Is a Recession the Only Way to Stop Inflation?

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On Tuesday, news broke that inflation continued to worsen in March, as consumer prices rose by 8.5 percent from a year earlier, the sharpest increase since 1981. While so-called core inflation — which strips out the volatile prices of fuel and food, both of which have surged because of Russia’s invasion of Ukraine — did decelerate since February, workers’ real wages are still eroding. If expectations of high inflation become entrenched, some economists worry that prices could spiral out of control.

The Federal Reserve is hoping to avoid that scenario by increasing short-term interest rates, which officials project will rise by 1.9 percentage points by the end of the year.

But this cure, if it works, may come with severe side effects. Higher interest rates drive down inflation by making debt of all kinds, from mortgages to car and business loans, more expensive. For the same reason, they can also drive up unemployment and trigger an economic downturn. In fact, for the nine instances since 1961 when the Fed raised rates to combat inflation, recessions followed all but one, according to research from the investment bank Piper Sandler.

Doubtless aware of that track record, Jerome Powell, the Federal Reserve chair, has said he is aiming to engineer a “soft landing”: a gradual slowing of economic activity that helps curb surging prices without endangering the recovery. But is the central bank on the right path to achieve such a rare feat? And what other factors outside its control might affect the U.S. economic outlook? Here’s what people are saying.

‘The Fed Can’t Save Us’

As the Times columnist Paul Krugman explains, there are, broadly speaking, two schools of thought about the causes of the current bout of inflation: The first school, “the Overheaters,” blames the raft of pandemic stimulus measures, such as the CARES Act and the American Rescue Plan, for pushing demand beyond the economy’s productive capacity. The second school, “the Skewers,” sees inflation primarily as a result of a pandemic-induced shift in consumer spending from services to goods, which occurred just as supply chains and labor markets were disrupted.

Perhaps the strongest argument against the Overheater hypothesis is that prices are also rising rapidly in other countries that responded to the pandemic with very different macroeconomic policies, as John Cassidy notes in The New Yorker. Last month, inflation in the eurozone reached 7.5 percent, not far below the U.S. rate. “In Europe, they didn’t do the big stimulus that we did, but the inflation is now almost as high as ours,” Austan Goolsbee, an economist at the University of Chicago, told him. “It’s a global phenomenon. It’s not primarily coming from U.S. stimulus.”

If supply-side disruptions are primarily to blame, interest rates increases could prove a flawed solution.

  • Powell has warned that the labor market is tight to “an unhealthy level,” citing the fact that there are about 1.8 job openings per person looking for work. But “rate hikes alone can’t increase the supply of workers or assuage people’s fears of getting sick from Covid,” Rachel Siegel writes in The Washington Post. “They can’t provide child care for working parents, change immigration policy or entice early retirees — some 2.6 million, by some estimates — back into the labor force.”

  • Similarly, interest rate raises cannot unsnarl supply chains, lower gas and food bills or alleviate the housing shortage that is driving up rents. To do that, Eric Levitz writes in a New York magazine post, “The Fed Can’t Save Us,” would require land-use reform and public investment in housing, along with federal action to encourage across-the-board energy production in the short term and renewable energy production in the long term.

“Given our existing balance of power and array of institutions, raising interest rates may be the best anti-inflation tool we’ve got,” Levitz writes. “But that is itself a kind of crisis. We can’t afford to keep relying on policy instruments that are more familiar than effective. The price of complacency is too damn high.”

The case for a hard landing

Perhaps the most prominent member of the Overheater school of thought is Larry Summers, a former economic adviser to President Barack Obama who warned that the country’s pandemic stimulus policies risked “inflationary pressures of a kind we have not seen in a generation.”

Summers still contends that those policies played a key role in driving up prices. But if supply-side problems are the primary culprit, the tools the Biden administration has to remedy them in the short term are limited, he argues, and it’s been reluctant to use those it has. In his view, then, the Fed’s obligation to raise rates remains unchanged.

