When Inflation Meets a War

Originally published in the New York Times.

While the extraordinarily strict sanctions imposed on Russia constitute an admirable policy response to its appalling invasion of Ukraine, we should not be complacent about the potential boomerang effect on the global economy.

The shunning of Russian petroleum has already caused oil prices to jump. Prices of corn and wheat, major exports of both Russia and Ukraine, have been soaring — in the case of wheat, to levels not seen since 2008.

That comes as we already endure the highest inflation in 40 years. Last Thursday, the Labor Department reported that prices in February were 7.9 percent higher than a year ago, an acceleration from the previous month.

More inflation likely means slower growth. On the demand side, the bite of inflation will leave households with less money to spend. On the supply side, already stretched supply lines will be further challenged by repercussions from the war in Ukraine.

This week, the Federal Reserve, our principal inflation-fighting body, will meet to try to navigate the conflicting challenges of slower growth and rising inflation, a combination that can easily become stagflation.

Before Russia invaded Ukraine, our immediate economic problem was inflation. A combination of excessive stimulus — from overly large fiscal rescue packages and overly expansive monetary policy — and pent-up demand from Americans unable to spend during the pandemic stoked a rush of consumer buying. Facing their own virus-related difficulties, supply lines have been unable to cope with the surge in demand, leading to shortages that added to the inflationary pressures.

In addition to energy and food, Russia and Ukraine supply significant amounts of important materials and components for manufacturing. For example, roughly 40 percent of the world’s palladium (used in catalytic converters in cars) comes from Russia and 70 percent of the world’s neon (central to the production of semiconductors) comes from Ukraine.

And as we learned during Covid, an inability to source even one small part can hurt a company’s ability to manufacture its product. By inhibiting production, supply-chain problems inhibit growth.

The Federal Reserve now faces its most significant policy dilemma since our last bout of inflation four decades ago. In managing other recent crises, like the Sept. 11 attacks and Covid, quiescent prices allowed the central bank to cut rates to offset disruptions.

Now, as the Fed chair, Jerome Powell, acknowledged this month, “We’re going to see upward pressure on inflation at least for a while.” That pressure has led economists to begin reducing their growth forecasts, creating the Fed’s dilemma.

If the Fed leans toward taming inflation, we face higher interest rates, slower growth and even recession. Holding back on increasing interest rates risks inflation remaining high or even accelerating.

The Fed has already signaled that it will proceed cautiously at its meeting this week, raising interest rates but likely by only a quarter of a percentage point. Before the invasion, many inflation worriers, including me, were hoping for a half point increase to attack rising prices more forcefully.

How the Fed juggles the competing goals of lower inflation and steady growth will almost surely define Mr. Powell’s legacy.

The Fed is one of our most effective governmental institutions and Mr. Powell has been a dedicated and thoughtful chairman. But with respect to the inflation of the past year or so, the Fed — to put it plainly — blew it, sticking firmly to “team transitory,” which expected smaller price rises that would quickly ebb. Mr. Powell acknowledged as much earlier this month. “Hindsight says we should have moved earlier,” he told Congress.

When it comes to tackling inflation, the Fed is, for all practical purposes, the only game in town. Nonetheless, eager to show engagement, the White House has taken a few small-bore steps, like releasing oil from our strategic petroleum reserve and jawboning companies not to raise prices. But these are charades, designed to shore up President Biden’s flagging approval ratings. None holds the prospect of a measurable impact on inflation in the near term.

That will be up to the Fed. My vote would be for the Fed to move robustly to tame inflation.

I’ve seen extreme inflation. As a young New York Times reporter, I was among those who were summoned at short notice on a beautiful fall Saturday in Washington to the vast (but elegant) board room in the Fed’s Eccles building.

With no foreshadowing, we were given a fact sheet that outlined the most dramatic change in monetary policy in modern times, and then the Fed chair at the time, Paul Volcker, addressed in his direct manner the clamor of questions surrounding the Fed’s fearsome new approach to tackling runaway inflation.

I don’t anticipate that we will have a repetition of the 1970s. Happily, nor do most measures of expected inflation. It’s the Fed’s job to ensure that these expectations don’t change and that will require steady and significant interest rate increases and a shrinking of the Fed’s balance sheet, engorged during Covid by trillions of dollars of bond buying.

Slower growth, weak stock markets, a tougher housing market, stagflation and possibly a recession may be on the horizon. But that is the price we must pay for bad fiscal and monetary policies as well as a meritorious effort to keep Ukraine from Russian domination.