Last Friday, the US Bureau of Labor Statistics released its May Consumer Price Index (CPI) report, which showed inflation worsening. On Wednesday, the Federal Reserve responded by raising interest rates by three-quarters of a point. Yet the bigger story, and bigger worry, is not inflation. It’s the distinct possibility of recession. Or perhaps both (what’s termed “stagflation.”) Here are some frequently asked questions:
1. Is the US heading for a recession? Many signs point in that direction. New home construction slowed in April. Mortgage demand continues to decline. Some of the country’s largest and most influential retailers are reporting disappointing sales and profits. The stock market is in bear territory. Futures markets are signaling trouble ahead.
2. What exactly is a recession? “Recession ”is a technical term, defined in the US as two consecutive quarters of shrinking gross domestic product. As a practical matter, recessions mean fewer jobs and lower wages.
3. When is a recession likely to happen – and should I panic? Don’t panic! If it occurs, it will not happen immediately. I’d guess some time over the next six months. It’s a possibility that you ought to be aware of.
4. Who gets hurt most by a recession? Lower-income Americans are especially vulnerable because they tend to be the first fired when the economy slows (and the last hired when it rebounds). Recessions also hurt younger people trying to get their footing in the job market. And they can be hard on retirees whose IRAs or 401 (k) accounts get clobbered.
5. Why are we heading toward a recession? Partly because of continued uncertainty from the coronavirus pandemic and Russia’s invasion of Ukraine. But the main cause in the US is interest-rate hikes by the Federal Reserve.
The Fed’s 0.75 percentage point rate increase on Wednesday was the largest single interest rate increase since 1994.
The Fed has raised interest rates by 0.75 percentage points so far this year, and Fed officials are signaling more aggressive increases ahead. When it meets Wednesday it will discuss raising its benchmark rate by as much as another 0.75 percentage points. That would be the largest single interest rate increase since 1994.
6. What’s the connection between Fed rate hikes and a recession? Rate hikes increase the costs of borrowing to individuals and consumers – which causes them to cut back on purchases of everything, including homes. This, in turn, causes the economy to slow.
7. Do Fed rate hikes always lead to recession? No. It’s possible that the US could have a “soft landing” that lowers inflation without causing a recession. But Fed rate hikes often over-shoot, resulting in recession – especially when they’re on the scale the Fed is contemplating. In 1981, for example, the Fed under Paul Volcker raised interest rates so high (to reverse double-digit inflation) it plunged the economy into deep recession.
8. Why is the Fed doing this now? Because it believes it must slow the economy in order to slow inflation, which is at a 40-year high.
9. Is the Fed correct? Slowing the economy will reduce inflationary pressures somewhat, but the Fed is operating under an old model of the economy – when inflation was driven largely by wage increases. The way to slow inflation then was to take the steam out of wage increases by reducing employment. Essentially, the Fed drafted a certain number of workers into the fight against inflation by pulling them out of the labor force. That was when American workers had strong unions and it was difficult for companies to increase capacity by outsourcing abroad.
These conditions no longer apply. Workers now have very little bargaining power relative to what they had thirty or forty years ago. Just look at the data: although wages are rising, they aren’t rising nearly as fast as prices.
10. But if raising interest rates will reduce inflationary pressures somewhat, why shouldn’t the Fed at least try? Because raising rates as much as the Fed seems likely to do will cause more harm than good. Current inflationary forces are worldwide – coming from huge global pent-up demand following the worst of the pandemic, coupled with supply shortages around the world, which have been aggravated by Putin’s war.
Inflation in the US isn’t as bad as in most other advanced economies. Slowing the US economy may put a dent in these forces, but not much of one. Yet the cost – in terms of a recession or near recession, and loss of jobs and wages – is likely to be huge.
11. Are there unique factors driving inflation in the United States? Yes. One of the biggest is coming from hugely-profitable corporations with significant market power, that are using inflation as a cover for raising their prices.
Oil and gas giants, for example, are raking in record profits. In the first quarter of 2022, Chevron’s profits more than quadrupled from the first quarter of 2021, and ExxonMobil’s profits more than doubled despite taking a $ 3.4bn hit for exiting its business in Russia. ExxonMobil will not be using its sky-high profits to ease the burden on consumers at the gas pump, but to increase its stock buybacks. The oil giant now plans to buy back $ 30bn of its own stock, up from the $ 10 billion it announced earlier this year. Note: the Fed’s rate hikes won’t stop this price gouging.
12. What will stop them? Three things:
(1) Vigorous antitrust enforcement that reduces their pricing power (even the threat of such enforcement will make them more reluctant to raise prices).
(2) A windfall profits tax that takes away a portion of their recent profits (and redistributes them to consumers), as the Conservative government in Britain is doing. And
(3) publicity: the government should shine light on highly-profitable corporations that are most flagrantly raising prices (such as Tyson Foods and ExxonMobil).
13. So why doesn’t the Biden administration pursue these? It seems to be embarking on stronger antitrust enforcement, but it’s doing so very quietly – too quietly to get big profitable corporations to pull back from raising prices.
Biden has begun shining a light on profitable companies that are raising prices. (Last Friday, he placed blame for rising prices on oil and shipping companies. In a speech at the Port of Los Angeles, when asked about Exxon-Mobil’s profits, Biden said “Exxon made more money than God this year.”)
But he and his administration seem strangely unwilling to criticize big corporations any more extensively than this. And they have not embraced or advocated a windfall profits tax. I don’t know why. It makes an enormous sense economically.
14. Speaking of politics, what’s the likely fallout if the nation succumbs to a recession? Bad news for Biden and the Democrats. Even though presidents and parties that control Congress don’t have much leverage over the economy, they get blamed for a bad one and get credit for a good one. Jimmy Carter and George HW Bush both lost reelection because of bad economies.
15. Ugh. Precisely. Which is another reason why it’s important for Biden and the Democrats to be seen taking all the actions I mentioned above – and calling out corporations and CEOs that are using inflation as a cover for hiking prices.