Are rate hikes stoking inflation?
Nobel Prize-winning economist and Columbia University Professor Joseph Stiglitz recently told ABC’s 7.30 program that hiking “too high, too fast, too far” would stoke inflation in goods and housing. Stiglitz still holds to this view.
The key global central bank, the US Federal Reserve or ‘Fed’, has hiked its cash rate aggressively since March this year in order to bring down rising prices (inflation) and to douse expectations of inflation. You can see the Fed’s rate rises over the last decade in the chart below - including the stepped hikes in 2016-19 and this year’s very aggressive hikes.
Joseph Eugene Stiglitz, a Nobel Memorial Prize-winner in Economic Sciences, is one of the most highly esteemed economists in the world. He’s had highly influential roles in shaping economic policy and thought at the federal and international levels. Time magazine named him as one of the top 100 most influential people in the world in 2011.
Stiglitz believes these hikes risk intensifying inflationary pressures. Why is he worried about this?
“The real worry in my mind is, will they increase interest rates too high, too fast, too far?” Stiglitz recently told CNBC.
Stiglitz thinks that while there was a need to adjust from the zero or near-zero interest rate policy in place since 2008, there are three reasons an aggressive Fed course could stoke inflation.
The first reason is that the overwhelming source of inflation, by Stiglitz’s analysis, is supply-side disruptions leading to higher prices in oil and food, even causing a shortage of baby formula. “Will raising interest rates lead to more oil, lower prices of oil, more food, lower prices of food? Answer is clearly not. In fact, the real risk is it will make it worse,” Stiglitz recently told CNBC. “Why? Because what we need to do is to make investments to relieve some of these supply-side bottlenecks that are causing such havoc on our economy. It’s going to make it more difficult.”
“Will raising interest rates lead to more oil, lower prices of oil, more food, lower prices of food? Answer is clearly not. In fact, the real risk is it will make it worse.”
The second reason is that profit margins for major corporations have been rising along with their input costs. “They’ve not only been passing on the cost,” Stiglitz says, “but passing it on even more.” Stiglitz says there’s a well-defined theory that points out that when interest rates go up, firms … take more advantage of raising prices today. Raising interest rates in non-competitive markets may lead to even more inflation, Stiglitz contends.
The third reason is that there is the potential for increasing costs in an important component of inflation: housing. “You raise interest rates, it gets reflected in rents, and there’s a Federal Reserve study showing that,” he said.
The Federal Reserve raised its benchmark rate by 0.75 percentage points in both June and July this year. Fed Chair Powell said that while higher rates, slower growth and softer labor market conditions would bring down inflation, that would also mean “some pain” for households and businesses.
Stiglitz has further concerns about the US economy’s impact on citizens (and citizens in other countries and economies like Australia).
One concern is that interest rates will continue to be raised faster than house prices fall. According to Stiglitz: “Prices are remaining high, they’re not going to come down as fast as interest rates are going up and that’s going to increase the intergenerational divide in our society.”
Another concern is that recent US job market data does not indicate as much strength as some people have suggested. “One indicator that they are not really capturing is what is going on with real wages, which normally go up when labor markets are tight,” he said. Real wages means wages adjusted for inflation.
“Labor markets are very tight, prices of goods are going up, that should mean you compensate workers even more but that’s not happening,” Stiglitz noted. “Real wages are going down, so that at least should make you worry.”
