Joseph Stiglitz says central banks were ‘foolish’ to lift interest rates so high

Visiting Nobel laureate and former chief economist of the World Bank Joseph Stiglitz says interest rates were hiked too far and too fast in the wake of Covid-19.

Nobel laureate and former chief economist of the World Bank Joseph Stiglitz. Picture: John Feder

As Australia grapples with uncomfortably high inflation, visiting Nobel laureate and former chief economist of the World Bank, Joseph Stiglitz, said central banks led by the US Federal Reserve were “foolish” to lift interest rates as much as they did as inflation soared after Covid-19.

“The consumer price index uses imputed housing costs so if rents go up because of a housing shortage we pretend that cost for everybody has gone up, even though two thirds of Americans own their home,” Mr Stiglitz said. “Our inflation data don’t reflect the real cost of living of people.”

Touring Australia this month to discuss the nation’s growing inequality and the levers available to governments to address it, the best-selling author and Columbia University professor saw no justification for the amount of monetary policy tightening banks delivered in pursuit of somewhat arbitrary inflation goals. In his view, an increase in policy interest rates to long-term “neutral” settings was all that was needed to deal with the “supply shock” caused by the pandemic.

“The central banks needed to normalise but they went well beyond that,” he said. “They increased rates too much and too fast, without much thought about what it would do to our financial system.”

The 81-year-old Mr Stiglitz is a New Keynesian economist and proponent of the Georgist theory of public finance is known for his criticism of globalisation, free-market economists and institutions like the IMF and World Bank. He was chairman of the Council of Economic Advisers under Bill Clinton.

Stiglitz blames the Fed for the collapse of Silicon Valley Bank, which was almost a systemic event.

“The Fed is responsible for the collapse of Silicon Valley Bank and the bailouts of other banks that followed … they were among the biggest bailouts in history,” Mr Stiglitz said. “Their models had not called attention to this … the Fed is not doing a good job.”

The speed and size of tightening by the Fed under Jerome Powell, was a “massive mistake”.

“They should have realised that this inflation was not caused by excess aggregate demand,” he said.

“And if you raise interest rates too far too fast, you’re going to cause stress in the financial system, and you’re going to cause global problems.”

He said the US often ignores the global impact of its monetary policy.

As the US jacked up interest rates after the pandemic, countries all over the world had to rapidly increase their interest rates if they didn’t want large changes to their foreign exchange rates.

“So in some sense, they forced others to raise the rates,” he said.

“We could manage our economy reasonably well because (President) Biden was having a strong fiscal policy through the IRA (Inflation Reduction Act), infrastructure and the chips act … amazing success in fiscal policy, but even Europe didn’t have the fiscal space or will that we had.”

While the Reserve Bank didn’t lift rates as much as its peers, it also “went too far”.

“It was based on the same misdiagnosis that inflation was caused by excess demand,” he said.

“It’s a global problem, global supply chain, global economy, and as those global supply chains get resolved, inflation is coming down, not because of what the central banks are doing, but because they get resolved. It’s part of the success of the market company.

“And then you have the special problem of higher interest rates exacerbating the housing crisis.”

A standard market response is to “try to encourage more housing when you have high rent”.

But high interest rates are a “barrier to relieving the supply shortage”.

NAB economists have said that whereas Australia housing starts are trending around 100,000 per annum, the nation actually needs to build something in the region of 240,000 houses per annum to fix its current housing crisis.

“It may be that you need a more active government housing program for a variety of reasons,” Mr Stiglitz said. “Sometimes markets are very slow to respond. Some countries have had very successful public housing programs, and if over a long period of time the private market doesn’t respond, I think one has to think of other solutions.”

Mr Stiglitz also sees “nothing magic” about 2 or 2-3 per cent inflation targets of central banks.

“That was pulled out of thin air, with no research,” he said.

“Economic research now is very supportive that in the context of a world with major restructuring, somewhat higher inflation is actually helpful in facilitating restructuring, because you can get larger changes in relative prices given the downward nominal rigidities.

“The (inflation) target is made up, and there is no basis for saying you ought to get there quickly.

“The point that we need to worry about is that you have a wage price spiral that gets out of control. As far as I know, no advanced country has that kind of dynamics, so there’s no reason to be particularly anxious, and as I say, this is a case where higher interest rates actually makes one of the central components of inflation – housing – worse.

“It’s not only not the solution, it’s actually exacerbating the problem.”

Mr Stiglitz warned of a “tendency of central banks to contribute to inequality without thinking about it”.

“In the pandemic, prices rose faster than wages, so real wages fell. As soon as central banks saw wages start to increase, they started tightening … but that’s like saying wages shouldn’t catch up with where they should have been to keep up with inflation. So it’s a downward ratchet of real wages.

“Their policies are committed to making real wages lower and hurting workers.”

He argues that Fed chair Powell has been “totally wrong” about the level of US unemployment that was needed to lower inflation back to the Fed’s target levels.

“If you are worried about wages, better to increase the supply of labour by getting women in the labour force, by having better childcare, better family leave policy … I don’t think you’re (Australia) as bad as we (the US) are,” Mr Stiglitz said.

“That is the natural, direct positive policy, rather than a policy of seeing how much I (central banks) could hurt workers.”