US can’t rely on inflation shamanism

Google “shamanism” and you will find that it is “a tradition of part-time religious specialists who establish and maintain personalistic relations with specific spirit beings through the use of controlled and culturally scripted altered states of consciousness.” Every element of that definition applies to monetary policymaking today, as illustrated by the reaction to the US Federal Reserve’s Sept 18 decision to cut the short-term interest rate by 50 basis points.
The “part-time religious specialists” are those economists who comment on Fed actions. The “specific spirit being” is Fed Chair Jerome Powell. And “controlled and culturally scripted altered states of consciousness” describes textbook economics and statements from people who write economics textbooks.
Consider Paul Krugman, a noted “part-time specialist” who burnishes his glory by holding up a “Nobel Prize” (in fact, the prize is awarded “in memory of Alfred Nobel” and funded by — surprise — a central bank, but let that pass). Commenting in The New York Times on the day of the Fed’s big move, he declares, “first and foremost … we’ve won the war on inflation. And we did it without a recession or a large rise in unemployment.”
Note the personal relationship that this statement implies. Who, exactly, is “we”? Mr Krugman does not say, but he clearly means to include himself (that is what “we” means in English). Still, the key player is not Mr Krugman; it is the spirit being at the Fed. As Mr Krugman explains: “the Fed is a tremendously powerful economic actor and one that can act quickly … So the Fed is basically the short-term manager of the economy.”
How, exactly, does the Fed go about managing the economy when inflation threatens? “By raising interest rates,” he explains, “and the reason you do that is to try to cool off the economy, reduce spending, and reduce the demand for goods. It’s standard practice.” He goes on to note, correctly, that the Fed’s interest-rate hikes after March 2022 were the biggest since the early 1980s.
Next, Mr Krugman offers his view of the specific spirit being. If Mr Powell says one thing, it means X; if he says another thing, it means Y. According to Mr Krugman, “it’s the words and the specificity” that matter. Or, to put it another way: it’s the “scripted, culturally specific state of consciousness.” This, he tells us, will determine the effect on long-term interest rates and thus economic performance.
Back in 1981, when the Fed chair, Paul Volcker, pushed the short-term interest rate to 20%, four times higher than now, the dollar soared, the economy crashed, unions and industry were destroyed, and unemployment hit 10% before he relented. That, and a global debt crisis and a commodity price crash, did bring inflation back down.
None of that happened this time. Growth did not slow, commodities have not crashed, and unemployment is up barely a point, hovering at levels that would have been considered hyper-full employment in the 1980s. So, how did the Fed manage to win the war on inflation?
The clear answer is that the Fed didn’t, in fact, win anything. Price increases peaked in June 2022 when the spirit being was still putting on his boots. After the start of the tightening cycle three months earlier, interest rates had risen only 75 basis points. And the inflation rate has been falling ever since, as the pandemic-related shocks, supply disruptions, and oil-price manipulations have passed through and out of the US economy. (The Russia-Ukraine war was a big factor in Europe, but not so much in the United States.)
The unmistakable conclusion — unless you’re a shaman — is that the Fed did not manage the economy by masterfully placating the spirits and demons of growth, employment, and inflation. Instead, it twiddled with its interest-rate levers, and — so far — nothing happened. As I wrote in May 2022, Mr Powell merely “waved his wand” — permitting his shamans to give him credit for developments that were already underway.
The question now is whether interest rates, still high, will produce a recession later this year or next. It is possible. To cause a slowdown, and soften up the labour market, was precisely the Fed’s goal. High interest rates are bad for businesses, and high mortgage rates are bad for housing. Bad business and bad housing are bad for jobs. A slowdown may be starting now. But it hasn’t gone very far — yet.
Causes must precede effects. A cause that has not happened cannot be credited with an effect that already has. This is a very simple point, yet Mr Krugman and his many fellow shamans overlook it. One would hope, however vainly, that the recipient of a big prize in “economic sciences” would see the problem. ©2024 Project Syndicate
James K Galbraith is Professor at the Lyndon B Johnson School of Public Affairs at the University of Texas at Austin and the co-author (with Jing Chen) of the forthcoming ‘Entropy Economics: The Living Basis of Value and Production’.