'A recession directly reduces economy-wide incomes while inflation does not.'
” effects of recessions on long-run potential growth are very large, and they almost surely dwarf any long-run effect from inflation over the coming years. Obviously, if U.S. inflation rose to 50% for a number of years, the growth-stunting effects of that would exceed the effect of recession scars, but nobody seriously believes scenarios like that are plausible.
Some arguing for a more-rapid pace of Fed tightening have claimed that even if you think recession is worse than inflation, it isto ever pull inflation back to more-normal rates without raising interest rates high enough to at least risk a recession. This thinking essentially argues that inflation is a one-way ratchet, only ever moving up until recession pulls it back down. This isn’t true.
This claim of a one-way ratchet in non-recessionary times is also not true more generally. The key variable for determining whether or not a softer labor market is needed to rein in inflation in coming months is generally the pace of wage growth. If wage growth is consistently running more slowly than inflation, thenfrom both the cost side and by generating lower real incomes for households, thus depressing demand.
One could certainly argue that the reason why wage growth is currently moderating is the recent hikes undertaken by the Fed, and their success in tamping down inflationary expectations. My own view is that’s. But, even if one believed this, it seems clear that going forward, the imperative to continue pushing interest rates up is gone.
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