Nobel laureate Paul Krugman predicts a housing market slump and a drop in exports – and suggests the Fed has already done enough to beat inflation

Nobel laureate Paul Krugman predicts a housing market slump and a drop in exports – and suggests the Fed has already done enough to beat inflation

The U.S. economy faces a painful housing downturn and a significant drop in exports, and that likely means the Federal Reserve has already done enough to beat inflation, Paul Krugman said.

The central bank has raised interest rates quickly this year in response to the rate of price growth hitting 40-year highs.

Krugman, a Nobel laureate in economics, outlined in a recent New York Times column how higher interest rates affect housing demand when they translate into higher mortgage rates. This leads to less construction, people in the industry spend less, and eventually the entire economy slows down.

While building permit applications have fallen, construction employment has not yet begun to decline — likely because there is a backlog of housing projects that were started before the rate hike, Krugman said.

As a result, he doesn’t expect higher rates to eat into home prices and housing demand anytime soon.

“The broader economic impacts of the coming housing slump are still many months away,” he said.

Krugman also pointed out that the US dollar’s surge to a 20-year high this year has made US exports less competitive and imports more affordable, posing a headwind to domestic growth.

“Decreasing exports and rising imports will ultimately be a big drag on the economy,” he said. “However, the transition to new suppliers takes time, so this effect will not really be felt until next year.”

Krugman listed several other reasons why he sees inflation falling. First, he pointed to slackening demand for apartments, as rising rents are a key driver of price growth.

He also noted that trans-Pacific shipping costs have fallen sharply from around $21,000 per container in September 2021 to around $2,300 today. That suggests supply chain disruptions during the pandemic, which created widespread shortages and fueled inflation, are easing, he said.

“I would say that these indicators tell us that the Fed has already done enough to ensure a big drop in inflation — but also, all too likely, a recession,” he said.

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The Fed’s hike lifted rates to more than 3% from near zero in March, and the aggressive policy fueled concerns that it had overreacted to inflation and fueled the US economy.

In his column, Krugman highlighted the growing risk of a banking crisis or market crash, citing the recent fiasco in British government bonds as an example of the kind of chaos that rapid rate hikes and a strong dollar can cause.

“We don’t want to let financial markets dictate Fed policy, but that doesn’t mean it should ignore financial dangers,” he said.

The Nobel laureate’s view is that the Fed could be going overboard in its fight against inflation because its rate hikes so far have not had the full effect and the inflation data it tracks lags behind reality. He doubled down on this attitude Twitter thread On Saturday.

“It doesn’t matter what the inflation and jobs data say right now; a big reduction in inflationary pressures — and a big drag on output and employment — is already in the works,” he said. “Do you really think we’ve seen anything like the full effects of the financial tightening that’s already happened?”

“I see a strong case that the Fed has done enough,” he added. “You want to shoot in front of a moving target, not behind it.

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