America Is Giving the World a Stomachache
How the Fed could accidentally break the global economy
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The global economy is a mess, and getting messier. In the past few months, the Federal Reserve has rapidly raised interest rates to stabilize prices. But core inflation, a basket of prices that excludes food and energy, is humming along, and the U.S. labor market is galloping ahead, despite some subtle signs of a slowdown. And even as the Fed fails to tame inflation here, it’s creating other kinds of pain here and around the world.
Those rising interest rates are leading investors to look for dependable rates of return. They’re buying U.S. bonds, which takes U.S. dollars, which is causing other currencies to lose value. In a so-called dollar-doom-loop scenario, countries with cascading currencies fall into recession, which further weakens their currencies against the dollar. All of this has contributed to what the economist Adam Tooze calls a “South Asian Polycrisis,” in which highly indebted countries struggle to pay their creditors and energy prices skyrocket. Other central banks are also raising interest rates to stabilize prices, which could contribute to a coordinated global slowdown. Global market risk is surging, and the United Nations now says a global recession is all but certain.
The Fed might be the single most powerful economic institution in the world. So why has it been more successful at accidentally exporting global mayhem than at purposefully reducing core inflation at home?
Here’s my best attempt to explain what’s going on. Let’s say you have a fever. It’s the highest temperature you can remember seeing on a thermometer in years. You go to your medicine cabinet and find that all you’ve got is Tylenol. So you go full goblin mode on those suckers. After a triple dose of Tylenol, you feel a mild stomachache. But the fever is still getting worse, so you take what you’ve got: more Tylenol. A few hours later, your tummy feels like a pin cushion with a dozen needles jabbing it. But the fever is still raging! So you take another Tylenol, and another …
In this analogy, you’re the Federal Reserve. The fever is U.S. inflation. The medicine cabinet is the Fed’s limited tool kit, and the pills are interest-rate hikes. Around the world, the negative side effects of a mild acetaminophen overdose are taking shape before the positive direct effects of the fever mitigation.
My analogy is a bit overwrought, I admit. But the fundamental point is serious: The Fed’s cabinet really is limited in its offerings. Its tool kit consists of interest-rate hikes, security purchases, and … saying stuff, all rather blunt instruments for a project like reducing domestic demand by increasing the unemployment rate. The U.S. is a service-sector economy, whose largest industries—health care, education, and professional services, such as marketing and media—aren’t sensitive to moderate interest-rate hikes. If interest rates go up by 100 basis points, nobody’s back pain goes away, and children still need to go to school.
So the same way that ibuprofen doesn’t instantly reduce a fever, the effect of interest rates on service employment is somewhat indirect. Let’s say that the Federal Reserve wants to target inflation by weakening the labor market in the booming category of leisure and hospitality. Here’s one way that could work. The Fed raises interest rates, which increases the cost of borrowing money across the economy, which will make it more onerous for companies and households to grow, which will cause high-growth companies to stall, which will create hiring freezes in some sectors, which will reduce total wages by putting some people out of work, which will mean those people have less money to spend at hotels, which will mean fewer bookings at hotels, which will mean hotels have to lay off people, which will mean higher unemployment in the services industry, which will mean less demand among those households, which will contribute to lower inflation.
Doesn’t that sound almost quaintly circuitous? It kind of is. Especially compared with fiscal policy. If a state government decides that the hotel industry is a nuisance, it can quadruple the lodging tax. If it decides hotel clerks are too poor, it can pass legislation to send a check to every household whose adjusted gross income was below the national average last year, and that will basically do the trick. But there is no simple mechanism for the Federal Reserve to commandeer the American travel industry and institute a hiring freeze in hotels.
To be clear, I don’t think the Fed’s policy goals are evil, or unreasonable. If inflation continues unabated, it will devour real wage gains for years. Everything will feel more expensive. Even as your salary rises, your income will fall behind the price of food, apartments, chairs, phones, dinners, and diapers. This is about as desirable as living with an indefinite 103-degree fever.
But right now, the Fed could afford to pull back on its ferocious rate-increase schedule to let the side effects of its fever-reduction strategy play out. Rent inflation, which peaked earlier this year, might not be visible in official government statistics for another quarter. If so, the Fed is further along in its goal to reduce core inflation than today’s numbers suggest. Some fevers take pills, and some take patience.