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Krugman doubles down

Inflation? What inflation?

11 June 2022

9:00 AM

11 June 2022

9:00 AM

Nobel Prize winning economist, Paul Krugman, is not a person without self-knowledge. He does admit that he has a tendency to believe what he wants to believe.

Last year, he was telling everyone who reads his columns in the New York Times that inflation in the US wouldn’t be a problem and that any price pressures were merely transitory and nothing to worry about. As an ardent supporter of the Democratic party, he realises that inflation is political poison for the Biden administration.

Unfortunately for Krugman, the ‘it’s only temporary’ thesis was disproved by the official inflation figures this year. For the year ending in March, the recorded rate of inflation was 8.5 per cent, before falling slightly to 8.3 per cent for the year ending in April. These figures are the highest they have been in 40 years.

With inflation landing way outside the acceptable band for the Fed, an inevitable tightening of monetary policy has now begun. The official interest rate has been raised by 100 basis points and the likelihood is that further increases of between 100 and 200 basis points will be executed before the end of the year. But Krugman is not prepared to raise the white flag just yet. His latest invocation is that ‘inflation in the United States has probably peaked’. According to him, rising prices have been the result of Covid-related supply-side disruptions, Russia’s invasion of the Ukraine and an overheated domestic economy.

Inflation is just a passing phase, according to him, an opinion he backs up by telling us that inflationary expectations are high in the short run but not so high in the medium term. (An obvious response is: just wait until we get to the medium term.) The likely outcome is a cooling US economy with slightly higher interest rates but an acceptable rate of inflation.

Krugman is keen to show that the ‘monetary hawks’ are wrong. These are the economic commentators who believe that the Fed set the official interest rate too low and printed too much money for too long. In their view, the inevitable consequence of the Fed’s approach was always an undesirable inflationary surge that would be difficult to control.


Needless to say, there are many who beg to differ with Krugman – including me. In fact, it looks as though the current inflationary spiral may be just getting under way; it could easily get worse – rising above 10 per cent. Higher petrol/diesel and energy prices have both immediate and lagged effects on other prices and there is nothing to indicate that these prices are going to fall significantly any time soon.

Take the impact of higher petrol/diesel and energy prices on agriculture. Farmers are already bearing significantly higher fuel and fertiliser costs (fertiliser is basically congealed natural gas) but there is a lag before these costs are reflected in higher retail food prices. More generally, higher transportation costs affect prices across a range of industries, with electric vehicles still an essentially niche form of private carriage.

The responses of the Biden administration have been both bizarre and unconvincing. The President expressed the view that higher oil prices could be a good thing because, ‘God willing, when it’s over, we’ll be stronger and less reliant on fossil fuels.’ Sure, Joe.

Referring to higher fertiliser prices, the head of Biden’s Agency for International Development, Samantha Power, argued that the solution is ‘natural solutions like manure and compost, and this hastens the transitions that would be in the interests of farmers anyway’. Just tell that to the poor citizens of Sri Lanka after their ill-fated mandated switch to organic farming.

The rebuttal from North Carolina pig and corn farmer, Lorenda Overman, was to the point: ‘That’s not the real world. We are in the highest density for pig production and there is not enough pig manure or turkey manure or chicken manure to fertilise our crops. There are not enough animals to produce the fertiliser we need.’

Biden’s Energy Secretary, Jennifer Granholm, also got into the act but declaring that higher oil prices were ‘an exclamation point’ for the need to transition to more solar and wind. ‘If you drive an electric car, this would not be affecting you,’ she added. This of course ignores the rising cost of electricity.

Mind you, the US is not the only economy staring down the barrel of much higher rates of inflation. The May figures for the Eurozone pointed to consumer prices rising by over eight per cent for the year, the highest figure since the Euro was first introduced in 1999. In Germany, the latest inflation recording was 8.7 per cent; in the Netherlands, 10.2 per cent; and in Spain, 8.5 per cent.

The head of the European Central Bank, Christine Lagarde (she has been on the international agency gravy train for decades), has refused to sanction any tightening of monetary policy in the Eurozone to this point. She has however foreshadowed that the bank’s bond buying will be wound back later this month which is bad news for a number of countries, including Italy. The ECB has been buying sovereign bonds for some time. The official interest rate may be raised in July.

Elsewhere monetary tightening has already begun, including in the UK, Canada and New Zealand. Even in Australia, where the recorded inflation rate was lower than in a number of countries (but still 5.1 per cent in the year to March), the Reserve Bank lifted the official cash rate by 25 basis points in the middle of the election campaign, then by a whopping 50 basis points in June. This was notwithstanding assurances from the RBA governor, Phil Lowe, that interest rates wouldn’t be increased until 2024 – oops.

Given the recent turmoil in the east coast gas market and rapidly rising wholesale electricity prices, it’s certain that our rate of inflation will rise further. (Gosh, even newly appointed Treasurer, Jim Chalmers, described our inflation rate as ‘skyrocketing’ – which was probably not a wise thing to say.)

In turn, the rise in the cash rates will follow, leading to higher mortgage and business rates. For those home owners on low honeymoon rates, that cliff when normal mortgage rates will apply looks particularly ominous.

If the contest is between Krugman and the monetary hawks, I’m putting my money on the hawks. Sugar hits from easy money and excessive government spending work in the short term but there is always a price to pay.

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