Rising prices and the Fed’s efforts to combat them have put the economy in a difficult situation. A recession is looming if the global economy doesn’t catch a few breaks in the form of unblocked supply chains, additional oil and gas production or a deal to allow Ukraine to export more wheat.
Like most problems, inflation is easier to solve in advance. The causes of today’s rising prices are not necessarily avoidable, but it is possible, even easy, to imagine that the US economy is in a better position to deal with this pressure. When historians assess US economic policy in the 2010s, they will see a decade of missed opportunities.
For example, if gas prices are the main issue today, wouldn’t it be better if the United States decarbonized its economy more quickly? If rent is a major contributor to inflation, wouldn’t more houses help bring it down? If the supply chain is blocked, would deeper ports and better airports help?
Looking back on policy debates over the past decade, it is increasingly clear that the decision to let public investment fall to its lowest level since World War II between 2014 and 2020 was a major mistake. The “jobless recovery” after the 2008 financial crisis left the Federal Reserve to hold interest rates near zero for five years before the slow rise began. These low interest rates have made public investment even more attractive than it might otherwise be.
We knew it at the time
It was clear at the time: Then-Federal Reserve Chairman Ben Bernanke repeatedly urged Congress to step up productive investment. In 2013, he complained about “strong headwinds created by federal fiscal policy” and urged Congress to show less restraint. Economist Larry Summers, who has become an inflation hawk, also called for more investment to combat “secular stagnation”, the idea that companies would not continue to invest if they saw little prospect of growth. Instead, spending limits were imposed as Republicans rejected the bulk of the Obama administration’s investment proposals, even against the backdrop of a bipartisan deficit-cutting deal. Ironically, the specter of inflation was often cited as the reason for these decisions even though the risk was low.
In retrospect, it was clearly the wrong choice and a missed opportunity. It’s not just that interest rates were low; it is Why they were weak: there was a downturn in the economy, with workers and potential capital sitting on the sidelines waiting to be mobilised. If they had combined to build useful things – deeper ports, public transport and housing, more tracks, bridges, pandemic response plans, electric vehicle chargers, solar and wind power plants – it is quite possible that our inflation problem is more manageable. These things would be just as useful if we built them today, but they will cost more due to rising prices of goods and labor, in addition to financing costs.
Public investment decisions are closely monitored by the private sector. Consider the American housing saga. Today, there are not enough houses for all the people who want to buy them. After the 2008 mortgage crisis devastated the homebuilding industry, skilled tradespeople left the industry and new ones did not join. The companies themselves, seeing the same economic indicators as everyone else, planned more conservatively and built less. Their timber industry suppliers have also cut spending. And then, when the demand for homes exploded, the industry simply couldn’t build more.
This dynamic has manifested itself in the choices that companies have made in all sectors. Oil refiners failed to increase production capacity in an environment of low growth and predictions of a carbon-free future. But green power hasn’t filled the gap, and gas prices have skyrocketed without additional capacity.
Would more spending during this period have caused interest rates to rise sooner? No doubt, but that would have been a sign of a healthier economy. It now seems clear that there was fiscal space for significant investments before the pandemic, which would have allowed the country and the Fed to better prepare for a crisis.
The world still needs more houses, energy, batteries, solar panels and wind turbines
To be clear, the idea of a missed opportunity should not suggest that now is not the right time to invest in infrastructure; capital investments of this type, as Fernanda Nechio, an economist at the SF Federal Reserve Bank, explains, have less impact on inflation than transfer payments. But the fact that much of what we would like to spend today was also discussed ten years ago should underline how much time has been wasted.
Some political analysts argue that interest rates are not such a big factor in the cost of US infrastructure. For example, Eli Dourado, a research fellow at Utah State University’s Center for Growth and Opportunity, says the priority should be to bring high construction costs in the United States in line with those in other countries.
The issue of US state capacity is real and needs to be addressed, but it bears remembering that the same logic has been deployed as an excuse for not investing. There is no need to oppose the two concepts to each other. Indeed, if it were simple to reduce the costs of an American project by 10 times, as Dourado uses in an illustrative example, we would have done it – and we should try again. But the reality is that breaking free from consultants, regulations and other cost drivers is not politically simple and only underscores the value of cheap financing. Indeed, public investment can be a tool for deregulation.
And politics matters here. Many officials who shaped American policy over the previous decade thought they were responsible, but instead wasted a chance to make the country and economy more resilient. The lesson of post-pandemic economics is that real assets matter as much as financial conditions. Consider point made by financial journalist Matt Klein, who notes that European policymakers cited the adage “fix the roof while the sun is shining” as they worked to reduce debt after the financial crisis. These countries are in better budgetary situations today, but it does not do them much good because they have not addressed the issue of energy dependence on Russia. Now they may be able to borrow more responsibly, but the natural gas ports and wind farms they want to build now will take much longer due to the scarcity of key materials and labor. .
This same principle applies more broadly: the United States has real material needs that could be met with better transportation, energy and housing infrastructure. It would have been better to build now than not to build at all, but it would have been better to have started building five years ago.