The War on Inflation

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The recent spike in inflation absolutely makes sense and could have reasonably been expected to occur. Just as inflation took time to show up, it will take time to conquer. Further, it’s still too soon to say this bout of inflation is not ‘transitory’. To better understand this rationale, let’s look at how we arrived here.

In response to the Covid 19 pandemic, the global economy, aside from a few essential industries, completely shut down. No goods other than food and medical supplies were being produced. People were out of work, but governments rightly stepped in and provided wages and stimulus checks to their citizens. During a “normal” recession, production slows, and some people become unemployed, leaving them with no money to spend or averse to spending what little they do have. During the height of the pandemic, businesses shut down, but people still had income and demand continued to be elevated relative to production. This scenario considerably decreased inventories, caused supply chain disruption, and resulted in prices of certain goods to immediately increase (i.e., lumber), while others increased months later as inventories were drawn down and not replenished (i.e., semiconductors and cars).

Even after the economy eventually re-opened, subsequent waves of infection and mutated strains of the virus have continued to cause additional shutdowns, labor shortages, and supply chain disruptions, especially in China where most of the world’s manufacturing takes place. It took about one year from the beginning of the pandemic for inflation to show up in economic readings. We can reasonably assume it will take at least that long for inflation to peak and begin to subside, possibly longer.

It is easy to look back at history, having all the facts and outcomes at hand, and ask, ‘why’; It is much harder to ask, ‘what if’.

A subset of people believe the government and the Fed recklessly provided monetary and fiscal relief during the pandemic. It is easy to look back at history, having all the facts and outcomes at hand, and ask ‘why’; It is much harder to ask, ‘what if’. However, it seems fair to say that had the fiscal and monetary policies not been in place as they were, we may be in a far, far worse place financially and economically than we are now. The Fed is currently doing its best to ensure a “soft landing”, and not induce another recession, by incrementally raising rates with the hopes that supply chain and inventory squeezes continue to ease. With savings accounts paying higher interest rates, people will hopefully be incentivized to save more, further reducing demand. A downside, although borrowing rates are still low by historical standards, is that businesses may be less likely to invest money to increase capacity and supply, as is badly needed right now. In this sense, interest rate hikes are akin to a hammer, when what is needed is a scalpel.

The idea of individual accounts owned by citizens and custodied by the Federal Reserve is not new, albeit controversial. A recent article in the Berkeley Economic Review posted on February 15, 2021, discusses such an idea (“Fed Accounts and the Right to Save”). Rather than have these Fed accounts serve as a replacement to traditional bank accounts, the accounts could be ‘weaponized’ to fight inflation.

Inflation is traditionally described as ‘more dollars chasing fewer goods.’ In viewing inflation through this lens, it seems reasonable that simply decreasing demand and increasing supply would counter inflationary pressures. During times of rising inflation, a portion of every individual’s paycheck, at a rate pegged to inflation, could be direct deposited into this Fed account as a sort of temporary “payroll tax” to reduce Americans’ discretionary spending, with the caveat that after inflation has been tamed, citizens can then access the funds in the Fed account to spend as they wish. In cases where inflation continues to rise, the Fed account funds could be accessed in retirement or in an economic hardship, like an IRA. There also would not be a risk of default if everyone were to withdraw funds at once since the Fed can print enough money to cover all of its liabilities. Therefore, deposit insurance provided by the FDIC would not be required for Fed accounts. These individual accounts would give the Fed a ‘surgical’ monetary tool to be used in future inflationary episodes, as opposed to the blunter tools the Fed currently has in its arsenal.