Recently, the Federal Reserve (Fed) indicated that it will be more aggressive in reducing money supply growth and raising interest rates in order to fight inflation.  While their actions are welcomed, they really need to get much more aggressive.

In March 2020, as the virus was expanding and the economy was shutting down, the Fed moved to lessen the impact of the resulting recession. It began to massively increasing the money supply and dropping interest rates to near zero.

By mid-March, the economy nearly completely shut down. Unemployment shot up from 3.5% to over 14%. Economic growth plummeted into deep negative territory.

Nevertheless, defying all odds, the economy re-opened on May 1st, and economic growth skyrocketed as the unemployment rate tumbled.

Inflation Lurking Behind Growth

By the end of last year, the economy had rebounded sharply although growth did slow somewhat in the fourth quarter as the virus expanded. Early this year, it became obvious the economy was heading toward solid growth. The fear was that inflation might be a problem.

Considering there were: 1.) supply chain disruptions, 2.) labor shortages leading to wage inflation, 3.) rapidly rising energy prices, 4.) huge federal government budget deficits for both 2020 and 2021, and 5.) the Fed’s very expansionary monetary policy, the inflation peril was obvious.

For the past decade, the average monthly increase in the Consumer Price Index (CPI) was in the 0.1% to 0.2% range, meaning that the inflation rate for any given year was around 2%.

By March 2021, inflation looked like it would be a very serious problem. The Fed should have acted swiftly, with authority, in March or April.

CPI on an Upward March

In January, the CPI increase was 0.3%.  In February the increase was 0.4%. In March the monthly increase was 0.6%. Although it fluctuated as the year went on, it was obvious that inflation was a  problem.

The Fed increases the money supply by simply electronically printing money to purchase $120 billion of government securities monthly. Last March, it should have started to reduce its bond buying. That alone would have taken about eight months to completely end the program. That means by November, the bond buying would have been completely over.

The Fed also should have begun to raise interest rates, usually by a quarter of a percent. Then every three months, the rate should have increased by another quarter percent. That action would have taken enough excess demand out of the economy to reduce inflationary pressure but not enough to slow growth. That action may have cut the current inflation rate in half.

Officials About to
Announce Inflation of 7.5%

Instead, the Fed did nothing as inflation increased.  By November, inflation hit 6.8%. By year-end the rate will be the 7.5%.  That will be the worst inflation in four decades.

In April, Fed chair Jerome Powell said that inflation would not be a problem. And, he said, the Fed won’t raise interest rates until late 2023. By June he was saying that the inflation was transitory. In November he said that the inflation was not transitory but that it would ease by the middle of next year. Now he is saying inflation could remain a problem beyond next year.

Somewhat fortunately, the Fed has just announced that it will be more aggressive in scaling back their extremely expansionary monetary policy. It will speed the reduction of the bond-buying program so it should be ended by next March. Then the Fed will begin to raise interest rates, probably by one quarter point every three months. That means three or four rate increases in 2022.

History indicates the Fed will wait to raise interest rates until after the bond buying program has ended, because officials fear doing too much too fast could shake up investors and cause markets to fluctuate widely.

The problem is that it takes time for policy changes to fully impact economic activity.  Usually, the largest impacts don’t come about until six to nine months after the action is taken. That means Fed actions taken in the first quarter won’t have a significant impact until the third or fourth quarter. 

By then inflation could hit double digit levels.

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Michael Busler is a public policy analyst and a professor of finance at Stockton University in Galloway, New Jersey, where he teaches undergraduate and graduate courses in Finance and Economics. He has written op-ed columns in major newspapers for more than 35 years.