Inflation and the failure of the Fed to act

Prices are rising at the highest rate in 40 years. The Federal Reserve’s overly expansionary policy is the main culprit. Yet the Fed has taken only minimal steps to address the problem.

After more than a year of inactivity, the Federal Open Market Committee (FOMC) finally started raising interest rates. It raised its federal funds rate target by 25 basis points in March, 50 basis points in May, 75 basis points in June and another 75 basis points in July.

However, this rate hike was too late and too small to stem the current wave of inflation. The FOMC will need more hard work To reduce inflation and to signal to the public that it is taking inflation Seriously. They should seize this opportunity to implement long-term policy reforms.

Consumer price inflation

The Consumer Price Index (CPI) has increased over the past year 9.1 percentWhile the Personal Consumption Price Index (PCEPI) rose 6.3 percent. Americans face rising prices for basic living expenses like food, gas, housing and clothing.

Fed officials have arrived accept Monetary policy as a major cause of recent high inflation. Auto computer chips and raw material shortages played a role in the early stages of recovery and High oil prices There are more recent contributions. But the price hike has been massive. Original PCEPI Inflation, which excludes food and energy prices, is well above the Fed’s long-term target of two percent.

The problem of inflation seems unending. Not “temporary”. As Fed officials had previously claimed. Despite recent rate hikes, inflation remains high. FOMC project Inflation will remain above target by 2024. Financial markets have implicit expectations about future inflation rejection Last month, but still suggests that inflation will exceed 2.5 percent per year over the next five years.

Fed inaction

Widespread and persistent inflation seems to be a symptom of monetary policy. Why did the Fed not respond to the threat of inflation earlier?

First, Fed officials relied too heavily on their technical model, which predicted that inflation was transitory. They failed to learn from their mistakes during the Great Recession of 2007-2009, when they were over-reliant on Defective model Prevents the FOMC from cutting interest rates fast enough, further exacerbating the extent of the recession.

Second, the FOMC has adapted its interpretation of its mandate in a way that allows for more inflation. it is changed From an inflation target of two percent per year to an average inflation target of two percent over time (so they are claimed), which delayed its response to high inflation. It reinterpreted its full employment mandate to be greater included And promised not to raise interest rates until the economy reaches this expansionary outlook Maximum employment. Additionally, Fed officials prioritize Pointless goals Inequality, climate policy, and emergency lending to non-financial corporations divert attention from the core task of keeping inflation low.

Third, the Fed monetized fiscal deficits on an unprecedented scale. By itself, debt-financed government spending has little effect on total spending. Additional government spending enabled by newly issued bonds increases the crowding out of private sector spending, as businesses and consumers face higher interest rates. When the Fed monetizes those bonds, however, the new money increases aggregate spending and, with it, prices.

In response to the pandemic, Congress increased fiscal spending $5 trillion. The Fed bought approx $3.4 trillion In US Treasury bonds. In other words, the Fed monetized about 68 percent of the borrowing needed to finance the fiscal policy response.

What can be done?

In the short term, the Fed must address the inflation problem. Raising interest rates may not be enough. The Fed should adopt a monetary policy rule to increase its credibility and reduce uncertainty about its policies. as Scott Sumner And others have argued, a nominal spending rule may be the most effective way to achieve it neutral, predictable Financial policy.

In the long run, the Fed should return to fundamentals. Fed officials must prioritize financial stability over political objectives such as inequality and climate policy. To simplify its tasks, the Fed should consider returning monetary policy to the pre-2008 corridor system.


Thomas L. Hogan is senior research faculty at the American Institute for Economic Research. He was previously Chief Economist for the US Senate Committee on Banking, Housing and Urban Affairs.

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