Former S&P Vice Chairman: "US Inflation Remains Strong, Interest Rates May Not Drop This Year" [Issue Interview]

Interview with Paul Sheard, Former Vice Chairman of S&P Global (Current Senior Research Fellow at Harvard Kennedy School)
Global Inflation Caused by Governments Printing Too Much Money After the Pandemic
Government Debt Has Increased but Not to a Worrying Level
US Inflation Remains, Federal Funds Rate Unlikely to Drop Until Year-End

Paul Sheard, former Vice Chairman of S&P Global (currently Senior Fellow at Harvard Kennedy School)

'Too much money chasing too few goods.'

This is a statement made by Milton Friedman, an American economist known as a defender of the free market economy, explaining the cause of inflation (rising prices).

Since the COVID-19 pandemic, the inflation shock has hit the world hard, and scholars are busy searching for its causes. The main causes of inflation identified by scholars include massive government fiscal spending for economic stimulus after COVID-19, rising energy prices triggered by Russia's invasion of Ukraine, and supply chain restructuring due to conflicts between the U.S. and China.

Recently, the claim that excessive government fiscal spending is the biggest cause of current inflation has gained attention. According to Friedman's explanation, the current inflation is a monetary phenomenon caused by too much money circulating within limited goods.

Paul Sheard, Senior Research Fellow at Harvard Kennedy School (former Vice Chairman of S&P Global), shares a similar view. In a written interview with Asia Economy, Sheard, author of the recently published Korean translation of "The Power of Money," said, "The global inflation shock after the pandemic mainly occurred because governments and central banks injected too much money into the market," adding, "The situation worsened further with Russia's invasion of Ukraine."

He evaluated that the war against inflation is ongoing and is lasting longer than expected. It is not surprising if the market's expected timing for the U.S. Federal Reserve's rate cut is delayed to the end of this year or early next year. He said, "Although the Federal Reserve (Fed) has aggressively raised interest rates, calming inflation somewhat, prices remain at a high level," and added, "It would not be surprising if the Fed's first rate cut occurs at the end of this year or even early next year."

While the market largely expects the Fed to cut interest rates in September, it could be delayed further. The delay in the U.S. rate cut is also affecting South Korea's monetary policy.

Sheard said, "South Korea maintains an open capital market and has a high economic dependence on the U.S., so it is inevitable that U.S. monetary policy has a significant impact."

He also predicted that the strong dollar would continue for some time. He explained, "The status of the dollar as the global reserve currency has risen after the pandemic-induced recession," adding, "The dollar's strength reflects the powerful position of the U.S. economic and financial system and politics in the world today."

He also argued that the controversy over excessive government debt, pointed out mainly in the U.S. due to the large amount of money printed by governments after the pandemic, is misleading. According to the U.S. Congressional Budget Office (CBO), the U.S. federal government debt reached $34.5 trillion as of last month. The government debt-to-GDP ratio exceeded 120%. In comparison, South Korea's ratio was about 55% last year.

Sheard said, "Considering the size of the U.S. economy, which produces $25 trillion per quarter, the government debt is not particularly high," and pointed out, "It is better to worry about inflation caused by excessive money issuance than about the government not being able to repay its debt."

He said that if government debt becomes excessive, the problem can be solved through macroeconomic policies such as monetary policy or fiscal tightening. He emphasized, "If debt grows too large and causes inflation, interest rate hikes and fiscal tightening (spending cuts or tax increases) can be implemented to suppress demand."

Paul Sheard, former Vice Chairman of S&P Global (currently Senior Research Fellow at Harvard Kennedy School) (c) Alice Cherry. Photo by the individual.

Below is a Q&A with Paul Sheard, Senior Research Fellow at Harvard Kennedy School.

- What are the causes of the inflation that has hit the world, and when is the U.S. expected to cut interest rates?

▲ The global inflation shock mainly occurred because governments printed too much money and central banks sharply lowered interest rates after the pandemic. The increased geographic and economic divisions following Russia's invasion of Ukraine worsened the situation. Recently, the Federal Reserve (Fed) has aggressively raised rates, improving inflation significantly, but it still exceeds the Fed's target. The economy remains strong, and the labor market is tight. It would not be surprising if the Fed's first rate cut happens at the end of this year or even early 2025.

