The Bureau of Labor Statistics just released the Consumer Price Index for the month of January. The CPI rose 0.5% while the CPI for the last 12 months was 6.4%, which is down slightly from last month’s CPI print of 6.5%. This data, along with previously released data about the job market, indicates that the Fed must be more aggressive.
Inflation became a problem in 2021. Prices started rising early in the year, yet the Fed followed a shockingly irresponsible monetary policy by keeping interest rates near zero until March 2022. The Fed also vastly increased the money supply mostly by buying $240 billion per month of government bonds.
Inflation rose steadily throughout the year and into 2022, peaking at an annual rate of more than 9% in June. In March, the Fed finally ended the bond buying program. In June the Fed finally started to increase interest rates. Because Fed policymakers were so late to react and because inflation was so high, the Fed had to raise interest rates aggressively. Four 75 basis point hikes were put in place before the end of the year.
In December the rate increase was only 50 basis points and in February only 25 basis points. Those rate increases should have been more. Today the Federal Funds Rate is about 4.5% while the inflation rate is 6.4%. That means real interest rates continue to be negative. That discourages saving and encourages spending, making the inflation problem worse.
Although the annual inflation number is 6.4%, some components of the CPI is disturbing. Food prices are more than 11% higher than this time last year. Although gasoline prices have fallen about 30% since the peak, they are still higher than they were last year. Electricity, fuel oil and natural gas are up at least 12%.
That means inflation for necessities continues to be a problem. Many economists are forecasting much higher oil prices later this year, mostly because China’s economy is re-opening from the COVID lockdowns of last summer and early Fall.
By easing the interest rate increases, the public has the perception that the inflation problem is subsiding. And with the low monthly CPI numbers for the last half of last year, many agree. The reality is that inflation paused during that time, but indications are that inflation will stay at the 6.4% level and perhaps increase later this year.
Although supply chain disruptions did contribute to inflation, they were not the primary driver. Rather, it was excess demand created by huge government spending deficits and by the expansive monetary policy. The Fed has reversed course, but the Biden administration continues to deficit spend at near-record levels.
Biden says he has reduced this deficit more than any president in history. After all, the deficit was nearly $3 trillion in fiscal 2021, and he reduced it to $1.4 trillion is fiscal 2022. That is the largest decrease ever.
But the deficit in 2021 was a result of the American Rescue Plan’s $1.9 trillion spending and the Infrastructure Bill’s $1.2 trillion. In 2022 the budget had neither of those, so why is the deficit still $1.4 trillion, which is the third-largest deficit ever recorded.
If Biden really was concerned about inflation, he would have reduced spending and eliminated most of the deficit. He tries to blame the tax cuts implemented in 2018 for the deficit, but the reality is that tax revenue in 2022 was about 40% higher than in 2017 before the tax cut.
Since Biden’s deficit spending fiscal policy will add excess demand, it is up to the Fed to control inflation. Interest rate hikes must be more aggressive. The longer and slower the Fed takes to fully react, the worse the inflation problem will get.
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