High US inflation and war are hardly new – so why were leaders caught by surprise?
W atch any sport nowadays, and you will be treated to instant replays that give you a detailed – often slow-motion – view of important moments. Watch the news, and you may find yourself feeling like you are similarly watching the past on playback. But these replays – of high inflation, soaring public debt, a brutal ground war in Europe, a new cold war and the rise of potentially destructive technologies – are far from instant, and the stakes are much higher.
Readers might recall that I predicted rising inflation and slower growth as early as spring 2021. The former US Treasury secretary Larry Summers did so even earlier. Yet the US inflation figures – the worst since the early 1980s – caught most people by surprise.
Supply-chain snarls, including energy-market and food-system disruptions linked to Russia’s war on Ukraine, contributed to the initial surge in prices. But the main driver of inflation has been profligate monetary and fiscal policies, which were upheld despite quicker-than-expected recoveries from pandemic lockdowns.
For example, Joe Biden’s $1.9tn American Rescue Plan, implemented in March 2021, was nearly three timeslarger than the Congressional Budget Office’s estimate of the GDP gap that still needed to be closed for the economy to reach its potential. One cannot but notice the echoes of Lyndon B Johnson’s use of debt to finance the Vietnam war and the “war on poverty” in the late 1960s.
Meanwhile, the US Federal Reserve kept its target interest rate close to zero for too long, and started to unwind its balance sheet too late – an approach that recalls the monetary-policy mistakes it made under Chair Arthur Burns in the 1970s. Central bankers thought that it would not hurt to let inflation run above the 2%
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