The Fed Cannot Stop Inflation. Can Anybody? (Yes!)
The real cause of, and cure for, inflation is easy to find but hard to change--it takes will power.
Stockbroker and financial commentator Peter Schiff made an interesting comment in discussing a brief stock market sell-off that led to a 1.7 percent one-day market loss in late February:
What was the news that drove the stock market down on Friday? And I think it’s more confirmation of stagflation, which is exactly what I have been predicting all along. And of course, stagflation is the one economic condition for which the Fed has no contingency plan.
When Powell was asked what his plan was for stagflation, he knocked wood. He banged on the podium. And he said, well, we’re just going to hope we don’t have it. Well, hope is not a plan. But the reason the Fed doesn’t have a plan is because there’s nothing in their toolbox that will work.
Schiff noted that the U.S. Federal Reserve (Fed) commonly indicates that it sees inflation as in great part a psychological phenomenon, blaming the public for it:
Now, the Federal Reserve puts a lot of stock in expectations. Powell says that all the time, right, because these guys think that inflation is like the field of dreams. If we build it, they will come, right? If people expect inflation, we’ll get inflation.
They think it’s kind of like a function of a self-fulfilling prophecy. They think if people expect inflation, well, they’ll demand higher wages. Businesses will expect inflation, so they’ll raise their prices in anticipation.
So it’s part of the Fed’s strategy for blaming the public for inflation. Well, we have inflation because the public irrationally expects it, and because they expected it, they made it come true. They raised their prices thinking that there was going to be inflation and that’s why we have it.
Certainly the Fed recognizes the important effects of monetary policy, interest rates, government spending, regulation, and other factors in causing monetary inflation, but the central bank’s actions do in fact show a very strong fear of … public fear of inflation. Whenever the economy starts to look good, the Fed threatens to tighten the money supply to slow down economic growth, on the premise that workers will start asking for higher wages.
The idea that workers should share in the results of productivity increases never seems to be an important consideration for the Fed. Making sure workers don’t get too greedy is an imperative for the central bank.
As I have noted regularly in this newsletter, including in an item just last week, the biggest (and possibly only real, fundamental) cause of inflation is excessive government spending. The Fed does not have any control over government spending, and that is why “there’s nothing in their toolbox that will work” against inflation, much less stagflation, as Schiff notes.
Nobody has control over inflation except the U.S. Congress and the president. On top of that, any particular Congress and president have only limited options themselves, as they are forced to try to repair the damage done by previous Congresses and presidents.
The only real solution to this problem is a constitutional amendment requiring a balanced budget.
Thanks, Richard. You are so right about the Fed myth: it is all about Congress and presidents escaping responsibility for their fiscal malfeasance. Your explanation of the four decades of economic stability is just right. When the government keeps its doggone hands off the American people, the latter produce goods and services in amazing abundance. That is the difference between the United States and the rest of the world: a government that does not interfere *quite* as much as they routinely do, and a population that has been raised up to expect just rewards for their productivity.
U.S. government spending has been awful in the present century, yet even so it has not been as bad as in most other nations, and we have had the advantage of reserve currency status and the petrodollar to soak up some of the inflationary effects of deficit spending. In addition to the fiscal madness of the Covid year and then, even worse, what occurred afterward, I think that the amount of regulation that Obama and then Biden imposed did more damage than most people appreciate.
Your observations about Covid policy and money velocity are interesting. Velocity was decreasing rapidly in late 2019 *before* the lockdowns and before Covid was thought to be of any concern at all (https://fred.stlouisfed.org/series/M2V#). After a brief blip up in mid-2020, probably in response to Covid checks, it did not rise until the Biden administration spending spree hit. Fiscal facts are stubborn things!
Another terrific piece. We really need to break the Fed myth, which is just another way for the political branches to shift blame.
I also agree that fiscal policy trumps monetary policy. For government spending to do the damage however, people have to reject the dollars the government is spewing. They do this especially when the real, after tax return on investment is low, because investors--who at the margin drive dollar demand--reject dollars and buy stuff, like art an real estate.
You can see this in the 40 years after the Reagan tax cuts which reversed the real after tax return on the stock market from negative in the 1970s to robustly positive. We got 40 years of mostly declining inflation and interest rates and vigorous economic growth. There were blips along the way, but months of recession per decade dropped significantly.
The Biden Covid deficits were so destructive because the economy was underproducing and we had massively subsidized non-work for two years. Prudently people banked the money, velocity fell--a lot. Post crisis that money flowed back into an underproducing economy velocity soared while good remained short.
This was a rare case where consumers outvoted investors, because they had more discretion over their own spending and became more influential over marginal demand.
At least I think so!!!