Washington Post columnist Megan McCardle said that the Federal Reserve could stem US inflation with tough monetary policy, but doing so would likely mean a brutal recession.

And I wondered which is better: inflation or stagnation?

I cited an example that occurred in August 1979, when Paul Volcker took over as Chairman of the Federal Reserve Board, where the Federal Reserve instituted a policy to rein in catastrophic (double digit) inflation by raising interest rates.

The result was that the inflation rate fell from 13.5% in 1980 to 3.2% in 1983, and interest rates rose;

Debt-financed businesses - including construction and auto sales - crashed and the unemployment rate reached 10.8%, a level that would not have been repeated until the global financial crisis in 2008.

She suggested that the current Fed chair could face a similar ugly trade-off, and said a recession would cause deep pain: It's bad, of course, to lose 8% of your purchasing power to inflation, but even worse is to lose 100% of your income to unemployment.

She said that the best option is to reach a stable inflation rate, and then gradually reduce this rate over time.

Stagnation will cause deep pain;

It is bad to lose 8% of your purchasing power due to inflation, but even worse is to lose 100% of your income due to unemployment.


To understand the inflation story

To understand what this option leads to - the writer says - imagine that you know that every year inflation will be exactly 10%, which is a very high rate, but if everyone knows what it will be, they will develop ways to mitigate the impact.

How?

  • Interest rates on bonds and savings accounts will rise to offset the inflation losses.

  • Employment contracts will specify annual increases of 10% in the cost of living.

  • Social Security and pension checks will have similar adjustments built in.

She added that the worst that could happen is that inflation reaches 10% unexpectedly, which is close to what America is currently witnessing;

Everyone's grocery budget had skyrocketed, savings had lost much of their value, and people had become anxious about being able to put gasoline in the car.

The writer described this as a completely different phenomenon, and much worse, because it makes it impossible to plan our financial lives.

She added that it would have been better if inflation had not happened at all now, because it would be uncontrolled inflation, because inflation-adjusting mechanisms that help people offset its cost can make it difficult for the Federal Reserve to control it.

In this case, the person in America who invested his life savings in a fixed annuity before inflation took an 8% premium, for example, is now permanently worse off.

Moreover, - as the writer says - if companies expect costs to rise by 5% next year, they will demand higher prices to compensate for the increase, and if workers expect higher prices, they will demand higher wages, which translates into higher costs for companies, and when expectations become “unstable” from Monetary policy In this way inflation feeds on itself.

The writer warned that it is too late for the Federal Reserve to choose the best option, which is to stabilize inflation and then reduce it gradually to avoid stagnation.


Wrong estimates of inflation

US Treasury Secretary Janet Yellen said on Tuesday she had been wrong in the past about predicting the path inflation would take, but said taming high prices was President Joe Biden's top priority, and he supported the Federal Reserve's actions to do so.

Asked in an interview with CNN whether she had been wrong to downplay the threat posed by inflation in public data over the past year, Yellen said, "I think I was wrong at the time about the path inflation would take." .

"As I mentioned, there were unexpected and significant shocks to the economy that boosted energy and food prices and supply bottlenecks that affected our economy severely, which I didn't fully understand at the time," she said, adding that the shocks include the Russian war on Ukraine and the recent anti-Covid-19 lockdowns in China. .

Joe Biden and Federal Reserve Chairman Jerome Powell discussed the country's record inflation at the White House.

Biden reiterated that his top priority is tackling inflation, saying that it begins with respect for the Fed, the independence of the central bank, and a promise not to interfere in the Fed's work to reduce inflation.

US consumer inflation rose to its highest level in more than 40 years, with an annual increase of 8.5% last March, and 8.3% last April.

Yellen stated that the recent decline in core inflation data was encouraging, but she indicated that oil prices remain high, and that Europe is working on a plan to ban Russian oil imports.

"We cannot rule out more shocks," Yellen said.