at the height of COVID.”
He added, “However, the increasing difficulty with which compromises are reached in Washington can be a cause for concern down the line.”
Resources:
Balazs Zelity, e-mail interview, Patch.com, Friday, September 8, 2023.
https://ctexaminer.com/2023/08/31/interest-on-debt-on-track-to-hit-1-trillion/’
https://abcnews.go.com/Business/interest-rates-22-year-high-heres-means-finances/story?id=101718022
https://fortune.com/2023/04/07/larry-summers-jobs-recession-risk-fed/
