How not to have a Putin recession
By Paul Krugman
Kevin McCarthy, the Republican House minority leader, said something cynical and transparently dishonest the other day. To be fair, that’s sort of an evergreen remark; you could have said the same thing about him just about any week over the past few years. But this particular statement seemed important, because it involved a lie that has a direct bearing on how America will respond to Russia’s invasion of Ukraine.
Here’s what McCarthy tweeted: “These are not Putin gas prices. They are President Biden gas prices.”
Now, that’s just false. You can argue about how much responsibility Joe Biden’s policies bear for inflation in other parts of the economy, but the rising price of gasoline reflects the rising world price of crude oil, which hasn’t been significantly affected by anything Biden has done. And soaring crude prices have caused prices at the pump to surge in nations around the world, indeed by roughly the same amount. That is, these really are Putin gas prices.
Why does this matter? Aside from the crassness of McCarthy’s attempt to blame Biden for something that really, truly isn’t his fault, there’s an important economic issue here.
Like it or not, the world is facing a Putin shock: a surge in the prices of oil and other commodities as a consequence both of Russian aggression and of the West’s retaliation with economic sanctions. But will the Putin shock lead to a recession (outside Russia itself, which is probably facing a near-depression)?
The answer is that it doesn’t have to; we can avoid having a Putin recession. Whether we do depends on our policy response. And to get this response right, we’ll need to be clearheaded about the nature of the problem.
This isn’t the first time we’ve faced a surge in oil prices driven by events outside the United States. The famous examples are the price surges after the 1973 Yom Kippur War and the 1979 Iranian revolution, but there are other big examples, such as the price surge of 2010-2011 as the world economy recovered from the 2008 financial crisis. That surge, by the way, raised gasoline prices very sharply; relative to the average worker’s wages, they hit a peak equivalent to more than $5 a gallon today.
The broader economic consequences of those earlier shocks, however, varied considerably. The oil shocks of the 1970s were followed by severe U.S. recessions; the 2010-11 shock didn’t derail the ongoing economic recovery at all. What was different?
Way back in 1997 Ben Bernanke, Mark Gertler and Mark Watson published a classic analysis of the effects of oil price surges on the U.S. economy. They concluded that the recessions that often followed oil shocks mainly reflected “the endogenous monetary policy response.” In English (more or less), recessions happened not because oil prices went up, but because the Fed, fearing a wage-price spiral, responded to rising oil prices by sharply raising interest rates.
And that’s precisely what didn’t happen in 2010-2011. Despite intense pressure from Republicans who warned that the dollar was being debased, Bernanke — by then the chairman of the Fed — and his colleagues stayed the course, keeping rates low. And the Fed’s refusal to hike rates was vindicated by events: Gas prices leveled off, inflation didn’t take off, and the economy continued to grow.
What does that experience tell us about the current situation? If U.S. inflation were low, the right policy would be obvious: don’t raise interest rates. Unfortunately, we’ve come into the Putin shock with uncomfortably high inflation. And while I’m usually a dove on such matters, I do believe that the Fed should be taking its foot off the gas pedal. That is, it should be gradually raising interest rates to cool off an economy that looks somewhat overheated.
What the Fed should not do, however, is allow itself to be bullied into slamming on the brakes, drastically raising interest rates the way it did in the 1970s.
Rising oil prices will lead to some big inflation numbers over the next few months, and there will be a lot of pressure on the Fed to overreact. Some of this pressure will be coming from people like McCarthy, who insist in the teeth of the facts that high gasoline prices are being caused by domestic policy choices. Some of it will be coming from permahawks, in whose minds we’re always about to see a reboot of that ’70s show.
But 2022 isn’t 1979. Current inflation is high, as are expectations of inflation over the next year, but medium-term expectations of inflation haven’t gone up much and are nowhere near their levels circa 1980. This suggests that inflation isn’t getting entrenched in the economy. If the economy cools off a bit and the inflationary shock from oil prices is, as I expect it to be, a one-off affair, we’ll do OK if the Fed just keeps calm and carries on.
Could I be wrong? Of course. But consider the costs of being wrong in the opposite direction and slamming on the brakes unnecessarily. Right now, it looks as if steady policy can keep the Putin shock from turning into the Putin recession. And that’s the result we want to achieve if at all possible.