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The Federal Reserve's war on inflation doesn't have to cause severe economic pain – but there's a risk the central bank will trigger more shocks like the recent banking debacle, according to Paul Krugman.
"I'm in the camp that believes that bringing inflation down doesn't have to be very costly," the Nobel Prize-winning economist wrote in a New York Times op-ed published on Thursday.
"But I'm very worried about the problem of sticking the landing in the face of huge uncertainty about the current state of the economy, possible future shocks like debt default or more Covid dislocations, and the often delayed effects of policies designed to fight inflation," he added. "For example, are interest rate hikes precipitating a bank crisis?"
The Fed has raised interest rates from nearly zero to upwards of 5% since spring last year in a bid to tame soaring prices.
Inflation has started to move towards the Fed's 2% target – and the US labor market has remained surprisingly resilient, with the economy adding 253,000 jobs in April per the latest employment report.
But there have been signs elsewhere that the Fed's tightening campaign is causing turmoil.
Most notably, Silicon Valley Bank collapsed in March after it disclosed significant losses on its bond portfolio, leading to customers rapidly pulling their deposits. Higher interest rates flow through into larger bond yields, which are inversely correlated to prices.
Krugman flagged two reasons he's worried about further shocks, even though he thinks a so-called "soft landing" scenario – when inflation falls to 2% without a rapid rise in unemployment – is still possible.
"First, inflation may have a lot of inertia, making it hard to slow," he wrote.
"Second, the tools we normally use to control inflation are blunt and imprecise, creating a high probability that we'll get it wrong one way or another," he added.
