Kevin McCarthy, Republican Minority Leader in the US House of Representatives, said something cynical and blatantly dishonest the other day. To be fair, this comment is almost always valid; you could say the same thing about him pretty much every week for the last few years. But this particular statement seemed important because it involved a lie that has a direct bearing on how the US will react to Russia’s invasion of Ukraine.
Here’s what McCarthy tweeted: “These are not Putin’s gas prices. These are President Biden’s gas prices.”
Well, that’s just a lie. You can argue how much responsibility Biden’s policies have for inflation elsewhere in the economy, but the rise in the price of gasoline reflects the rising price of oil, which has not been significantly affected by anything Biden has done. And the shot made pump prices go up in countries all over the world, in fact at roughly the same rate. That is, these really are Putin’s gas prices.
Why does it matter? Aside from McCarthy’s clumsy attempt to blame Biden for something that is really, truly not his fault, there is an important economic issue here.
Like it or not, the world is facing a Putin shock: a surge in prices for oil and other commodities as a result of both Russian aggression and the West’s retaliation with economic sanctions. But will the Putin shock lead to a recession (outside Russia itself, which is likely facing a near depression)?
The answer is that this is not mandatory; we can avoid a “Putin Recession”. Whether we do so will depend on our political response. And to get this answer right, we need to have a clear mind about the nature of the problem.
This is not the first time that we have faced a rise in oil prices driven by events outside the US. Famous examples are the increases after the Yom Kippur war in 1973 and the Iranian revolution in 1979, but there are other great examples, such as the 2010-2011 price increase as the world economy was recovering from the 2008 financial crisis. high, incidentally, increased gasoline prices very sharply; relative to the wages of the average worker, peaked at more than $5 a gallon today [cerca de R$ 6,80 por litro].
The broader economic consequences of these earlier shocks, however, varied considerably. The oil shocks of the 1970s were followed by severe recessions in the US; the 2010-11 shock did nothing to detract from the ongoing economic recovery. What was different?
Back in 1997, Ben Bernanke, Mark Gertler and Mark Watson published a classic analysis of the effects of rising oil prices on the US economy. They concluded that the recessions that often accompany oil shocks mainly reflected “the endogenous reaction of monetary policy”. This means (sort of) that recessions happened not because oil prices rose, but because the Fed, fearing a wage and price spiral, reacted to rising oil prices by sharply raising interest rates.
And that’s exactly what didn’t happen in 2010-2011. Despite intense pressure from Republicans who warned that the dollar was being degraded, Bernanke — then Fed chairman — and his colleagues stayed the course, keeping rates low. And the Fed’s refusal to raise interest rates was justified by events: gasoline prices leveled off, inflation didn’t take off, and the economy continued to grow.
What does this experience tell us about the current situation? If US inflation were low, the right policy would be obvious: not raising interest rates. Unfortunately, we entered the Putin shock with uncomfortably high inflation. And while I’m generally positive about these issues, I believe the Fed should be taking its foot off the gas. That is, it should be gradually raising interest rates to cool an economy that seems a little overheated.
What the Fed should not do, however, is allow provocations to slam on the brakes, sharply raising rates as it did in the 1970s.
Rising oil prices will lead to big inflation figures in the coming months, and there will be a lot of pressure on the Fed to react firmly. Some of that pressure will come from people like McCarthy, who insist, contrary to the facts, that high gas prices are being caused by domestic policy choices. Some of that will come from the eternal hawks, in whose minds we’re always about to see a reboot of that ’70s show.
But 2022 is not 1979. Current inflation is high, as are inflation expectations for next year, but medium-term expectations have not risen as much and are nowhere near their circa 1980 levels. it’s not getting embedded in the economy. If the economy cools down a bit and the inflationary shock to oil prices is, as I hope it will be, a one-off issue, we’ll be fine if the Fed just keeps calm and moves on.
Can I be wrong? It is clear. But consider the costs of being wrong in the opposite direction and slamming on the brakes unnecessarily. Right now, it seems that firm policy can prevent the Putin shock from turning into a Putin Recession. And that’s the result we want to achieve, if possible.
