(UnitedVoice.com) – In March, President Joe Biden echoed the sentiment of his economists and the Federal Reserve. As the US emerged from pandemic shutdowns, prices for gasoline, groceries, and consumer goods rose significantly. The government’s answer? They expected some ‘temporary’ inflation. As summer turned to fall, price increases didn’t appear to be temporary. Some economists began insisting inflation could last well into 2023.
On Tuesday, November 30, Federal Reserve Chairman Jerome Powell sent shockwaves through the markets. He said the word ‘transitory’ needed to be removed from America’s vocabulary and made the case there is too much cash in the economy. He suggested there was one way the Federal Reserve could fight off inflation, but it may come with other repercussions.
Powell Concedes He was Wrong About Temporary Inflation
The chairman of the world’s most powerful economic institution admitted the Federal Reserve got inflation wrong. Federal and private-sector economists determined inflation was likely temporary under the assumption the pandemic had a beginning, middle, and end. Under that belief, government economists believed inflation and the pandemic were tied together.
Powell didn’t directly address the government’s massive injection of money into the economy as the principal cause of the demand spike for goods but instead only hinted at the core problem. Yet, he did acknowledge supply and demand imbalances as one of the indicators trouble was looming. He also pointed to rising energy and rent costs, as well as wage gains as factors that will continue to keep inflation high.
Powell Signals Changes Could Be Coming
The Federal Reserve chairman said to get back to the labor market prior to the pandemic, the solution is to create price stability for businesses and consumers — a feature that is currently lacking. In October, prices increased 5% over the same time last year.
Perhaps the biggest reason for inflation is, between Congress and the Federal Reserve, the government injected $7.5 trillion into the economy in 2020. So far, 2021 is running into a similar pattern. Nobel Laureate Economist Milton Friedman demonstrated in the 1970s that when the government increases the money supply, prices increase proportionally.
One of the key responsibilities of the Federal Reserve is to keep inflation under control. It does so through two means:
- Controlling the supply of money in the economy.
- Increasing or lowering interest rates.
During the Fed’s last meeting on November 2-3, the board agreed to pull back significantly on what’s known as quantitative easing. The Federal Reserve decided to draw down its $120 billion monthly asset-purchase programs it instituted at the beginning of the pandemic by $15 billion from November to June. At that pace, the Fed would stop injecting money into the economy through asset purchases altogether.
Powell said while the economy is strong, inflation is too high. The Fed’s primary means to control inflation is by increasing interest rates. However, before doing that, the fed must stop pumping money into the economy by purchasing various assets, such as mortgages and debts. Instead of waiting until June, Powell wants to reduce the purchase by $30 billion per month to end the practice in March.
Interest Rates Rise to Combat Inflation
After the Fed stops purchasing assets, it will likely start increasing interest rates. Why is this important? Raising interest rates is the principle means the Federal Reserve uses to begin taking money out of the economy. By making it more expensive to purchase homes or cars and use credit cards, people will taper their spending habits.
Interest rates have the effect of either cooling or heating an economy. In this case, the federal reserve wants to cool it. The hope is, at some point, as spending trends drop, demand for goods decreases. Along with lower demand, prices come down.
It’s good the chairman recognizes the word transitory needs to be retired. Neither Biden nor Powell shouldn’t have used the term. Whether it’s inflation or increased interest rates, it’s not a good political position to be in if you’re Joe Biden or a Democrat running for re-election in Congress next year.
Stay tuned. The economic and political fallout could be significant in the weeks, months, and years ahead.
Don Purdum, Independent Political Analyst
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