The inflation dilemma: Patience vs. recession
Want to bring down inflation? The great dilemma is this: The only real options are to be patient, or cause a recession.
Why it matters: It is a pick-your-poison environment for the Biden administration and the Federal Reserve, who face public discontent over economic conditions — and the risk that discontent would only get worse if the alternative was a new recession.
- The inflationary pressures from strained supply chains and labor shortages look likely to persist through 2022 and maybe beyond.
- But the measures that would be needed to bring inflation down more rapidly would risk sending the economy into a tailspin.
The big picture: In the decades after World War II, episodes of inflation have ended when the Fed took steps to tighten the money supply, causing recessions.
- In other words, companies can't hike prices and workers can't demand higher pay if the economy is contracting and more people are out of work.
- In the most extreme example, Fed Chair Paul Volcker engineered a steep downturn in the early 1980s that ended the double-digit inflation of that era — but at the cost of double-digit unemployment that pummeled President Reagan's popularity.
This time around, the goal is a soft landing. The Fed is looking to move toward higher interest rates gradually, not with the kind of shock Volcker engineered.
- And the Biden administration is decidedly not talking about spending cuts or tax increases that might act as fiscal anti-stimulus.
Yes, but: Patience is a virtue, but not necessarily in politics. High inflation is hammering President Biden's approval ratings, and could cost Democrats big in November mid-term elections.
- And there is no guarantee of when or how much price pressures will come down, even as the world economy rebalances after the pandemic.
The bottom line: Inflation hurts. Recessions can hurt more. Ultimately, economic policymakers are betting that tolerating some pain now in hopes that conditions look better in a year or so is safer option.