The Fed Fiddles While Inflation Burns

By at 10 November, 2021, 8:32 pm

by Raymond J. Keating – 

The Federal Reserve under the leadership of Chairman Jerome Powell needs to start doing its job. That is, the Fed needs to stop pretending that it can magically generate economic growth, and understand that it is more than capable of generating high inflation via loose monetary policy. Indeed, inflation is here, and the Powell Fed cannot simply go on pretending that it isn’t.

The U.S. Bureau of Labor Statistics has reported that inflation, as measured by the Consumer Price Index, jumped to 0.9 percent in October. That matched the sky-high level registered in June, and it meant that a hopeful calming in inflation, thanks to some slowing (though still hot) in inflation from July to September, has failed to materialize.

Source: U.S. Bureau of Labor Statistics

Over the past 12 months, inflation registered 6.2 percent.

The question about inflation this year has been: Is this transitory due to a combination of the economy climbing back, demand rising, supply chain challenges, and labor shortages; or something deeper and potentially more permanent?

The problem is that even if inflation is transitory at the start, it easily can feed into something deeper and more troubling, especially when the Federal Reserve has been running loose money without precedence since the late summer 2008. See the following chart tracking the monetary base (currency in circulation plus bank reserves), which Fed policy has direct control over.

Source: Federal Reserve Bank of St. Louis, FRED

Unfortunately, as made clearer in the following chart, even as inflation has been ignited this year, the Fed keeps running inflationary monetary policy – again, according to some bizarre belief that it is helping the economy stay afloat or recover.

Source: Federal Reserve Bank of St. Louis, FRED

In reality, of course, inflation only serves to create uncertainty, raise costs, increase interest rates, diminish the value of the dollar, and raise taxes (such as the capital gains tax since gains are not indexed for inflation), and therefore, to undermine the economy.

Monetary policy is not separate from the issue of inflation, no matter how much Fed officials might wish that to be the case. Feds of the past have made this assumption – namely, the Arthur Burns Fed of the 1970s – with dire consequences. Rather, monetary policy is central to inflation – you know, the old truism that inflation results from too much money chasing too few goods.

Even if we agree that this inflation started due to transitory issues, that doesn’t mean the Fed can continue with dangerously loose monetary policy. Transitory inflation can transform into a more entrenched inflation when the Fed runs inflationary monetary policy. This should be obvious. The Fed desperately needs to get refocused on the only job where it can have an impact, that is, maintaining price stability.

The U.S. economy cannot afford to sink into a situation in which the Fed fiddled while inflation burned. Does Jerome Powell want to be known as a Nero when it comes to inflation?

We need the answer to be “no.”

Raymond J. Keating is chief economist for the Small Business & Entrepreneurship Council.


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