Rising costs have wrecked household budgets and everyone knows that high inflation is to blame. In the last few months, it appeared that things have seemed shaky and maybe the economy was on its way to recession 2023. But if Nobel prize-winning economist Paul Krugman is to be believed, a runaway inflation and recession is unlikely and inflation is falling faster than the Fed thinks.
He also warned that recession could become a self-fulfilling prophecy if the Fed keeps responding to imaginary stagflation. The economist is also worried that investors are moving too fast and easing financing conditions too quickly could cause high inflation to make a comeback. Krugman shared his thoughts in an op-ed for the New York Times on February 6.
Meanwhile, at the Economic Club of Washington, Federal Reserve Chair Jerome Powell mentions that in case inflation continues to rise, the Fed will have to raise benchmark interest rates.
So, where does inflation stand? Is the economy improving and can we put fears of a recession behind us?
Let us study how inflation has changed and what top economist Paul Krugman believes.
Paul Krugman on High Inflation and the Fed
In his write-up the economics professor notes that the Fed is responding to a stagflation scenario that does not exist. Recalling the grim forecasts of last year where experts and analysts predicted an economic doomsday in 2023, he points out that things have improved in comparison to last summer. Although inflation continues to be high, prices have cooled and we are looking at an improving economic situation, he stated.
“Until a few months ago many if not most economic prognosticators were far too negative about America’s prospects. In particular, we went through what I think of as the summer of stagflation,” he writes.
Krugman pointed out the recent labor and housing market data to support these comments. In January 2023, nonfarm payrolls increased by 517,000, more than double the expected 187,000. The unemployment rate also fell to 3.4%, which is the lowest since May 1969.
In November 2022, the economist had pointed out that falling rental prices and slowing wage growth indicate that the US inflation has cooled to less than 4%. At the time, he also opined that the core Consumer Price Index (CPI) inflation excludes food and energy prices and this might be why it is overestimating figures.
This time, he notes that predictions of high inflation are “wildly over-pessimistic” and although it is not fully under control, there are clear signs that it is falling.
The economist also warned against proceeding with a negative view as the Fed’s cautiousness could spell trouble for the US economy. If the Central bank continues to keep interest rates high, hoping to rein in imaginary high inflation, it could negatively impact the market.
Fed Chair Jerome Powell on Inflation
On Tuesday, close on the heels of Krugman’s publication, Fed chair Jerome Powell declared that the agency will make changes depending on how the market performs. A Fed interest rate hike would be in the works if high inflation persists and the economy suffers.
“The reality is if we continue to get strong labor market reports or higher inflation reports, it might be the case that we have to raise rates more,” he revealed at the Economic Club.
Although he acknowledged that prices seem to be easing, he cautioned that the economy still has a long way to go. He confirmed that the Central bank is seeing very early stages of disinflation but warned that there is still a long way to go, before financial measures are eased.
Powell also reminded that while most people expect high inflation to disappear quickly and painlessly, it is very unlikely. Erring on the side of caution, he forewarned analysts that the Fed rate hikes might have to continue before the Fed decides that inflation is under control.
The Fed chair is also wary of skilled labor shortages and mentioned that it can throw the job market out of balance. Shortage of skilled workers could translate to higher demand and wage rises, which could keep inflation high.
For the time being, Powell believes that inflation has started to decline and the Fed might be able to prevent a steep recession.
Despite the differences in their outlook both Krugman and Powell agree that inflation has begun to ease. The Fed, however, is extremely cautious and wants to see whether the decline will sustain before making any promises about the economy.
