Bret Stephens thinks that a decade of artificially low interest rates has led to asset inflation, and that the Fed will cause a nasty recession by raising rates in response to the current wave of inflation. Is he right?
Yes and no. Consider the following:
- Interest rates over the last decade were not artificially low; they reflected a period of unusually low inflation, which was caused by all of the factors I call the dollar store economy: globalization; technological change; free trade; loss of union power; and regressive tax cuts. Why would you increase rates when you can’t even meet your inflation targets?
- On a similar note, asset inflation was caused less by low rates than by the lack of other investment opportunities in the dollar store economy.
- But I worry that Stephens is right about the Fed causing a recession by raising rates in 2022. I have argued on several occasions that the current economy is hooked on low rates. Both the stock and the bond markets will tumble if rates go up, and the cost of financing the government will increase significantly. That is why it is important for the Fed to avoid overreacting to today’s inflation; it should rely more on rhetoric than action in order to prevent an unnecessary recession.