Why this isn’t an economic crisis

We're dubbing Foreign Policy's summer 2022 magazine the "Back to the Future" issue because key aspects of global affairs seem like echoes from the past: fears about nuclear war, great-power politics, a new arms race, the return of nonalignment, a food shortage, and so much else.

In one of the essays in the magazine, FP columnist Adam Tooze takes on the perception that inflation is back to where it was in the 1970s. Although the comparison is itself an obvious one to make, Tooze writes that policymakers shouldn't rely too much on lessons from that period.

I spoke with Tooze in an FP Live interview marking the release of FP's print issue. You can watch the full discussion in the video below. What follows is a condensed and edited transcript.

Foreign Policy: Why do you think some of the lessons we've drawn from the 1970s don't accurately apply to the current moment?

Adam Tooze: I think you could look at it and say superficially, "There's a war." There are blockages in the global energy supply system; there's a food price crisis. All of these things look like 1973, frankly, which is the last time we saw this kind of configuration. But what sustains the inflation over the long term, over the entire decade of the '70s, was something that was really outside that picture: class struggle. It has to do with class forces and the balance of power between organized labor, trade unions and employers, and governments around the world in the 1970s.

FP: It's people asking for a welfare state?

AT: Yes, more government spending and higher wages and bargaining between trade unions and employers over how prices and wages will be set—what was called liberal corporatism. All of a sudden, you are granting to interest groups key levers of economic policy. And that is really the heart of what the 1970s crisis was: the fear among many elites around the world that they were losing control of this battle for the entire apparatus of what we've now learned to call neoliberal governance that comes into form in the 1980s and 1990s. And that has long-term consequences. Inequality rises in both the U.K. and the U.S., which are the paradigmatic examples of this kind of policy from the 1980s onwards. And even though we now do have rapid inflation in both the U.S. and the U.K., what we've also seen is real wages falling. And that's hardly surprising because the structure of collective organization—of workers, trade unions, the ability to counterbalance and push back—is hugely reduced compared to where it was in the 1970s. So symptomatically, you could say the current moment in some ways resembles that earlier decade. But if you dig into the social structure, it's radically changed.

FP: There's a part in the essay where you write that "the radical energy of the early Biden administration has largely dissipated." I read into that a tinge of regret.

AT: Yeah. I mean, I identify as a left liberal, and there are a number of structural changes that need to be brought about in the United States if the 21st century is not going to be catastrophic, not just for disadvantaged groups but for American society as a whole. I don't believe that American society can continue to function in a way that I would want without, for instance, adequate family welfare apparatuses. There needs to be an apparatus that enables young American families to survive and prosper and raise their children much better than they do because otherwise, it has catastrophic consequences for society. Every country in Europe has more generous support for young families than the United States.

The Biden program had three wings, right? It was climate and infrastructure plus jobs and family welfare. And that has died over the course of the last 18 months. So, yes, absolutely. It's not just a matter of regret. I think it's a tragedy.

FP: Much of what we're discussing here is mired in politics and polarization. But the other aspect of economic policy is monetary, controlled by central bankers. Have Western central bankers so far approached the current economic crisis in the right way?

AT: I would hesitate to describe our current situation—yet—as a crisis. There was a crisis in 2020 during the COVID shock, and that was the most savage, most rapid, most dramatic, most comprehensive economic shock the world has ever seen. And then what we engineered quite deliberately was the most rapid recovery from such a crisis. What we're now seeing is not a crisis but the most rapid slowdown in growth that we've seen in eight years.

FP: Thanks for saying that. Perhaps I'm channeling popular dissatisfaction with inflation, but you're right, this is not a crisis.

AT: It's not a crisis. America right now has full employment by any conventional standard. But you're absolutely right, if you conduct opinion polls of the American public right now—especially if you take those predisposed to be hostile to the Biden administration—they will be convinced America is in a recession. That's a counterfactual. I mean, it's a remarkable claim. America may slide into a recession.

FP: I think people often conflate slowdowns with recessions, which are, of course, two consecutive quarters of negative growth.

AT: Yes, of course, what they are experiencing, which is very real, is a cost-of-living shock the likes of which we haven't felt for a long time. What they are experiencing is a fall in real wages. And people are feeling that, and it's real pain. It's a very serious situation, no doubt. It's just not a recession or a crisis at this point.

We don't currently have much risk of an implosion in the financial system like we saw in 2008. Why do we know that? We can infer it from the fact that the central banks are pushing interest rates up. If they thought that there was real risk of a financial crisis—in other words, financial institutions failing their balance sheets—they wouldn't be making these moves. The [U.S. Federal Reserve] is raising rates because they see the inflation problem. They feel they need to be seen to be doing something. It may very well cause a slowdown. It already is. And that could produce a recession, but that would be par for the course in terms of containing relatively rapid inflation. It's not unusual to have a recession, but because a recession is defined technically as two quarters of negative growth, and negative growth is rarely large, we still expect 2023 to be a year of overall average growth—just at a slower rate.

We're quite a long way from a crisis. It's much better to describe this as a slowdown.

FP: Much of our discussion so far has essentially been about rich Western countries. What about countries in the global south, where central bankers have less agency to begin with? Inflation tends to be higher anyway, so when it rises, it bites harder and can become rampant more easily. I'm thinking about countries like Sri Lanka, Pakistan, Egypt, and also Argentina and Turkey. How do those countries handle a period of high inflation?

AT: Yes. I mean, they will be advised to do very many of the same things. Their central banks will raise interest rates. They may attempt fiscal tightening. But the problem in countries of the type that we're talking about now is that they have very large populations of people. And as they confront rising costs of living, one of the things that governments will—quite reasonably, I think—attempt to do is either freeze or subsidize prices. The government budget absorbs the difference, and that then produces deficits, which produces pressure on the fiscal side. And that's where the hard trade-offs really begin.

The other shock that these countries will suffer is through the exchange rate. Sri Lanka, for instance, imports almost all its fossil fuels. As the currency devalues, the cost of those rises because you pay in local currency a higher price for your foreign currency imports. And those are the cycles that are really destabilizing.

There are certain advantages, of course, to devaluing your currency. Turkey is a good case of this because it has a powerful export sector. So as the lira falls, their exports surge, and there is an offsetting gain in terms of employment and, therefore, standard of living for people who work in that sector. So it's not all losses from this kind of process, but it's very painful—and much more so in societies with smaller cushions.

FP: I have a subscriber question for you. Glenn C. asks if "expected inflation" is a major driver for eventual inflation, how can anyone predict future inflation?

AT: One of the things that was learned in the 1970s is that if you are managing inflation, what matters even more is managing what economists call "actors." In other words, businesses, trade unions, people who make decisions in the economy, what they expect the future to be. Because depending on that, they will raise their prices or attempt to raise their wages. If you anticipate inflation and then you fail to raise your wages, you're basically writing a big L on your forehead and saying, "I'm going to be a loser."

So when central bankers say they are in the business of controlling inflation, it's literally true that the most important thing they are in the business of is controlling inflationary expectations.

And one of the reasons why I think this is a "keep calm and carry on" kind of moment is that we haven't seen a panic in the bond markets. If people in the bond markets thought there was a real risk of us returning to the 1970s, bonds would be priced very differently from the way they are right now. But what we haven't seen is the sort of tremor that suggests 5 to 10 percent inflation for the next 10 years. It's just not there.

Ravi Agrawal is the editor in chief of Foreign Policy. Twitter: @RaviReports

Disclaimer: This article first appeared on Foreign Policy, and is published by special syndication arrangement.