March 15, 2022
With bad news on oil prices, and a new wave of COVID-19 shutdowns in China, the inflation hawks are getting really excited. After all, higher oil prices and further supply disruptions are sure to add to the inflation the economy is already seeing. I guess they were right with their warnings.
Okay, let’s get back to Planet Earth. The large stimulus package that President Biden pushed through last year undoubtedly added to inflation in the economy, but it also quickly got the economy back to something close to full employment. If we had not had a big package, maybe the inflation rate would be a couple points lower, but the unemployment rate might be closer to 5.8 percent, rather than the 3.8 percent reported for February.
The point that many of us keep making is that most of the inflation we have seen over the last year was due to the reopening from the pandemic, not the stimulus package. A simple picture makes this point well. Inflation jumped pretty much everywhere across the OECD.
The rise in the United States was somewhat higher than average, but not hugely so. And countries like Spain and Belgium, which did not have huge stimulus packages, actually have higher rates of inflation.
So, what about the current issue with surging oil prices and new supply disruptions in China? First, the jump in oil prices associated with the war in Ukraine is likely not as bad as previously advertised. The big risk for oil prices was the withdrawal of Russia’s oil from world markets, which could result either from European sanctions or a unilateral decision by Russia to stop exporting its oil.
Neither of these scenarios seems very plausible. Europe doesn’t seem likely to join the U.S. sanctions on Russian oil, but even if it did, Russia’s oil would not disappear from world markets. Russia would look to sell its oil to China, India, and other countries not imposing sanctions. The oil that these countries would have otherwise been importing from Middle East or elsewhere, would instead be available to Europe and the United States.
There clearly would be costs associated with this sort of reshuffling, but nothing close to the costs of losing Russia’s exports of five million barrels a day. The markets seem to have figured this out, as oil prices have plunged by more than thirty dollars from their peak last week.
The other big source of higher inflation is the new round of COVID-19 shutdowns in China. These shutdowns have hit several cities that are major sources of exports of a wide variety of manufactured goods. This will worsen the supply chain problems we have been seeing over the last year. It’s clearly not good news for the economy (and obviously bad news for the people in China getting COVID-19).
Anyhow, the question that all of us, including the Fed, should be asking, is whether these stories would be better if Biden had not boosted the economy and we still had something like a 5.8 percent unemployment rate? It’s hard to see how the answer to that question is yes.
The price of oil is determined on the world market. If Russia’s exports were withdrawn from the market, slightly lower demand from the United States would make very little difference. We still would be looking at a big jump in oil prices.
The same applies to the COVID-19 shutdowns in China. Would the pandemic not be spreading there if Biden hadn’t passed his stimulus package? We would still be facing pretty much the same supply chain problems even if the unemployment rate were 5.8 percent.
In short, the inflation hawks may be enjoying a victory lap, but the facts don’t support their case. We are seeing higher inflation primarily because of factors that have nothing to do with Biden’s stimulus package. We would not be better off if we faced slightly lower inflation with another 3 million people out of work.