- Paul Krugman sees a housing-market slump and a drop in exports hitting the US economy over time.
- The Nobel laureate said the Fed has likely raised interest rates high enough to crush inflation.
- Krugman warned further rate hikes and a stronger dollar could destabilize the financial system.
The US economy is set to suffer a painful housing-market downturn and a material drop in exports, and that likely means the Federal Reserve has already done enough to conquer inflation, Paul Krugman has said.
The central bank has rapidly raised interest rates this year in response to the rate of price rises hitting 40-year highs.
Krugman, a Nobel Prize-winning economist, outlined in a recent New York Times column how higher interest rates weigh on demand for housing, as they pass through into higher rates for mortgage borrowing. That leads to less construction, people in that industry spending less, and eventually the wider economy slowing down.
While building-permit applications have dropped off, construction employment hasn’t started shrinking yet — probably because there’s a backlog of housing projects that were started before rates rose, Krugman said.
As a result, he doesn’t expect higher rates to tank home prices and housing demand any time soon.
“The wider economic effects of the coming housing slump are still many months away,” he said.
Krugman also emphasized that the US dollar’s surge to a 20-year high this year has made American exports less competitive and imports more affordable, and that represents a headwind for domestic growth.
“Falling exports and rising imports will eventually be a major economic drag,” he said. “But it takes time to shift to new suppliers, so this effect won’t really happen until next year.”
Krugman laid out a couple of other reasons why he sees inflation waning. For one, he pointed to flagging demand for apartments, as rent growth is a key driver of price increases.
He also noted that trans-Pacific shipping costs have plummeted from about $21,000 a container in September 2021, to around $2,300 today. That suggests the supply chain disruptions during the pandemic, which sparked widespread shortages and fueled inflation, are clearing up, he said.
“I’d argue that these indicators tell us that the Fed has already done enough to ensure a big decline in inflation — but also, all too possibly, a recession,” he said.
The Fed’s hikes have lifted rates from near zero in March to upwards of 3%, and the aggressive policy has fanned fears it has overreacted to inflation and will tank the US economy.
In his column, Krugman underscored the mounting risk of a banking crisis or market meltdown, citing Britain’s recent government-bond fiasco as an example of the kind of chaos that rapid rate hikes and a powerful dollar could cause.
“We don’t want to let financial markets dictate the Fed’s policy, but that doesn’t mean it should ignore financial dangers,” he said.
The Nobel laureate’s view is that the Fed could go overboard in fighting inflation, as its rate hikes so far haven’t taken full effect and the inflation data it tracks lags reality. He doubled down on that stance in a Twitter thread on Saturday.
“Never mind what inflation and jobs data are saying right now; there’s a lot of reduction in inflationary pressures — and a lot of drag on output and employment — already in the pipeline,” he said. “Do you really think we’ve seen anything like the full effects of the financial tightening that has already happened?”
“I see a strong case that the Fed has already done enough,” he added. “You want to shoot ahead of a moving target, not behind it.”