When inflation began to surge last spring, the Federal Reserve responded cautiously. The pandemic economy did not follow the classic boom-and-bust cycle. Broken supply chains appeared to be responsible for a significant portion of the price spikes, and rebuilding them is outside the central bank’s power. The argument for some monetary tightening, although strong, was not overpowering. The Fed’s reluctance to weaken the recovery was understandable.
Month by month, though, it has become clearer that Covid-related disruptions to productivity are not behind all of this inflation. An increase in the level of spending throughout the economy has added to the inflationary pressure. And that is very much the Fed’s responsibility. The latest evidence of “demand-side” inflation came last week, when the Bureau of Economic Analysis released its estimate of GDP for the fourth quarter of 2021. By one measure, spending was 3 percent higher than expected.
Federal Reserve chairman Jay Powell has been sounding more hawkish in recent months, talking about raising interest rates over the course of the year. That’s a welcome change, but the Fed is still playing catch-up with economic conditions. It may need to deliver a jolt to markets by accelerating its schedule, while also moving more aggressively than previously planned to shrink its balance sheet. It should also say that it is committed to tightening until spending growth moderates.
There remain some holdouts who believe that the Fed should “let the economy run hot.” They contend that tighter money reduces inflation only by throwing people out of work, which reduces labor’s bargaining power and thus reduces wages and consumption. Note, however, that this is a case against ever tightening money, no matter how high inflation is running — a classic case of proving too much. It is also mistaken both in the short and long terms. Any transient employment gains bought by too much spending will not be sustainable, and unemployment will rise more if the central bank lets inflation become more deeply embedded in the economy before acting.
Much work remains to be done on the supply side, including cutting tariffs and reducing shipping regulations. But the fight against inflation has several fronts, and the Fed is moving too sluggishly on its.