Who Gets the Blame for Inflation
Post from First Trust Economics Blog
Brian S. Wesbury – Chief Economist
Robert Stein, CFA – Deputy Chief Economist
Jan 17th, 2022
Consumer prices rose 7.0% in 2021, the largest increase for
any calendar year since 1981. As a result, politicians across the
political spectrum are working overtime to find someone to
blame and attack.
Some politicians on the left are blaming “greedy”
businesses for inflation. But we find this explanation completely
ridiculous. Of course, businesses are greedy, in the sense that
they’re run by people who are free to maximize their earnings!
But businesses are no greedier today than they were before
COVID. In the ten years before COVID, the consumer price
index increased at a 1.8% annual rate; in the twenty years before
COVID, the CPI rose at a 2.1% annual rate. Both figures are a
far cry from 7.0%.
Those blaming greedy businesses for higher inflation have
no rational explanation for why businesses somehow missed all
the opportunities to raise prices faster in previous decades but
suddenly had a “eureka moment” and decided to do so in 2021.
Under this economically illiterate theory, think of all the profits
they’ve voluntarily foregone for decades.
Meanwhile, think about the rapid increase in workers’ pay
in 2021, when average hourly earnings rose 4.7%. Did workers
suddenly become greedier, too? Is all this greed contagious?
Can we stop it by wearing masks? What does the CDC have to
But the political left is not alone in misunderstanding higher
inflation. Some politicians on the right are saying the inflation
is due to the huge surge in COVID-related government spending
and budget deficits. Part of this is likely tactical: by blaming
government spending and deficits, they can reduce the odds of
passing the Biden Administration’s Build Back Better proposal,
which they’d like to see defeated.
What they’re missing is that there is no consistent historical
relationship between higher spending, larger deficits, and more
inflation. Yes, inflation grew in the late 1960s after the
introduction of the Great Society programs. But government
spending also soared in the 1930s under Roosevelt’s New Deal,
without a surge in inflation. Budget deficits soared in the early
1980s and inflation fell. The Panic of 2008 led to a surge in
government spending and deficits and inflation remained tame.
So, if it’s not greed or government spending, by itself, then
what is causing higher inflation? We think it’s loose monetary
policy. The M2 measure of the money supply has soared since
COVID started. That is the (not-so-secret) policy ingredient that
has converted extra government spending and deficits into more
inflation rather than higher interest rates.
That, in turn, makes it important to follow the path of
monetary policy this year and beyond. In recent weeks, a number
of Fed policymakers have hinted at rate hikes starting in March,
including Mary Daly, the president of the San Francisco Fed and
considered a dove. Rule of thumb: when the doves get hawkish
and start hinting at rate hikes, it’s time to believe the hints.
The futures market in federal funds is pricing in four rate
hikes this year. For now, we think the most likely policy path is
three hikes – 25 basis points each: in March, June, and
December, with a hiatus for the mid-term election season.
In addition, we think the Fed finishes up Quantitative
Easing (QE) in March and starts Quantitative Tightening (QT)
around mid-year. The easiest and most straightforward way for
the Fed to do QT would be by selling Treasury and mortgagebacked
securities to the banks and having the banks buying them
send their reserves back to the Fed. The Fed can then erase those
reserves from its balance sheet. That would result in the Fed
holding fewer bonds as assets while being liable for fewer
reserves, reducing its overall balance sheet. Instead, the Fed will
probably take a more complicated path of not rolling over some
assets when they mature, which means the Fed will have to
coordinate its operations with the Treasury Department.
The key to remember, though, is that a few rate hikes and
some modest QT will still leave monetary policy too loose.
“Real” (inflation-adjusted) short-term rates will still be negative
while actual short rates remain well below the trend in nominal
GDP growth (real GDP growth plus inflation).
The Fed has its work cut out for it. Its goal is to execute a
reduction in inflation while sticking a soft-landing for the
economy. A year from now, we’ll have a much better idea
whether it can meet both these goals.