Tag: John Horn

On June 16, the Federal Reserve announced it may raise interest rates twice in 2023 in response to higher-than-expected increases in inflation. In his announcement, Fed Chairman Jerome Powell said the higher inflation recorded this year should be temporary, but the risks that it would be “higher and more persistent than we expect” could not be ignored.

John Horn, professor of practice in economics at Olin, agrees with Powell’s overall inflation forecast of 3.4% for 2021. Inflation in some high-demand categories — such as travel, construction material and automobiles — may be even higher, he said.


However, some prices, such as lumber, are already coming back down, providing hope that current inflation is a short-term corrective measure and not a sign of long-term systemic problems.

“The uncertainty for me is how this gets played politically and what messaging gets through,” Horn said.

Inflation, Horn explained, can be a self-fulfilling prophecy. Worry about rising inflation can lead employees to demand higher wages. In order to pay those higher wages, employers raise prices for their products and services, creating actual inflation. The wage-price spiral is a vicious cycle. Likewise, inflation expectations will cause banks to increase interest rates, making it more expensive for businesses and individuals to borrow money.

“It’s important for the Fed to make sure that this is seen as a temporary blip and not systemic. Because if it’s seen as a systemic problem, and inflation expectations take charge, it’s really hard to make it stop,” Horn said. “Once that happens, the only way to stop inflation is to raise the interest rates really high and cause a recession. Maybe not in 2022, but it will be on the Fed’s radar. They will want to stop [rising inflation] sooner than later.”

“However, if prices come down and people see this as a temporary blip related to COVID-19 and the supply chain problems — if that story takes hold — then I’m not worried about inflation,” he added.

What’s driving inflation?

In the simplest terms, inflation occurs when consumer demand increases or supply contracts causing prices to rise. The current economic situation is a little more complicated, in part because both effects are occurring.

“There’s not a clear understanding of what is currently driving inflation, but most people are pointing to a couple of things,” Horn said. “First, as the economy is recovering from COVID and the shutdown, there has been an increase in demand for things people weren’t buying over the last year due to uncertainty about job future or lack of opportunity — like travel and dining out. As demand increases, so do prices. That’s one driver.”

Adding to the problem, many of the fastest growing sectors — including travel and hospitality, entertainment and restaurants — are struggling to find people to fill open jobs. These jobs typically don’t pay the best wages, and some would-be-workers are looking for better opportunities in other industries. Lack of child care and fears over COVID-19 exposure also are keeping former employees from returning, Horn said.

Another contributing factor: When the pandemic hit, companies scaled back production or, in some cases, shut down factories altogether. Now that demand is increasing, it will take time for the supply chain and production to catch up, Horn said. A highly publicized example of this is the global shortage of semiconductor chips.

“They are used in more things than might expect — not just electronic devices, but also automobiles and appliances. Even if production capacity is available, the raw material inputs are not always available. When we think of the supply shock, the supply is constrained because all up and down the supply chain, companies slowed down or shut down at the beginning of pandemic. And the startup is not instantaneous,” Horn said. 

Ongoing effects of trade wars started under the Trump administration also have driven inflation.

“International trade normally lowers price because you have more opportunities for competition and lower prices,” Horn said. “The trade conflicts, coupled with COVID, have reduced that as an option for price competition.”

While a boost in international trade would have a positive effect on inflation, many of the countries that have historically provided lower-cost labor will continue to struggle with COVID-19, Horn added.

A measured response

The trillion-dollar question of the day is whether the current inflation is just a corrective shock coming out of the COVID-19 pandemic or rather a longer-term systemic shift. The answer will be primarily determined by monetary policy, Horn said.

Since the Great Recession of 2008-09, central banks around the globe have been pumping money into their national economies in an effort to stimulate the economy. Before the Great Recession, the Fed had just $800 billion in the economy. Today, that figure has grown six-fold to $6 trillion.

“When that extra money is out in the economy and there’s not more products to buy, prices will go up because consumers will be willing to pay more to get the products they want,” Horn said.

“That’s the longer-term systemic problem with having an increase of money in the system. And most central banks around the world have been doing this for more than a decade.”

Decreasing the money supply without triggering a recession is a challenge, though. Before the pandemic, the Fed had successfully decreased the money supply to the $3-tillion range. But, over the past 15 months, the money supply has doubled and surpassed its post-Great Recession peak, Horn said.  

“This really is a balancing act: How fast can they pull back on money supply to prevent inflation from taking off without putting the brakes on the economy just as we’re recovering from COVID?” Horn said.

“If the Fed takes the money out too slow, it causes systemic inflation, as opposed to temporary corrective inflation, which may be what’s happening right now. On the other hand, if they start to incrementally increase interest rates ahead of that happening, they’ll also cause a recession. It’s not like the global economy is so stable and strong that the Fed has a lot of wiggle room to play with.”

While it has been more than 40 years since the U.S. experienced serious inflation, the country has already experienced two significant recessions in a little more than a decade. A third recession could be disastrous, especially for younger generations. Getting this response right is of the upmost importance, Horn warned.

