By Laura Gillies
Jerome Powell, Federal Reserve (Fed) Board Chairman has acknowledged to the American people both that he failed to foresee the persistence of inflation and that the Fed must now take action to bring it under control.
As the world tries to recover from a pandemic, the underlying rate of economic recovery has surprised most. However, more surprising are the rampant and persistent rates of inflation being experienced in all aspects of the economy. In fact, many of the tools, such as economic stimuli, being deployed to avoid economic implosion may themselves be responsible for the inflation in part. That inflation is threatening to strangle the economic recovery and is leaving law makers and policy influencers at odds as to how to resolve the dilemma. It is creating a real political threat for President Biden as the Republican party seize on it to challenge his economic leadership, severely denting the probability of his further economic stimulus policies aimed at progressing the Democratic agenda passing.
The US consumer price index (CPI) has rocketed, increasing by 7.5% year-over-year in January, making it by far the fastest rate of increase since way back in the early 80s. Oil and electricity prices rose by 9.5% and 4.2% respectively just during the month of January, a major contrast to the negative prices of oil during the pandemic.
This of course is a global phenomenon but given its economic might, many are looking to the US for leadership and more importantly action. Necessarily, the Fed has sought to stabilize markets by indicating an intent to act by March, but many observers are indicating this is too little too late. That of course means raising interest rates to increase the cost of borrowing and in turn cool inflation by effectively taking cash away from consumers. This will be the first increase in interest rates since the beginning of COVID-19. Jerome Powell stated that the “Federal Open Market Committee is “of a mind” to start hiking rates at its March meeting to more effectively fight inflation.” Economic and monetary policies, such as decreased interest rates and buying government securities in enormous quantities has had the desired or even more than the desired effect. With the pendulum having swung so far from the depths of the pandemic it is now time to act to rebalance the economy to create a more sustainable economic environment.
The immense increase in inflation rates has also put Biden in a sticky situation with the midterm elections around the corner. According to CNBC the “Biden administration misread the rising threat of inflation.” Biden has suggested “that his administration was using every tool at its disposal to try to curb inflation.” But will Biden’s administration’s so-called ‘tools’ be enough to help put the economy and its inflation rates back on track?
For your average American this in effect means the cost of living is going to become more expensive, which in turn will cause the average American to become more cautious with respect to their spending habits. Much of the sentiment around this will be driven by messaging both by the current administration and the Fed. Too confident and inflation will not be brought under control, too cautious and risk an economic reversal and potentially a recession.
The stakes for the average American, America and the global economy are high. Whilst many observers say Covid is in retreat and the pandemic is over, whether that is even true remains to be seen. What is for sure, is that while the human cost of the pandemic is becoming clearer, the full economic impact of the pandemic has yet to be seen. America can lead, but it cannot act in isolation. This is a global problem probably requiring a concerted global effort to bring inflation under control and to put the global economy on a stable trajectory. The reality is however that no one knows if Covid is in retreat. Whilst the world hopes that is the case, no one can say for sure. Economic policy making is not easy and not for the faint hearted, but nowhere in history is there a precedent given the acceleration and globalization of the economy over recent decades. On a human level we have become more aware of how little control we have over our environment and the impact it can have on our lives. Similarly, we have become more aware of the impact human activity has had on the environment. We will find a path to economic stability, but the path may have many twists and turns in it. If there is a positive to be found from it is a renewed commitment to creating a sustainable environment may be the new normal way of thinking. Time will tell.
The views expressed in this article are the author’s own and may not reflect the opinions of the St Andrews Economist.