Recession or Inflation?

On Match 15 I was doing my usual thing. I was reading the Wall Street Journal online and perusing the New York Times free online summary. No, I will not pay for a full subscription to the NYT. That would be like me ordering Bananas Foster when I am allergic to bananas. 

Anyway, I loved the stark contrast. While I could not read Paul Krugman's whole article in the NYT, its title was enough to send the message  -- "We can avoid a Putin recession in the U.S. — if the Federal Reserve doesn't overreact to rising oil prices." Got it? The Fed should not be worried about rising oil prices. It should not cause a recession. It should not tighten monetary policy.

Meanwhile, the WSJ was writing the opposite. "Let's Start Raising Interest Rates" was the title their article. I was able to read that article. 

It is worth writing about this here since this is a classic battle between left and right macroeconomics. The right wants to put out inflation flames. The left worries more about a recession. 

If you know me at all, you know that I side with the righties. I think history is on my side but let's go through this one more time. Krugman is right on one score. Monetary or macro policy is not effective against rising  prices of one or even a few commodities. Macroeconomics teaches the difference between problems that start from microeconomic sources and those that are macro. 

If prices of cigars rise, this is because there is an imbalance between the supply and demand for cigars. We don't bother monetary policy about that. Using monetary policy to attack the price increases of cigars or energy, might be effective but it is overkill. 

So Krugman is right when he says monetary policy is not the best tool to fight energy prices. But as usual, Paul Krugman can be right about one thing but wrong about the right thing. Krugman's past reveals that his real passion is about unemployment rising in a recession. He loves using inflation as his cover, but that's just a game. Ask Paul Krugman. He is more concerned about unemployment. That's his goal. 

But that is exactly the problem. How can one argue about reducing the misery caused by high and rising unemployment? Anyone who ever had a heart (isn't that the words to a song?) has to care and do something about unemployment. No argument there. 

The issue is what to do about a recession and rising unemployment -- especially during a time period when inflation is rising. Yikes -- two problems -- rising inflation AND rising unemployment! 

That's the quagmire. Its a deep quagmire because the usual tools of macroeconomic policy will improve one at the expense of the other. Krugman wants lower unemployment. Good man! But wait -- if we use monetary or fiscal policy to expand spending in the economy that will raise output and employment. Case closed. Nope. 

If there is already high and/or rising inflation and you use policy to expand spending even more, then it will make inflation go higher. Cool. Employment is higher and the cost you pay is higher inflation. 

That's bad enough since no one loves paying higher prices, but the story doesn't end there. Higher inflation and higher expected future inflation drive up wages and many other costs paid by companies. In other words, higher inflation will lead to conditions of lower profits and firms will cut back. They will cut back on output and employment because conditions are poor for earning profits. Got it? Fighting unemployment means unemployment goes down and then it goes back up. Yikes. It's a policy boomerang. 

What did Krugman say about the boomerang in his recent article? Nada. He wants to help folks by expanding the economy and jobs. But what he doesn't say is that doing that in inflationary times just won't work. I won't bore you with the 1970s stagflations -- but history is there for you, me, and Paul to read. 

What do we do when inflation and unemployment are increasing at the same time? First, realize that the idiots running our national policy never should have got us into that place to begin with. Second, fight the inflation, tolerate rising unemployment, and then watch as both problems improve. Third, use something called supply-side policy. I am at my word limit so I won't open up the supply-side can of worms today.