Central banks are moving aggressively to tackle inflation, maybe even going too far. But would the Fed's monetary stance be enough to curb the high inflation rate which stood above 8 percent for seven months? Or is the Fed more likely to blink rather than risk a severe economic recession?
Inflation Is Primarily a Monetary Phenomenon
- Fed must reduce the growth of the money supply below the growth in output to curb inflation
- Too much money chasing too few goods, driving up prices
- The Fed also needs to keep inflation anticipations anchored
- Without an excess of money supply relative to output, no supply shock could have led to a general increase in the price level
- A likely full-fledged recession ahead, which normally should reduce inflationary pressures
Stagflation Could Derail the Fed's Benign Scenario
- The current spike in inflation is a mixture of a long-lasting credit boom, supplemented by generous government budget handouts to both businesses and households during the pandemic.
- Fiscal easing is likely to counteract deflationary pressures stemming from ending the credit expansion, as budget deficits have reached warlike levels peaking at almost 15 percent of GDP in 2020.
The Fed's Monetary Stance Is Too Lax
- With prospects of stagflation materializing, the Fed's current scenario of monetary tightening is obviously too dovish
- History shows that the US Great Inflation of the 1970s could only be ended by hiking interest rates into real positive territory for several years in order to reanchor inflation expectations
- Inflation had accelerated to almost 12 percent when Volcker took over as Fed chairman in November 1979
- While he gradually reduced the policy rate over the next five years, the real rate was always positive and exceeded 5 percent on average from 1981 to 1984, so that inflation dropped below 4 percent
https://mises.org/wire/feds-current-monetary-stance-will-lead-stagflation-not-deflation
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