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.