- Paul Krugman predicts stubborn inflation will lead to higher interest rates for longer.
- The Nobel Prize-winning economist puts the risk of a US recession at 25%.
Paul Krugman expects nagging inflation to force the Federal Reserve to keep lifting interest rates — but he sees only a slim chance of a US recession.
"Fed rate hikes are not slowing things down the way that people expected they would," the Nobel Prize-winning economist said during a recent question-and-answer session hosted by Macmillan Learning.
"The amount of Fed hiking that it may take to squeeze out the rest of the excess is now looking bigger than it did," Krugman continued. The US central bank might also keep rates elevated for longer than previously expected, he added.
In response to inflation spiking as high as 9.1% last summer, the Fed has lifted its benchmark rate from virtually zero to upwards of 4.5% in the past year. Higher rates can curb price increases by encouraging saving over spending and making borrowing more costly. However, they can also weigh on asset prices and choke demand, sparking an economic downturn.
Krugman said he supports further rate hikes, as the inflation threat hasn't yet receded.
"I might have said different before the last jobs report, which was so strong," he said. "But at this point there really is not much sign of the economy slowing."
The Princeton professor and New York Times columnist warned that if the Fed halts its hikes, investors might embark on an asset-buying spree that worsens inflation pressures.
"If it stopped now, the markets would take that as a signal basically to go out and have a party," he said. "We're probably not ready to have that yet."
Even though Krugman predicted rates would continue climbing, he still deemed a protracted economic downturn unlikely.
"I don't think we're going to have one," he said, putting the probability of a US recession at 25%.
During the conversation, Krugman underscored the difficulty of the challenge facing the Fed.
"They're trying to control heavy machinery in a dark room wearing mittens," he said.
"They don't have fine control, they don't have a very good view of what's going on — so the chance that they'll overshoot and create a recession is definitely there. But it's not looking like a a really overwhelming case anymore."
The Nobel laureate cautioned that if US politicians fail to resolve the debt-ceiling crisis, that could send markets and the economy into a spiral.
"If Treasury bills suddenly cease to be a safe asset because the US government no longer can be counted on to redeem them when they come due, God knows what happens," Krugman said. "We would have a financial meltdown."
"That's scary," he continued. "That's one way to have a recession."
Krugman, who has repeatedly panned bitcoin, also took a jab at the coin and its kin during the Q&A.
"Cryptocurrencies have not become something that people use to a significant degree for real economic transactions, aside from ransoms and illegal stuff," he said.