- What is the cause of the current global dollar strength, and how long is it expected to continue?

▲ The dollar's strength reflects the powerful position of the U.S. economy, financial system, and politics in the world. Thanks to a large, productive, and innovative economy and sophisticated capital markets, the U.S. dollar serves as the global reserve currency. The strong economic rebound after the pandemic-induced recession is also a cause of the dollar's strength.

- South Korea's interest rates are heavily influenced by the U.S. Federal Reserve's rates. Should this also be seen as the power of the dollar?

▲ If exchange rates cannot be fixed and capital flows freely, it is difficult to maintain control over the currency. This is a well-known result in international economics (Mundell's impossible trinity). If a country like South Korea maintains an open capital account and tries to peg its exchange rate somewhat to the dollar, the autonomy of domestic monetary policy inevitably decreases. The correlation between Korean and U.S. interest rates is likely due to South Korea's high economic dependence on the U.S. and global common factors affecting economic activities in both countries.

- In "The Power of Money," you said there is no need to worry much about government debt. If an unpredictable global economic crisis occurs, wouldn't large government debt become a problem?

▲ Saying there is no need to "worry" about government debt means we need to change our existing mindset. Government debt simply represents the government's accumulated budget deficits and is a different concept from household or personal debt. The government can create money freely, so it cannot run out of money and does not need to repay it. The money created by the government is not a promise to repay but a means to facilitate current economic exchanges and transfer claims on purchasing power and assets into the future. However, inflation triggered by excessive government debt can be problematic.

- Large government debt may not be a problem for the U.S., a reserve currency country, but it could be for small open economies like South Korea. South Korea's government debt-to-GDP ratio was 55% in 2023. Is this considered healthy?

▲ Government debt relative to GDP should be calculated on an annual basis. Therefore, South Korea's 55% government debt ratio means that if the government had to repay all its debt at once, it would take a little more than six months of revenue. For a government with a perpetual concept, this is not a large number.

- You said that if government debt grows too large, the problem can be solved through monetary policy and fiscal tightening. What are the specific methods?

▲ Government debt represents potential purchasing power, and if demand overwhelms the supply capacity of goods and services, inflation can occur. Then, it is necessary to suppress demand through monetary tightening (interest rate hikes) and fiscal tightening (spending cuts or tax increases). The government can raise taxes and reduce spending to generate a budget surplus and reduce debt.

- What is your opinion on the criticism that Modern Monetary Theory (MMT) is the cause of inflation?

▲ There is a claim that the current inflation shock is due to MMT, but this is misleading. MMT should be understood as a collection of ideas and insights about how monetary and fiscal systems work. Inflation is not caused by MMT but can be seen as a policy mistake by governments failing to read the balance of supply and demand after the pandemic.

- You argued that taxing the rich is not a solution to wealth polarization. Do you see other active solutions?

▲ A dynamic market economy and equal distribution of wealth are difficult policies to reconcile. However, the government can alleviate social inequality by investing in education and creating various economic opportunities. Even if the government takes money from a tiny number of the wealthy, it is not enough for the poor. Ultimately, the middle class, not the very rich, will pay to support the poor.

- Could virtual assets revolutionize the existing monetary system?

▲ "Revolution" seems like too strong a word. The possibility of virtual assets replacing sovereign currencies is slim. However, they are expected to play a role in forcibly innovating national currency systems.

- Recently, central banks worldwide have been conducting projects to introduce CBDCs (Central Bank Digital Currencies). What does the research on CBDC introduction signify?

▲ The emergence of virtual assets, including Bitcoin, has sounded an alarm for central banks and monetary authorities. The widespread adoption of CBDCs is a matter of time. As money becomes increasingly digital and virtual asset technology matures and spreads, it is natural for central banks to provide digital currency directly to the public. How to do this while considering the banking system, financial stability, monetary policy decisions, and citizens' privacy rights is a significant challenge for central banks.

This content was produced with the assistance of AI translation services.