The Fed Has Failed in Its Inflation Mandate

T he Consumer Price Index (CPI) measure of inflation clocked in at 7.9 percent for February, marking the highest level of inflation since January 1982. At this rate, consumer prices will double roughly every nine years.

The increase in prices includes many everyday consumer staples. The price of gas in February was up 38 percent since last year; utilities were up 24 percent, and steak and bacon were up 17 percent. Many clothing items were also up by double-digit percentages.

If we can learn anything from this, it is that the Federal Reserve has failed abysmally in its efforts to maintain low and stable prices.

Since 1977, the Federal Reserve has abided two distinct goals, known as its dual mandate. The first is to maintain a low and stable price level. The Federal Open Market Committee (FOMC) considers a 2 percent annual change in the inflation rate of Personal Consumption Expenditures (PCE) — the Fed’s preferred inflation measure — to be consistent with its goal.

From 1990 to 2019, the rate of inflation for PCE averaged 2 percent and rarely exceeded 3 percent.

Then came 2020.

At an economic symposium in Jackson Hole, Wyo., in August 2020, Federal Reserve chairman Jerome Powell announced a fundamental shift in the Fed’s dual mandate — away from a 2 percent target and toward a goal of average-inflation targeting. This change amounts to running inflation above target for some time to make up for the below-target inflation of prior years.

The justification for these changes was largely based on the concern that below-target inflation would lower interest rates, diminishing the Fed’s ability to boost employment — the Fed’s second mandate — during economic downturns.

In addition, the Fed and its regional banks have been increasingly advocating progressive goals such as a focus on race, ethnicity, and gender when determining employment objectives.

A forthcoming research article from the Independent Institute finds that Federal Reserve economists are increasingly driven by political activism and affiliation; they also demonstrate a growing preoccupation with politically charged topics such as climate change, discrimination, and economic inequality. These goals add more pressure on the Fed to maintain accommodative monetary policy, even as inflation spirals out of control.

Perhaps this provides another explanation for why the federal-funds interest rate is still at zero and the Fed is still engaged in quantitative easing after eleven consecutive months of the annualized CPI running above 4 percent.

When outlining its average inflation target in 2020, the Fed kept the details of its new inflation goals very vague — perhaps purposefully so. Jerome Powell noted that his aim was to “achieve inflation moderately above 2 percent for some time.” The problem here is that no one truly knows how much and for how long the Fed plans to run inflation “moderately” above that mark.

No one actually believes that the Fed planned to run PCE inflation at 4 to 6 percent for a year or longer, yet that is exactly where we are heading. Even if we look at PCE inflation averaged over two years, to avoid base effects, average inflation is running at close to 4 percent and has been above the Fed’s 2 percent target since April last year.

When economists were polled in December 2021 on their inflation expectations, most believed that peak inflation had already passed and would return to the 2 percent trend by the end of 2022. Yet many of these same economists have been falsely forecasting peak inflation for almost a year. Somehow peak inflation keeps being pushed back.

A variety of mostly supply-side excuses have been offered to explain away what many saw as “transitory” inflation. These included high lumber prices, base effects, demand for used cars, drought in Taiwan, and broad supply-chain restraints. Yet even Fed chairman Powell retired use of the term “transitory” after realizing that inflation trends were proving to be persistent and at levels well above expectations.

There is a missing piece to this puzzle — namely, demand-side factors. Yet after 14 years of accommodative monetary policy and unprecedented increases in government spending, we rarely hear Fed officials talking about them.

What now remains to be seen is whether the Fed has the stomach to tackle spiraling inflation. This will require a swift and significant increase in the federal-funds rate, in addition to reducing its bloated balance sheet.

Even if the Fed does take appropriate action, it may prove to be too little, too late.

One thing, however, is certain: A reckoning is in order, after the agency has so abysmally failed in its effort to keep inflation low and stable.