The Federal Reserve, Inflation, and Jackson Hole Wyoming

It is the duty of the US Federal Reserve to minimize inflation and maximize employment. As anyone who has recently been to the Golan Heights restaurant can attest, inflation has certainly been an issue over the past year. In fact, the government's inflation measurement, called the consumer price index (CPI), has increased 8.5% over the past 12 months, after increasing by 7% in 2021, the highest level of inflation since 1982. US inflation usually hovers around the more desirable level of 2%. In the context of this crisis, central bankers, academics and other influential economic thinkers met in Jackson Hole, Wyoming. This is the first time the once-annual conference has taken place since Covid began and a lot has changed since then. To paraphrase Christopher Leonard’s “The Lords of Easy Money,” the Fed has long sought to make these meetings seem boring, technical and only of interest to economists and bond traders. However, now that inflation has eaten away at nearly every American's pocketbook, the importance of understanding what takes place at these meetings is more important than ever. 

The most important player in this story is Jerome Powell, current Chairman of the Federal Reserve. Powell has many powerful tools at his disposal including the ability to print US dollars out of nothing and the ability to set interest rates, as well as subtler methods of influence, such as merely hinting at what he might do next. But all of these tools, despite their astronomical power, can only influence people’s real-world economic circumstances, not change them outright. Predictably, in his Jackson Hole speech, Chairman Powell made inflation reduction his number one priority, professing a willingness to cause economic “pain” in order to accomplish it, despite recession fears. Over the following three days the Dow Jones Industrial Average dropped 1,000 basis points, a reminder of the astronomical power of his words. To put this speech into context, the most famous inflation-busting Fed chairman in history was Paul Volcker, who brought interest rates up to 20% a year, which while defeating the rampant inflation of the early 70s, made borrowing so difficult it brought the economy to its knees. It’s no wonder the markets dropped in response to this announcement. 

However, while discussing the issue, many experts agreed that inflation may be more difficult to fight than has long been assumed. Economists have long debated the mechanism behind inflation, with various theories holding sway during various time periods. One theory is that inflation, i.e. price increases, is caused by an increase in the money supply while the amount of goods stays the same. Others argue that inflation comes from a consistent money supply while the supply of goods decreases. The former theory suggests that the Fed can fix inflation by adjusting monetary policy. Unfortunately, the latter theory may be correct, as the current inflation seems to stem partially from supply shocks caused by Covid and the war in Ukraine, issues too difficult for any central bank to solve. Additionally, all that money printed over Covid has compounded the issue. At the moment the supply of goods went down, the supply of money went up, making that money less valuable. 

This leaves central bank governors across the globe in a tight spot. Before the current crisis, most economies had been running “hot,” meaning that money was easy to borrow and hard to save, encouraging speculative growth. Now, many fear economies will have to run “cold,” meaning economic growth will be practically nonexistent. One theory is that before covid, the negative effects of running the economy “hot” were absorbed by the economic growth that came from increased globalization, new technologies and low prices for raw materials. Now that those factors appear to be drying up, some are expressing fear that the old tactics of lowering interest rates and printing money might merely increase inflation, not economic growth. Other current crises, such as the European energy crisis and the Chinese real estate crisis, also seem to be the result of real-world factors outside the influence of the levers that bankers control. Currently, the Fed seems like it will continue to raise rates, hopefully bringing inflation in check without hurting the economy too much. As always, speculation about what should and will happen next is a highly contentious topic among economists.

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Photo Caption: What inflation does to your money 

Photo Credit: Pixabay