Food and the Fed

A field of soy beans, left, meets drought-damaged corn in Mead, Neb., Tuesday, July 31, 2012. Soy beans, while distressed, ar
A field of soy beans, left, meets drought-damaged corn in Mead, Neb., Tuesday, July 31, 2012. Soy beans, while distressed, are less sensitive than corn to the drought. The drought covering two-thirds of the continental U.S. had been considered relatively shallow, the product of months without rain, rather than years. But a report last Thursday showed its intensity is rapidly increasing, with 20 percent of the nation now in the two worst stages of drought — up 7 percent from the week before.(AP Photo/Nati Harnik)

The record drought and crop failures will create shortages, especially of corn, and will increase the prices of many foods that either contain the stuff or use it to feed livestock. That, in turn, will cause an uptick in the rate of inflation. And higher prices will give the inflation hawks in the Federal Reserve more ammunition in their insane campaign for higher interest rates.

At the most recent meeting of its policy-setting Open Market Committee, Aug. 7, the Fed declined to lower interest rates further, under pressure from inflation hawks. The vote to keep rates at their present level was only 7-3, with the dissenters favoring tighter money.

But raising interest rates now or any time in the near future would be insane, since the underlying economy remains very weak. Any increase on food prices will reflect heat waves, factory farming, and of course global climate change -- not the price pressures of a recovery.

If you think the Fed would not be so crazy as to tighten money because of a drought, think again. In the 1970s, inflation was the result of price spikes in key sectors -- energy, food, health care, and housing. It was emphatically not the result of macroeconomic overheating, the classic reason for the Fed to damp down the economy with higher interest rates.

The OPEC oil cartel had quadrupled the price of crude oil. The advent of Medicare and Medicaid, without controls on how much doctors and hospitals could charge, cycled through the system in the form of higher prices for health care. Bad harvests in the U.S. and overseas caused food shortages. Rising interest rates, meanwhile, were causing more expensive mortgages -- which translated to higher housing prices.

The solution was to address these price increases at their root causes -- a shift to renewable energy, a more efficient health system, strategies to smooth out farm prices and sustainable agriculture, as well as affordable housing policies -- sectoral strategies, as progressive economists such as Gar Alperovitz and Jeff Faux argued at the time.

But instead, the Fed in that era sent interest rates above 20 percent. That cured inflation all right. It also created the worst recession of the postwar era.

Interestingly too, the perpetrator of these mistaken policies was one Paul A. Volcker, then the chair of the Federal Reserve. Volcker, in his retirement, is something of an improbable hero because he favors much stricter financial regulation than the Obama administration does. He even favors restoration of the Glass-Steagall Act, a wish that President Obama has honored in the breach by naming a watered down version of Glass-Steagall "the Volcker Rule."

But Volcker was no progressive hero then. The crushing interest rates pushed unemployment above 10 percent, and helped elect Ronald Reagan in 1980.

Policymaking back then was also complicated by the fact that in the 1970s, unions and even non-union workers enjoyed "cost of living" clauses in their contracts. Imagine that! (you can still find such clauses -- on display in the Smithsonian). When prices rose 5 percent, so did wages. In a climate of rising inflation, all this created what economists called a "wage-price spiral." Wages chased prices and then prices chased wages. This embedded inflation in the economy.

But those days are long gone. And even back then, many economists urged sectoral strategies to temper the dynamics of the spiral, rather than the blunt instrument of higher interest rates.

The last thing the economy needs now is tighter money. But watch for op-eds and speeches by the inflation hawks pointing to rising food prices and calling for higher interest rates.

It's also clear that the insane weather is a clarion call to get far more serious about global climate change. Readers of my stuff will note that, like columnist Gail Collins on the subject of Mitt Romney's dog-on-the-roof, I never pass up an opportunity to point out that World War II cured the Great Depression; and that today we need massive social investment to cure slumping demand.

Today, that needed investment, rather than going to war, should go to renewable energy, mitigation of the climate damage already done, and other strategies to allow decent living standards at a much lower toll on the planet. The current low interest rates allow government to borrow serious sums to finance these social investments.

What's depressing is that the mainstream debates are over here, and the solutions are over there. While we drag the policies that we need regarding climate change onto center stage, let's at least not make matters worse by raising interest rates.

Robert Kuttner is co-editor of The American Prospect and a senior fellow at Demos. His latest book is A Presidency in Peril.