The paper says raising Fed rates won’t stop inflation if government spending remains high

Chairman of the Federal Reserve Jerome Powell He repeated his pledge last week to “firmly” control inflation, regardless of the broader economic cost.

But a research paper published by researchers at Johns Hopkins University and the Federal Reserve in Chicago on the same day Powell’s keynote address at Jackson Hole suggests that the US central bank may fail to cool consumer prices by raising interest rates unless government spending slows in parallel.

“Recent fiscal interventions in response to the COVID pandemic have changed private sector beliefs about the fiscal framework, accelerating recovery, but also defining an increase in inflation,” the paper said. “This increase in inflation could not have been avoided once monetary policy was tightened. Overcoming post-pandemic inflation requires mutually consistent monetary and fiscal policies to avoid stagnation of fiscal stagnation.”

In other words, it requires taming the inflation crisis that has swept the United States for more than a year Federal Reserve to tighten monetary policyPlus the federal government is pumping the brakes on spending.

The Federal Reserve raises interest rates by 75 basis points in another historic move to tackle inflation

Federal Reserve Chairman Jerome Powell

Federal Reserve Chairman Jerome Powell, right, Lyle Brainard, Federal Reserve Vice Chair, and John Williams, President and CEO of the Federal Reserve Bank of New York, at the Jackson Hole Economic Symposium in Moran, Wyoming, Friday, August 26, 2022. (David Paul Morris/Bloomberg via Getty Images/Getty Images)

The authors — Francesco Bianchi, a professor of economics at Johns Hopkins University, and Leonardo Melusi, chief economist at the Federal Reserve Bank of Chicago — blamed the massive amounts of spending in response to the COVID-19 crisis for much of the rise in inflation. Prices have risen to 9.1% over the past year, the highest since 1981, although they have fallen slightly since then at 8.9% in July.

In just two years, Congress has unleashed a torrent of federal funds to protect the economy from the coronavirus pandemic, and has approved nearly $6 trillion in relief measures. Lawmakers approved about $2 trillion under President Biden and $4.1 trillion under former President Donald Trump, according to COVID money tracker Published by the Committee on Responsible Federal Budget, a nonpartisan organization based in Washington.

Biden and Democrats in Congress have also approved a bill of nearly $790 billion for health care and climate change — about half of which will go toward paying off the deficit — as well as canceling up to $10,000 in student loans for millions of borrowers and $20,000 for Bill Grant. recipients. The Committee on Responsible Federal Budget has estimated that it could cost up to $600 billion.

As a result, the paper notes, the Fed can only reduce inflation once “public debt can be successfully stabilized through credible future fiscal plans.” Without limits on federal spending, raising interest rates will only increase the cost of servicing the $30 trillion national debt, driving up inflation.

“Rate increases by themselves will not prevent the recent rise in inflation, given that a large part of the increase was due to a change in the perceived policy mix,” the study authors said. “In fact, rising rates without proper fiscal support can lead to stagflation. Instead, overcoming post-pandemic inflation requires mutually consistent monetary and fiscal policies that provide a clear path to both the desired rate of inflation and debt sustainability.”

The paper was published just a day after Powell emphasized that fighting inflation remains the Fed’s No. 1 priority and vowed to rein it in with a series of interest rate increases that he warned would cause. Economical ‘pain’ For millions of homes and businesses.

“While high interest rates, slow growth, and weak labor market conditions will bring inflation down, they will also cause some pain to households and businesses,” he said. “These are the unfortunate costs of lowering inflation. But failure to restore price stability will mean much more pain.”

US Capitol Building

The US Capitol building on August 6, 2022 in Washington. (Anna Rose Layden/Getty Images/Getty Images)

Even with four consecutive interest rate increases, including two in a row of 75 basis points, Powell stressed that the Fed was in no place to “pause or pause” — an unwelcome signal to investors who had been expecting a rate cut. . Next year.


The current benchmark Fed Funds range of 2.25% to 2.50% is around the “neutral” level, which means it is neither supportive nor constrained The economic activity. But the Fed chief indicated that a restrictive stance would certainly be necessary as the central bank tries to put pressure on the economy.

“We are purposefully moving our policy position to a level that is restrictive enough to bring inflation back to 2%,” Powell said, noting that “restoring price stability is likely to require maintaining a restrictive policy position for some time. The historical record is a strong caution against premature easing policy.” “.

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