Economist Claudia Sahm Questions How the Fed is Fighting Inflation

Blog Post
Thursday, November 03, 2022

This week on Facing the Future, Tori Gorman filled in for Bob Bixby as host and spoke with influential economist Claudia Sahm. Claudia’s resume includes important advisory roles with the Federal Reserve and the Council of Economic Advisors for the Obama Administration which makes her an ideal guest to weigh in on the current battle to fight inflation. Sahm has been quite critical of the Fed’s response to high inflation, calling the rapid increases in interest rates a “war on workers,” that will cost millions of workers their jobs and will likely induce a recession, both here and abroad.. While she says it is true that the factors that led us to high inflation are low interest rates for more than a decade and trillions of dollars in emergency pandemic related spending, the Fed only has very limited tools to influence the major force behind price spikes. 

“Prices have gone up particularly when we think about necessities like food, energy, and housing. This is a big problem and frankly, these are exactly the parts of the cost of living the Federal Reserve has very weak tools over, and actually they can make things worse,” said Sahm. “We had a long-standing problem, particularly with housing going into this crisis. I hope - my thin silver lining with this better be that that policy makers figure it out. The Fed can’t solve all these problems. We have to deal with the problems we went into COVID with: unaffordable housing, the high cost of higher education, seniors that can’t buy the medications they need. We had big problems going into this, and COVID and Putin have made things worse.”

 

Russia’s invasion of Ukraine has created instability that has driven up fuel and food costs, especially given that Ukraine is such a massive global grain supplier. Sahm says while the Fed’s ability to raise interest rates may have a chilling effect on the demand side of money in terms of borrowing and spending, it cannot fix the other major driver of inflation: disruptions to the supply chain making goods and services scarce. 

 

“We put a lot of money in people’s hands, and into small businesses. And as the vaccines came out in the spring of 2021, the world really reopened, there was this massive pent-up demand, and people normally wouldn’t have money to get in on that, and that was exactly the time that the supply chains didn’t heal,” says Sahm. “It turns out that customers can come back a lot easier than the stuff we want to buy, and frankly customers came back faster than workers, for a lot of different reasons. So if you have too much demand, and not enough supply, you’ll get inflation. The supply chains were broken, and workers weren’t coming back. In the summer, I was part of team transitory - inflation is coming down, workers are coming back, things are reopening, schools are going to reopen, and in fact inflation had started coming down in the summer and in the fall. Then we got Delta. Then we got Omicron. We got multiple variants. We have millions of people who got long COVID, we lost a million Americans. And then, Putin. We have had repeated tragedies.”

 

So now, what do we do about the stubbornly high inflation? And will the Fed’s strategy of raising interest rates to bring down prices lead to an economic recession not only in the U.S. but worldwide? Can anything be done to avoid this? 

 

“A recession is not inevitable. A severe recession, like what Paul Volcker engineered in the early 1980s, is absolutely not inevitable and frankly if we get there, there will have been some massive policy mistakes made in particular by the Federal Reserve,” said Sahm. “While we have high inflation, and that is a problem, we had a job-full recovery. We have unemployment rates low, we have people that have gotten wage increases that frankly businesses have told us were never worth a wage increase. Low wage service workers have gotten increases, people have moved to better jobs, there is far more recovery in the full time work than the part time, all those part time jobs are really crappy jobs. Americans have income, they are spending. We are in such a better place than Europe, even many parts of Asia. If we screw that up, we will have done a major disservice to our economy.”

 

Sahm says there are clear signs that the Fed’s actions by bringing interest rates up are starting to work, and that everyone needs to be patient, because there is always a lag of a few months to see the real impact [of rising interest rates], but prices will start to come down. Pushing those rates up any higher, says Sahm, will likely cause economic damage to our European allies. 

 

“We have raised interest rates more quickly than any of our peer countries in Europe,” said Sahm. “Investors abroad want to buy U.S. treasuries, because it pays off. Well, it turns out you have to buy them in dollars. The demand for the dollar has gone up, and the dollar is really strong relative to other currencies. So goods produced elsewhere are cheaper for us to buy. So this is a beggar thy neighbor strategy. We are importing disinflation, things that will eventually push down inflation. Because eventually, competitive forces will get businesses to lower prices, or at least stop raising them so quickly. But we are exporting inflation. We are making it more expensive in particular for countries in Europe that are the front line against Putin. We are pushing inflation at them, and they are already dealing with really high energy inflation. So we’re going to bring down U.S. inflation, it’s clear it’s coming. It makes me sad that Americans are paying more, especially for necessities, but it also makes me sad that we are solving it by destroying demand in other countries.”

 

The Fed’s open markets committee met this week and decided to raise interest rates another three quarters of a point

This could potentially push 30-year fixed mortgage rates to their highest level in 20 years. The net result, Sahm fears, is millions of people unnecessarily out of work in the U.S. and abroad.   

Hear more on Facing the Future. Bob Bixby regularly hosts the program each week on WKXL in Concord N.H., and it is also available via podcast. Join our guests as we discuss issues relating to national fiscal policy with budget experts, industry leaders, and elected officials. Past broadcasts are available here. You can subscribe to the podcast on Spotify, Pandora, iTunes, Google Podcasts, Stitcher, or with an RSS feed. Follow Facing the Future on Facebook, and watch videos from past episodes on The Concord Coalition YouTube channel.

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