Can The Fed Stop Inflation? There was something of a public debate going on at the end of 2021, in which government officials and industry insiders were torn on the issue of whether rising inflation was just a temporary phenomenon of the time, or a rather more serious – and possibly permanent – feature of the looming economy.
Indeed, Treasury Secretary Janet Yellen initially claimed the former was at play, later having to backtrack when she admitted she could no longer continue describing the deteriorating situation as merely “transitory”.
And Yellen wasn’t the only expert to start off relatively relaxed about how things were progressing back then – the Federal Reserve came across pretty sanguine in a FOMC statement released later that year, stating that “indicators of economic activity” were continuing to strengthen.
That said, not everyone was as confident as the apparatchiks working out of Washington, D.C. In fact, those at the coalface of the business world – like Unilever’s CEO Alan Jope – had identified much earlier on that what was occurring was a “once in [a] two-decade” event – and that inflation was likely here to stay.
Yet, that question no longer seems to be moot.
The recent results of such reckless actions as unbridled money-printing – and the outbreak of war in the Ukraine – have conspired to create what are now some of the highest inflation rates seen among western nations in over 40 years.
And this isn’t the first time the US has encountered out-of-control price rises either.
Beginning in the early-1970s, the country faced a perfect storm of rising unemployment and a severe stock market crash, culminating – along with other significant events – in a decision by the then-President Richard Nixon to end the so-called “gold standard” monetary system, a scenario long associated with the Bretton Woods post-war economic settlement.
This de-coupling of the US dollar from the price of gold was meant to fast-track the Nixon administration’s efforts in creating cheap money for the nation – but things didn’t work out quite as expected. Inflation would grow from the low single digits in 1972, to 12% by the time Nixon left office in 1974.
But the arrival of Jimmy Carter at the White House signaled a new dawn for America in many ways, and getting inflation under control was one of his main priorities.
To do this, Carter immediately nominated Paul Volcker as his pick for Fed chairman. Volcker would go on to become a towering figure in American politics, and the radical monetary policies he instituted had a profound impact on the fate of the US economy.
It shouldn’t go without saying, however, that Volcker’s actions at the Federal Reserve were just as contentious then as they are now.
He set about rectifying the damage done by the Nixon-era policymakers in a new way: rather than maintaining the federal funds rate within a narrow window – which was the mandate set by congress – Volcker actually raised the rate to never-before-seen levels.
This led in the first instance to a debilitating recession, eliciting some of the most vociferous protests against the central bank in all its history. The recession eased a number of years later, after which the economy began to recover.
The degree to which Volcker’s interventions were successful or not is still up for debate, and his legacy remains somewhat mixed. But what’s not in contention, however, is the fact that the US and the rest of the world is facing a crisis on the same scale and magnitude that Volcker and his peers faced all those decades ago.
But will the path taken by the Fed in the 1980s work now? And if not, what will?
Supply Chain Challenges Are Far More Complicated
The problem for the Fed today is that the material conditions of the economy in the present climate are substantially different to the ones that Volcker was dealing with at the end of the last millennium.
Perhaps the most important distinctions now are the highly unique supply chain issues that have gripped the entire world since the beginning of the COVID-19 pandemic.
To begin with, supply chains have been so disrupted – and for so long now – that products in the system are simply not getting through to the end-users who need them.
And this causes a whole raft of problems. Not only does a shortage of marketable products cause price increases through a lack of viable competition, but manufacturers and shipping companies have to burden the cost of storing any idle merchandise themselves.
Furthermore, those businesses that can carry more inventory inevitably pass on the price of doing so onto their customers. All these factors are ultimately inflationary, and there’s no quick way to solve them.
Stagflation, Not Inflation
The outcome of all these trends isn’t just inflation. Instead, the resultant economic situation causes something known as stagflation.
The term, first coined in 1965 by British politician Iain Macleod, refers to a state of affairs in which there’s rising inflation coupled with high unemployment, leading necessarily to a decline in overall economic growth rates too.
Ironically, if the Fed does try to follow Volcker’s methods this time around, it’s only going to cause more upheaval. With output already effectively reduced due to the parlous nature of supply chains right now, the recession that Volcker’s actions led to in the 1980s will surely be repeated.
There’s also the risk that raising interest rates could cause even more damage than is already anticipated. Outside investors would eventually realize that they could garner bigger returns on their capital by investing within the US, which would drive the dollar ever higher while increasing asset prices in foreign denominations.
Indeed, stagflation is so damaging because there’s no straightforward way of tackling it. Volcker’s remedy was a bitter pill to swallow, and not one the people of America probably want to face again. The Fed has some difficult decisions to make in the coming months – decisions that might be a lose-lose bet no matter what direction it takes.
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