“My grandparents’ generation lived all their lives as if they were still in the Depression,” he said. “There already is some evidence that younger generations — Gen Z and millennials — are starting to behave this way. If that cohort goes through three major recessions in less than two decades, it will affect consumption — probably for the rest of their lives.

“That’s not good for the long-term economic growth of the U.S.”   

John Horn, professor of practice in economics, wrote this article with contributions from Taylor Begley, assistant professor of finance.

In a well-functioning economy, the bankruptcy process should be able to sort out why a particular company failed. Was the company structurally unable to compete? Did executives make poor choices (like taking on too much debt)? Or were circumstances simply unlucky?

John Horn

But when large swaths of the economy default concurrently, banks shouldn’t hold individual businesses responsible for the disruption. Though the Coronavirus Aid, Relief, and Economic Security (CARES) Act and subsequent bills provide some small business relief, they largely leave the existing bankruptcy process in place.

Unfortunately, that process will take years to sort through the chaos. Unless we take additional action, when the crisis ends small businesses that were perfectly viable will face challenges in accessing the cash they need to start up again.

Cataclysmic events

In contract law, “force majeure” clauses are intended to protect both parties from cataclysmic events beyond their control. But force majeure—in short, an extraordinary, unforeseen event—won’t absolve most current borrowers from default. Few small business loans have such clauses, and, even if they do, courts will have to decide whether the pandemic counts as such an event. This, in turn, will require a lot of one-off decisions from lenders, further clogging the system.

Here’s the bottom line: We are not ready for the economy to come out from under a large number of defaults once the coronavirus is contained sufficiently. We can’t rely on existing contractual clauses to remedy the situation. In an ideal setting, a bank will take into account the business’ situation before the COVID-19 crisis and evaluate it on the pre-crisis fundamentals.

This will work best when the lenders have a more intimate knowledge of the borrower and their history. That’s more likely to occur when the bank is a local entity. However, the banking industry has been closing branches over the past 10 years, and closures appear likely to continue amid this downturn.

The correct action requires coordination: All lenders need to act in a similar fashion at the same time so no one bank feels like it’s the only one taking a risk by doing something different.

Banks’ unwillingness to take risks on their own shouldn’t be surprising; we’ve seen this in the recent past. Since the Great Recession, banks have been holding excess reserves (cash in their vaults that they are allowed to lend out, but don’t) between $685 billion and $2.7 trillion since mid-2009. As comparison, the number averaged $1 billion between 1985 and 2008. Also during the Great Recession, banks tightened standards for small-businesses loans and have not relaxed them significantly since that crisis officially ended.

What can be done?

If we can’t rely on banks to self-start the lending cycle, what can be done? There are a couple of ways the federal government can improve liquidity for small businesses by putting all banks on the same footing with regard to the underlying insolvency risk.

  1. The simplest correction would to be for the government to underwrite the continued financing of small businesses until the crisis has passed. Ensure these businesses have access to funding they need to pay off all of their bills and remain viable. The CARES Act (and second round of Paycheck Protection Program funding) was a good first step, but Congress will need to continue funding small businesses until the crisis ends.
  2. If it doesn’t, then Congress should enact legislation that would count any bankruptcy/default from March 2020 until the end of the crisis as a nondefault event. Sure, some risky borrowers would have defaulted anyway without the coronavirus shutdown, but many of the other conditions (like cash flow, tenure of business) will still be used to underwrite future loans, as will bankruptcies/defaults before March 2020.
  3. Create new investment protection vehicles for banks/lenders to incentivize certain types of loans (modeled on the FDIC insurance—i.e., only for loans up to a certain amount, only for certain types of loans—and the mortgage loan backup created after the Great Recession). This would be similar to the current CARES SBA loans and allow for smaller minimums than the Fed’s Main Street Lending Program (currently $500,000).

Small businesses are hurting. If the current economic crisis doesn’t end in the next few weeks, they face an existential crisis that will be hard to endure—and find it hard to rebuild once the economy starts to rebound.

John Horn

Olin professor  John Horn says Missouri exports to Mexico and Canada, its chief international trading partners, could be put at risk if the Trump Administration moves forward with plans to withdraw from NAFTA, the North American Free Trade Agreement.

“This is where Missouri exports. And this is where St. Louis exports,” said Horn, senior lecturer in economics, during an interview this week with St. Louis Public Radio. “So the state will have to replace those exports somewhere.”

In a nearly five-minute segment aired during Morning Edition, Horn addressed the consequences of talks this week in Montreal, where negotiators are gathered to discuss reworking the pact, or the possibility of the United States withdrawing. According to the public radio piece, the U.S. Chamber of Commerce estimates a loss of 250,000 jobs in Missouri if the Trump administration exits the agreement.

Horn addressed the benefits or demerits of NAFTA, whether it has cost jobs in the United States, and the potential benefits of renegotiating the agreement.

The current round of negotiations, Horn said, introduces uncertainty in the business community, which can be unhealthy.

“If businesses don’t know where they should be investing, or how they should be investing, they tend to hold back on investments and that is going to slow growth down,” he said.

Read more about Horn’s interview or listen to the complete piece on St. Louis Public Radio’s website.