After we curb inflation, then what?
We have lost sight of this question over the last year or so, caught up in the drama of a price spiral unprecedented in most of our lifetimes. But whether the Fed has crashed the economy into a recession or still manages to engineer the soft landing, we are likely to emerge from this episode into a difficult economic landscape that presents problems with no straightforward solutions.
It does appear we are on the way out. Investors in bond markets are expecting inflation to moderate in a couple of years. Despite hiccups in China, global supply chains seem to be recovering from the pandemic shock. The Fed is raising rates pretty furiously and the last vestiges of the enormous rounds of fiscal stimulus to demand are waning, trimming personal savings. Job growth is slowing.
The problem is that the new normal will return us to a version of the hole we’ve been in: a morass of shrinking workforces and low investment, stagnant wages and rampant inequality that gummed up prosperity for years.
The critical economic question—where does growth come from?— will get even trickier if energy remains expensive and China stops growing like an emerging market and starts slowing like a developed one.
Unlike bouts of inflation—a problem that the Federal Reserve and other central banks have learned how to deal with by raising the policy interest rate—the post-inflation scenario is hard to diagnose, let alone solve.
Aging is shrinking the size of the labor force, raising dependency rates not only across rich nations but also in China.
This dynamic lies at the heart of many of our misfortunes, stunting economic growth. It is a core driver of so-called “secular stagnation,” which before Covid-19 was considered the main economic challenge of our times: a combination of high savings and lackluster investment that has given us stubbornly low growth alongside stubbornly low inflation and stubbornly low real interest rates.
Stagnation seems likely to stay with us. Olivier Blanchard, former chief economist at the International Monetary Fund, notes how workers expecting to spend longer shares of their longer lives in retirement will spend less and save more. Lower fertility rates push in the same direction, reducing the future workforce relative to the pool of retirees.
It would be tough to solve this puzzle even if everybody agreed on its features. Try as it did to goose the economy by buying up long-term debt, the Fed undershot its inflation targets for years. Growth disappointed for a decade following the financial crisis and interest rates remained at rock bottom.