OPINION:
As the Federal Reserve begins the Kevin Warsh era, combating inflation — not unemployment — in a more hostile world will be the chair’s toughest challenge.
With slower indigenous population growth, baby boomers motivated to retire earlier by artificial intelligence and President Trump’s limits on immigration, the number of jobs the economy must create to cruise near full employment has fallen.
In the summer of 2023, the unemployment rate bottomed out at 3.5%, yet the Biden economy added an average of 127,000 jobs in its final 15 months.
Since Mr. Trump’s return, monthly jobs growth has slowed to 26,000, but unemployment is hardly excessive.
Assisting the unemployed, whose skills often do not match shifting workplace requirements, is a task better suited to state vocational education and federal apprenticeship programs than Fed interest rate policies.
Federal deficits are out of control.
Since 2016, the combination of rising healthcare costs and pressures from other entitlement programs, President Biden’s infrastructure program, industrial policies and Mr. Trump’s tax cuts has driven the federal funding gap from 2.9% of gross domestic product in 2016 to nearly 6%.
Now, Mr. Trump wants to increase defense spending by $1.5 trillion over several years, but he has said nothing about new taxes to finance it.
With the odds favoring Democratic control of the House in 2027 and perhaps the Senate, pressure to increase Obamacare health insurance subsidies and other social spending is likely to grow. Without control of the White House until at least 2029, the Democrats will not be in a position to impose large new taxes.
The federal deficit could swell to 7% of GDP, and the Fed will be under increasing pressure to accommodate this by buying more Treasurys and federally sponsored mortgage-backed securities.
Annual U.S. borrowing abroad and inward foreign direct investment, which permit Americans to spend more than we produce, have increased from about 2% of GDP in 2016 to nearly 4%, but even that has not been enough.
The Fed has financed significant portions of the federal debt by printing money to purchase Treasurys and mortgage-backed securities. Its balance sheet has swelled from $4.5 trillion in 2016 to $6.7 trillion.
Mr. Trump may be more vocal, but presidents almost always prefer that the Fed keep interest rates down.
These combined pressures limit the Fed’s independence to control the money supply to lower inflation to its 2% target.
Globalization is mutating.
Even as nations become more protectionist, international trade volume continues to grow.
Instead, the lessons of China’s grasp on rare earth minerals, the U.S. control of high-end microprocessors, and the impacts of the Persian Gulf closure on global fertilizer, aluminum, helium, plastics and petroleum supplies motivate governments and businesses to focus more on resilience in forging international commerce and less on efficiency.
Such caution is inherently more inflationary.
Whereas globalization, which integrated China into supply chains from the 1990s to the pre-COVID-19 era, drove down prices, new national economic and security arrangements will push prices the other way.
For the Fed, that is not something it can influence; it is simply a fact of life.
In the post-American-led international system, with its breakdown of traditional alliances such as NATO and security arrangements in the Pacific, the United States will throw less weight, and its debt will become less attractive.
With China gaining dominance in green industries, gas and electric automobiles, drones and now, perhaps, pharmaceuticals and the United States more likely to disrupt than stabilize international financial and trade arrangements, yuan-denominated securities will become more attractive. Dollar-denominated government and corporate debt will become a less compelling choice.
The U.S. dollar may remain the coin of the realm in international commerce and a convenient place for businesses engaged in cross-border transactions to store value, but foreign central banks will continue to reduce the weight of dollar-denominated holdings in their currency reserve portfolios. Private investors, expecting more U.S. inflation, will demand higher interest rates.
In turn, those will create more, not less, pressure on the Fed to buy Treasurys and other federal government-backed securities to hold interest rates at attractive levels.
Pressures from other asset markets also come into play.
With incomes, wealth and consumer spending increasingly concentrated among the top 20% of households and seniors in retirement, and those groups more dependent on capital gains for income, maintaining stock market valuations becomes more central to sustaining economic growth and employment.
The Fed can ill afford interest rate volatility that may upset share values for publicly traded companies or the estimated worth of privately held businesses.
All these culminate in pressure on the Fed to print more money.
During the two decades before COVID-19, consumer price inflation averaged 2.1%. Since the shutdowns ended, inflation has averaged well above the Fed’s 2% target.
If we are lucky, that is the new normal. Barring an economic crash, inflation near or just above 3% is likely.
• Peter Morici is an economist and emeritus business professor at the University of Maryland, and a national columnist.
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