Cross-posted on my Substack
That’s a quote from Jamie Galbraith in his article, Mainstream Economics’ Medieval Inflation Medicine. Now that inflation is approaching the Fed’s 2% target, the Fed and other supporters of raising interest rates to fight inflation are taking an undeserved victory lap because the Fed raised rates. The past two years have shown that inflation has decreased in spite of rather than because of the rate increases.
Mainstream economists believe raising interest rates will curb inflation because it will create unemployment, which will decrease demand, leading to lower prices. So the underlying theory is you have to cause pain among workers to control inflation. Economic terms thrown around to support this idea, include the “Phillips Curve” and “NAIRU.” The Phillips Curve posits an inverse relationship between inflation and unemployment: If unemployment is low, inflation will increase. This led to the idea of NAIRU: The Non Accelerating Inflation Rate of Unemployment — that there is an “ideal” unemployment rate to minimize inflation risk, which can be traced to Milton Friedman.
The leading proponent of this is Larry Summers, who said in June 2022, we need five years ears of unemployment above five percent to fight inflation. The last 18 months, in which inflation has come down even as unemployment stayed low show the utter folly and cruelty of Summers’ policy.
Galbraith was debunking this since at least 1997, when he wrote: Time to Ditch the NAIRU. More recently, John T. Harvey, and economics professor at TCU known as the “Cowboy Economist” described it this way:
Stop for a second and assume that those pushing this policy don’t have “PhD” after their names. Imagine instead that someone on a street corner is yelling to anyone passing by, “Listen to me, people! Prices are rising and we are all hurting! Demand that your government lower your incomes today!” You’d rush by as quickly as possible, avoiding eye contact and keeping one hand on your wallet. What an idiot: help people afford to put food on the table by depriving them of income? Insanity.
Not only is fighting inflation this way cruel, the past two years have proven it does not work. Galbraith writes:
inflation peaked back in June 2022, only three months after the Fed started hiking interest rates. At that time, the Fed’s policy rate had risen just 75 basis points, and no one knew how much higher it might go. In fact, we have no evidence that monetary policy had any significant effect on the course taken by prices – certainly not before the June 2022 turning point, and not thereafter, either.
And since that turning point, unemployment has remained below four percent. So why has inflation declined?
Because the factors driving the recent inflation were energy prices, supply chain bottlenecks and housing costs, and these have abated through policies of the Biden administration, such as having ports open 24/7, and outside factors such as the easing of the Pandemic and market forces over time.
Raising interest rates brought down inflation in the early ‘80s under Fed Chairman Paul Volcker — but only by raising the rates so much that they caused a deep recession. Economist Stephanie Kelton wrote how this worked in her best-selling The Deficit Myth Modern Monetary Theory and the Birth of the People's Economy":
As the recession took hold, Volcker’s policies sent the US unemployment rate soaring above 10 percent. The rate hikes also intensified crises in Latin America and across the Global South. And yet to this day, Paul Volcker is lionized for having had the “courage” to slay the inflation dragon even as his policies inflicted decades of immense pain, both domestically and across much of the developing world.
Medicine has moved on from bloodletting to penicillin. Mainstream economists like Larry Summers are still dwelling in the dark ages.
