MILTON EZRATI is chief economist for Vested, a contributing editor at The National Interest, and author of “Thirty Tomorrows” and “Bite-Sized Investing.”
Milton Ezrati
A Recession Is on the Horizon
One way or another, inflation will bring on recession
T
he recent disappointing report on the gross domestic product (GDP) may reflect statistical particulars more than the immediate onset of a recession. But the real thing nonetheless lies on the horizon, probably in the next 18 to 24 months. Inflationary pressures are the culprit. They make recession all but inevitable. The downturn will arrive in one of two ways: the Fed’s anti-inflation fight will trouble markets and bring on a recession, as such policies have many times in the past; or if the Fed refuses to fight sufficiently, an unchecked inflation will, in time, produce enough economic distortion to create a recession on its own. This unwelcome prospect confronts the country because, contrary to Washington’s repeated claims, today’s inflation is neither a “transitory” reflection of post-pandemic strains nor the immediate result of the fighting in Ukraine. Though these developments surely have contributed, current price pressures mostly reflect more than a decade during which Washington—under both Democrats and Republicans— has run huge budget deficits that the Fed has financed by creating a torrent of new money. The Fed has, during this time, used new money to purchase some $5 trillion in government debt, some $3 trillion in just the past couple years. This modern equivalent of financing government by printing paper money is a classic prescription for persistent inflation. The Fed has only just begun to respond to the demands of the inflation fight. It has raised the benchmark federal funds rate by 0.75 percentage points from its lows to 1.0 percent and has promised more such increases. Policy has also reversed
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the so-called quantitative easing program. Instead of creating new money and financial liquidity to buy bonds directly on financial markets, the Fed will now sell some of the securities it has amassed in past years and, in so doing, absorb some of the inflationary money from financial markets and the economy. All this tends to restrain economic activity.
To erase that incentive and tame inflation, the Fed will have to raise interest rates above the ongoing rate of inflation. Getting there quickly enough to have an effect will inevitably shock markets and the economy. Fed policy will have to do considerably more to deal with what is now embedded inflation. Even after the Fed’s latest move, consider that short-term rates still stand at only 1.0 percent. In today’s 8.5 percent inflation, a borrower will repay the lender in dollars worth a lot less in real terms than he pays in interest. In real terms, the lender actually pays the borrower to use the money—a huge incentive to borrow and spend remains. To erase that incentive and tame inflation, the Fed will have to raise interest rates above the ongoing rate of inflation. Getting there quickly enough to have an effect will inevitably shock markets and the economy enough to cause a stall in economic activity and likely at least a brief downturn. No doubt the Fed has begun cautiously for fear of such a recessionary
effect. The economy, however, cannot avoid it. Even if monetary policy remains frightened and timid, a recession will come. Eventually, unchecked inflation will make business planning so fraught with uncertainty that businesses will forgo investment projects that would otherwise enhance the economy’s productive potential and encourage job growth. Workers, even if able to secure wage hikes, will still struggle to keep up with the rapidly rising cost of living. By eroding the value of dollar-denominated assets, such as stocks and bonds, inflation will also cause a retreat in financial markets and, in so doing, further discourage investments in real productive capacities. Meanwhile, ongoing price pressures will redirect what investment monies are available into inflation hedges such as art and land speculation, instead of more productive activities. All these distortions will bring on recession even if the Fed fails to act, likely a more severe and long-lasting one. The recession, now in the cards, might have been avoided. Had Washington a year ago, when the inflation first became evident, begun to shift policy instead of dismissing the problem, the authorities would not now have to shift as radically as they do to have a sufficient anti-inflationary impact. Instead, Fed Chairman Jerome Powell for months insisted that the inflation was “transitory,” as did Treasury Secretary Janet Yellen. Even President Joe Biden, as late as last summer, made such claims. Now he blames Russian President Vladimir Putin. Prompt action couldn’t have avoided all the inflationary pressure, but it could have eased the intensity of the trouble the United States now faces. That opportunity is of course now gone. A recession is unavoidable.