“It’s not an excuse for inflation to blame it on supply,” he told the Times columnist Ezra Klein on a recent episode of his podcast. “It’s a reality in the environment that you have to deal with. And so the job is to look for measures of overheating and, when you see measures of overheating, to apply restraint.”

Summers has argued that the Fed will need to raise rates to 4 or even 5 percent to curb inflation — a far more aggressive increase than officials now appear to be considering. The consequences of such a tight monetary policy, he acknowledges, could be painful, resulting in the kind of hard landing that Powell is seeking to avoid. “I think the likelihood is that we will not return to 2 percent inflation without having at least a mild recession,” Summers told Klein.

But if the Fed doesn’t rein in inflation now, some worry that it could become self-perpetuating. “If consumers and businesses anticipated rapid price increases year after year, that would be a troubling sign,” The Times’s Jeanna Smialek writes. “Such expectations could become self-fulfilling if companies felt comfortable raising prices and consumers accepted those higher costs but asked for bigger paychecks to cover their rising expenses.”

Summers is not alone in thinking that a hard landing would be preferable to the long-term effects of runaway inflation. William Dudley, a former president of the Federal Reserve Bank of New York, has argued that if the Fed had begun raising interest rates last year, inflation could have been reined in without causing a recession. Now, however, he believes one is “virtually inevitable.”

How a soft landing could happen

As The Times’s Ben Casselman reports, a majority of economic forecasters still believe that a recession remains unlikely in the near term. For one thing, there are signs that some goods, like used cars, are already coming down in price. The decline may owe to a delayed buildup of inventory from retailers that overbought earlier in the pandemic, along with a shift in consumer demand back to services.

“This is all good for consumers — prices for freight will come down,” writes Craig Fuller, the chief executive of FreightWaves, a company that specializes in supply-chain analysis. “What were recently inventory shortages are now gluts, and will likely result in price discounts, not increases.”

Even if inflation continues to put a drag on the U.S. economy, many analysts think the economy is strong enough to keep growing, albeit at a slower pace. As Krugman argues, the combination of higher gas and food prices, caused by the Ukraine war, and the Fed’s modest interest rate increases could be enough to slow growth without crippling it.

Aneta Markowska, the chief economist for the investment bank Jefferies, agrees. “It’s easy to construct a very negative narrative, but when you actually look at the magnitude of all those impacts, I don’t think they’re significant enough to push us into a recession in the next 12 months,” she told The Times. “I just don’t see what would cause businesses to do a complete 180 and go from ‘We need to hire all these people and we can’t find them’ to ‘We have to lay people off.’”

One reason for this kind of optimism, as Insider’s Ben Winck explains, is that even with inflation, Americans still enjoy a substantial cushion of corporate profits and household savings built up over the pandemic. Citing an estimate from Bloomberg economists, he notes that Americans collectively hold about $2.5 trillion in excess savings, only about 27 percent of which will go toward paying inflation-associated costs.

“The Fed, then, could be timing its policy pullback just right,” Winck writes. “While Americans feel badly about the economy, they’re still spending big and have boosted savings to draw from. Demand for workers is also at historic levels. Higher rates will dampen the speed of the recovery, but if Powell is right, the Fed is on its way to engineering an extraordinary soft landing, considering the circumstances.”

Do you have a point of view we missed? Email us at [email protected]. Please note your name, age and location in your response, which may be included in the next newsletter.


“Inflation’s 40-Year High” [The New York Times]

“Some Economists Celebrate Biden’s Economy, Even if the Public Doesn’t” [The Washington Post]

“Inflation Is About to Come Down — but Don’t Get Too Excited” [The New York Times]

“How to Engineer a Soft Landing” [Bloomberg]

“Inflation is hurting, but will it last? Between normalization, Putin’s war and China’s Covid shock.” [Chartbook]


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