Slashing interest rates won't reignite inflation - and delaying could spark a recession, Nobel economist Paul Krugman says
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- Inflation didn't fall because of the Fed, so cutting rates won't reignite it, Paul Krugman says.
- Price growth has slowed as supply chains have recovered, not because rates rose, Krugman said.
- The Nobel Prize-winning economist warned that delaying rate cuts risks an unnecessary recession.
Inflation hasn't slowed because the Federal Reserve has hiked interest rates, so slashing them won't reignite price growth, and delaying the cuts only raises the risk of a recession, Paul Krugman says.
"What I'm concerned about is that clinging to a view of the economy that has been disproved by recent events makes it more likely that we'll mess this up, putting the economy through a recession that, it turns out, we didn't and don't need to control inflation," he said in a New York Times column this week.
The pace of price increases hit a 40-year high of over 9% last year, spurring the Fed to lift rates from nearly zero to north of 5% in under 18 months. Krugman's view is the disruption to global supply chains caused by the COVID-19 pandemic and Russia's invasion of Ukraine caused prices to take off in 2021 and 2022, and they're now rising slower because supply networks are running well again, not because rates are higher.
The Nobel Prize-winning economist pointed out that higher rates typically cool inflation by putting people out of work, which reduces consumer spending and upward pressure on wages, yet unemployment has remained near record lows this year.
There's also no evidence that the Fed's tough talk on inflation has created a self-fulfilling prophecy, where prices are rising slower because people expect them to rise slower, Krugman said. Most of the producers and workers who actually set prices and wages in the economy don't do so based on the Fed's latest comments, he noted.
Krugman drew an analogy to a decade ago, when he ridiculed the idea that slashing government spending would boost employment by fueling more investment as believing in the "Confidence Fairy."
"What we're seeing now might be called belief in the Credibility Fairy," he said.
Krugman called out economists like Larry Summers, the former Treasury chief, for continuing to proclaim that inflation is stubborn and the Fed needs to talk tough to bring it down.
"I guess you're willing to run big risks of recession to preserve the Fed's inflation-fighting credibility," he said.
"Recession looks like a bigger risk than resurgent inflation," Krugman continued. "And I worry that this risk will be increased if policymakers listen to people who are reluctant to admit that they got the inflation story wrong and are clinging to a false theory about how we got inflation down."
In other words, Krugman's big fear is that crediting the Fed with crushing inflation, and warning it not to cut rates too quickly at the risk of reigniting prices, will result in the central bank dragging its feet on rate cuts, potentially triggering a recession that might have been avoided otherwise.
It's worth noting that Fed Chair Jerome Powell signaled last week that rates may be at their peak, and the central bank penciled in three rate cuts for 2024, suggesting the Fed might not be shy about slashing.
Krugman also predicted that 2023 would go down as one of the best years in economic history, given inflation has normalized incredibly quickly at no apparent cost. He noted the Fed's preferred measure of core inflation slowed to jut 2.5% in the six months to October, and may well have hit the Fed's target rate of 2% in November.
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