The inflation rate is likely to be more like “two point something” than “two point zero”, writes the former vice-chair of America’s central bank
Federal Reserve and other central banks have raised interest rates to fight inflation, they have increased the cost of borrowing for governments. Yet many central banks operate in countries where governments run large budget deficits even as they are more indebted, relative to, than at any time since the second world war.
Today’s disinflation has only just started. Though the White House got the fiscal stimulus it wanted, the Fed has not got the 2% annual inflation rate it wants. Those who blame the Fed for inflation might respond that the central bank purchased trillions of dollars of Treasury bonds between March 2020 and March 2022. Wasn’t the Fed, not the market, financing the government—and therefore unleashing inflation? Indeed, for a long time quantitative easing appeared to be a “free lunch” for the government. The Fed’s purchases were financed by the creation of bank reserves which pay a floating rate of interest very close to those on Treasury bills.
Because the Fed got aggregate supply wrong, the monetary-policy stance in place when post-pandemic supply constraints began to bite in the second half of 2021 was too loose. As Jerome Powell, the Fed’s chair, has indicated, although the Fed can’t do anything to boost aggregate supply it can curtail aggregate demand to bring it in line with supply. In March 2022 it began to do this, by raising interest rates.
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