Does the Fed Still Believe in the Efficacy of Monetary Policy?
In January, consumer price inflation of 7.5% for the past year represents the highest twelve-month increase since 1982. As alarming as that is, the more shocking development is that the Federal Reserve eased monetary every month for the past year and continues to do so even today.
For a central bank that has repeatedly stated that "inflation is always and everywhere a monetary phenomenon," the policy decisions of the past year are unprecedented and indefensible. It is unclear how much politics and financial markets influenced policy decisions, but policymakers are overly sensitive to both.
As bad as the policy decisions were in 2021, policymakers don't seem aware of the challenges they face to get inflation under control. Even though one policymaker called for a 50 basis point move at the next FOMC meeting in March, press reports indicate that others still believe a gradual or measured approach is the best policy option.
If policymakers still believe in the efficacy of monetary policy, how does the projection of three of four rate hikes to 1% in 2022 slow an inflation rate of 7.5%? That policy would still leave monetary policy in a more accommodative position than any time during the pandemic and with a jobless rate of 4% and fast-rising wages. Blunders by the Fed come with a cost, and the price is increasing with every passing day policymakers do not pursue a policy stance to contain inflation.
The current generation of policymakers faces a new trade-off. The choice is to fight inflation now with more forceful actions and let the financial markets bear the brunt of the policy adjustment or continue with a modest, gradual approach and risk a more wrenching and hard landing in the economy and financial markets later.
A student of inflation cycles finds similarities between the 1970s and the current inflation cycle. Supply shocks sparked both cycles. In the 1970s, policymakers' fear of the negative trade-off between fighting inflation and triggering more unemployment kept policy too easy for too long, extending the inflation cycle and ending with a hard landing.
In 2022, policymakers fear the negative trade-off between fighting inflation and starting a substantial fall in asset prices. Maintaining an easy money policy might be today's politically correct and market-friendly policy, but it's not a sound monetary policy.
It took Fed Chair Paul Volcker's wisdom and courage to break the 1970s inflation cycle. But those hard decisions came late and with huge costs (i.e., three years of recession). Is there a Volcker-type among the current generation of policymakers? I don't see one.
There's an old saying, "Pay me now, or pay me more later." By not making the hard decisions today, policymakers are increasing the scale of "pay me later."