Simple and Tricky: Where Inflation Comes From and How to Fix It – Texas CEO Magazine

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So much for the “temporaries”: inflation isn’t getting back to normal anytime soon. Although there were good signs during the summer, new data suggest that the pressure on prices remains strong. The Bureau of Labor Statistics reports 8.2 percent year-over-year inflation for September. Core inflation, which excludes volatile food and energy prices, was 6.6 percent. Wages are growing at 6.7 percent, only now it is catching up with inflation. Households have faced a decline in purchasing power for almost two years.

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Maintaining the value of the dollar is one of the most important tasks of the Federal Reserve. Our central bank has a mandate from Congress to pursue full employment and stable prices. Unfortunately, monetary policy makers are weak on both counts. The Fed has been in operation for over 100 years and still can’t get basic monetary policy right. We should seriously reconsider how much openness we allow the Feds to police themselves.

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Inflation is difficult to predict yet easy to understand. This is caused by too much money chasing too few goods. In economics parlance, the purchasing power of money falls when the money supply consistently exceeds the demand for money. This is exactly what has happened in the last two years. In March 2020, the money supply totaled $15.5 trillion. By the end of fiscal year 2021, this has increased to $21 trillion – a 35 per cent increase. Markets were certainly hungry for liquidity due to COVID-19-induced uncertainty, but the Fed’s monetary expansion has piqued our appetites.

Other explanations for inflation do not stand up to scrutiny. Yes, the federal government ran massive deficits in 2020 and 2021: $3.1 trillion and $2.8 trillion, respectively. But deficit spending by itself does not cause inflation. If Uncle Sam consumes more of the economy’s output, someone else must consume less. Excessive spending only became inflationary because it was supported by the central bank. Over the same time period, the Fed added $3.3 trillion in government bonds to its balance sheet. Monetary policy, not fiscal policy, is the determining factor.

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Nor are global supply problems the primary culprit. To be clear, when supply conditions are bad, prices go up. But it is a secondary factor in the United States. Unlike Europe, where a large portion of inflation can be explained by energy prices, US inflation is broad-based. Supply-side problems tend to make inflation worse, but price increases would have increased even without them.

Attention Nobel laureates. The blame for inflation lies with the central bankers. They are undoubtedly smart, reliable and kind. Still, he fanned the fire of inflation.

Milton Friedman said it best: Inflation “can arise only from a more rapid increase in the quantity of money than it can be produced.” Attention Nobel laureates. The blame for inflation lies with the central bankers. They are undoubtedly smart, reliable and kind. Still, he fanned the fire of inflation. It is time to stop playing with personnel and focus on policy. We need major structural changes at the Fed to prevent this from happening again.

The Fed ultimately lacks discipline. Congress has the right for this, yet the legislators have not given concrete instructions. The dual mandate is very vague. How much employment is “full” employment? How slow must prices rise to qualify as “stable.” Absent Congress’ guidance, the Fed answers these questions for itself. Worryingly, this makes the Fed a judge in its own case. “We examined ourselves and found out that we did what we were supposed to do.” This is not a recipe for responsible policy.

Congress should come forward to solve this problem. The Fed has the expertise to conduct monetary policy when given certain objectives. It is up to the people’s representatives to determine what that objective is. The best, and most likely, option is to focus on price stability alone. Employment is subject to many economic factors outside the Fed’s purview. The purchasing power of the dollar, however, may moderate this.

There are two major alternatives to monetary policy rule imposed by Congress. The first is the price level target: The Fed is committed to keeping the value of money stable. The second is the nominal GDP target: The Fed commits to keeping aggregate spending on final goods and services, which economists call aggregate demand, constant. Each has its own merits. Dollar stability is great for long-term planning, but it can make the economy more vulnerable to supply-side disruptions. Aggregate spending stability is nimble in the face of productivity changes, but the value of money over time is hard to estimate. What is important is that both rules can control inflation better than the highly discretionary procedures used by the Fed.

There should be a lively public debate on the costs and benefits of each regulation. But either rule is better than no rule. It is clear that the Fed, as currently constituted, is a poor steward of the dollar’s value. Let’s ask Congress to change that.

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