Trying to Figure Out the Fed and Inflation

By at 1 May, 2024, 9:49 pm

by Raymond J. Keating – 

The Federal Open Market Committee (FOMC) announced on May 1 that it would leave interest rates unchanged – that is, it would “maintain the target range for the federal funds rate at 5-1/4 to 5-1/2 percent.”

That was largely expected. But something far more interesting was said. And let’s give credit where credit is due.

The most accurate statement made by Federal Reserve Chairman Jerome Powell at his press conference was that the substantial reduction of inflation experienced in the U.S. economy starting in mid-2022 had little to do with monetary policy, and mostly to do with a healing or recovery on the supply-side of the economy.

That’s correct, and actually quite an admission coming from a Fed chairman.

The pandemic closing of businesses and collapse of supply chains, for example, combined with government ginned-up demand played a key part in igniting inflation. As private investment and businesses got the economy back on track, inflation eased considerably.

At the same time, however, the unprecedented loose money that the Fed has been running since the financial crisis of 2008 provided the foundation for inflation, and inflation continues to run too hot.

Though not surprising, the chairman asserted that the Fed’s main tool of monetary policy is manipulating interest rates. If you believe that inflation results from too much economic growth and/or too much employment, then there might be something to that. But in the end, inflation results from too much money chasing too few goods. And hence, the Fed’s most important tool is its control over the money supply, and the Fed has direct control over the monetary base (i.e., currency in circulation plus reserves).

As noted in the above chart, which SBE Council has highlighted before, it’s hard to seriously assert that the Fed has tightened monetary policy in any serious way. And it is this part of monetary policy that has created uncertainty for the past 15-plus years, and will continue to do so for the foreseeable future.

Raymond J. Keating is chief economist for the Small Business & Entrepreneurship Council. His latest books on the economy are The Weekly Economist: 52 Quick Reads to Help You Think Like an Economist, The Weekly Economist II: 52 More Quick Reads to Help You Think Like an Economist and The Weekly Economist III: Another 52 Quick Reads to Help You Think Like an Economist.


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