Reviews | Act now to curb inflation


The students looked at me questioningly when I mentioned the word “inflation”, as if I remembered the invention of the spinning jenny. No more. Last Friday’s Consumer Price Index report showed inflation hit 6.8% from last November’s 1.2% rate, the fastest rate in nearly 40 years .

Is it time to panic? No. But President Biden and Jerome Powell, the chairman of the Federal Reserve, must act now.

Around the same time last year, few forecasters were forecasting inflation close to 7%. Yet when consumers want to buy more than the economy produces – the story of the year – it is a classic harbinger of rising prices. The Covid pandemic has caused supply shocks in the form of disrupted workforce and supply chains. This, in turn, put upward pressure on prices. Very low interest rates and generous government Covid assistance programs, designed to cushion a drop in demand in response to the pandemic, have exacerbated demand and price pressures.

Last year, the Federal Reserve, which oversees interest rates, the country’s banks and money supply, instituted a new framework. He proposed that inflation levels above 2%, the Fed’s traditional target, could compensate for lower inflation levels in the economy. lived in the years following the 2008 financial crisis, but before the Covid-19 pandemic.

Policymakers have injected three rounds of fiscal stimulus into the economy affected by the pandemic. The most recent ride was sitting at the top household savings accumulated of at least $ 2 trillion, according to recent estimates. These savings have been accumulated through previous rounds of stimulus measures, as well as improving the labor market. A new infrastructure bill and the possible passage of Mr. Biden’s Build Back Better program provide additional deficit financing and a surge in demand.

For much of this year, the Fed has argued that inflation will be “transient”: price increases will decline rapidly and future inflation expectations will stabilize. Although Mr Powell recently retired the use of the term, it was never entirely clear what time frame he was referring to. Many economists and business leaders fear that the Fed’s decision to exceed 2% inflation has gone too far.

As supply chains normalize, inflation will almost certainly subside. But by this time next year, inflation as measured by the Consumer Price Index, the weighted average of a basket of goods commonly purchased by households, could still reach 4.5 percent; core inflation highlighted by the Fed, which excludes food and energy prices, could be 3%.

Higher inflation is not a victimless crime. Middle-income savers and fixed-income retirees are threatened by higher inflation. And workers whose wages don’t keep up with rising inflation are in a similar boat. In September, wages for the previous 12 months had increased 4.2% while consumer prices rose 5.4%, according to the employment cost index, a measure of changes in the cost of labor. labor force published quarterly by the Bureau of Labor Statistics of the US Department of Labor.

To a large extent, Fed officials are fighting the war of the latest financial crisis and recovery, a period characterized by weak job growth and low inflation. This crisis was one of tumbling down demand, while the pandemic economy has been plagued by supply constraints and increasing demand.

So what should policy makers do? They need to recognize that keeping inflation under control will likely require restraining demand.

Part of the solution involves the purchase of assets by the Fed. These purchases aim to reduce borrowing costs. But the Fed persevered even as the recovery took hold in an effort keep the labor market recovery buzzing. Particularly difficult to explain is the continued purchase of mortgage-backed securities even as the real estate market is white-hot.

The Fed needs to start cutting back on asset purchases more aggressively now. In recent weeks, Powell has signaled his willingness to double the pace of the cut to $ 30 billion per month – a move he is expected to make at this week’s meeting of Fed officials. Such a change would dampen the aggressive push in demand the Fed provided during the pandemic.

The Fed is also expected to raise its benchmark federal funds rate in early 2022. This is a short-term interest rate at which banks borrow and lend each other reserve balances. He should also be prepared to make other adjustments in the event of conditions, including broader and more sustainable inflation, demand it.

The Fed argued that running the economy hot could bring more workers back into the workforce. But unemployment is already low at 4.2%, and weekly unemployment insurance claims are at their lowest since 1969.

If Mr. Powell fails to change the Fed’s course now, current high inflation levels will start to affect long-term inflation expectations. When consumers and businesses expect inflation to be high, it fits more into economic decision-making – things like business investment or negotiating higher wages. The only way to remedy this would be a sharp and rapid contraction in the form of rising interest rates and a shrinking balance sheet. But such a sudden turnaround could trigger a recession. Prudent risk management, on the contrary, would force the Fed to gradually tighten financial conditions – from now on.

As a result, monetary policy will become less accommodating. But that would be better than the more aggressive approach that might be necessary if the rise in inflation persists until next year.

This approach to fighting inflation also means that the President and Congress must recognize that now is not the time to stimulate demand further. That means reducing Mr Biden’s Build Back Better program – a plan that the Congressional Budget Office has reported would increase the budget deficit if passed.

For this gradual cooling of the economy to work, it must start now. And the Fed and the White House need to carefully communicate their intentions.

Glenn Hubbard is Professor of Economics and Finance at Columbia University and was Chairman of the White House Council of Economic Advisers from 2001 to 2003. He is the author of the upcoming book “The Wall and the Bridge”.


About Meredith Campagna

Check Also

Bahamian Securities Regulator Freezes FTX Assets

The Bahamas Securities Commission (BSC) froze the assets of FTX Digital Markets (FDM) and “related …