The threat of Trumpflation and a Fed war

INFLATION in the United States is lower than it was a year ago, and substantial economic weakness elsewhere is driving other central banks towards interest-rate cuts. With little empirical basis to believe that US monetary policy is not restrictive, I continue to believe that in 18 months, the Federal Reserve will have wished that it had started cutting rates in January 2024.

If I am right, the US is not headed for a soft-landing path; it is already on the runway, albeit with a monetary policy rudder steering sharply towards contraction, rather than being held in a straight-ahead neutral position. Yet, many commentators and Fed officials continue to believe that interest rates should remain at their relatively high levels, because they are fixated on the 1977-1979 period, when a near-stabilised inflation rate spiralled out of control.

Back then, the Carter administration’s nominal gross domestic product forecast had been dead-on, real growth came in two percentage points low, and inflation came in two percentage points high. Then came the Iranian Revolution and the second major oil-price spike of the decade, leading ultimately to the “neoliberal turn”, the Volcker disinflation (when the Fed hiked rates to 20 per cent), and Latin America’s “lost decade”. To those who worry that history will rhyme, keeping interest rates too high for too long is a risk worth taking.