Discover more from Complex Effects
Fed Schedules Higher Interest as Inflation Challenges Recovery Efforts
Jay Powell, in a video news conference this week, described the Fed's plans to start increasing interest rates over the coming months and years in an effort to curtail inflation. This news comes after 20 months of insistent 'lower for longer' interest rate talk. Due to unexpectedly high inflation and an economy that is doing quite well, the Fed's change of heart seems to stem from their need to keep Americans calm, unlike our weather.
Contrary to what your local politicians might be preaching, the inflation we are enduring is not due to the spending by progressives, it is due to supply chain issues and infrastructure shortcomings. The pandemic threw a wrench into supply chains around the world and the result has, unsurprisingly, become Republican firepower. To better understand the economics of the pandemic, we will look at why the Fed has changed their mind so suddenly, what this means for the Build Back Better infrastructure bill, and what we should expect over the next couple of years.
How Raising Rates Should Help
The Federal Reserve has two main tools at their disposal: printing money and buying/selling assets. Over the pandemic they bought billions of dollars of government and corporate bonds in order to lower interest rates to where they are now. This happens because the decrease in available bonds raises the prices of assets across the board in a cascading affect. This is one of the reasons stock prices have surged during the pandemic. The result of higher bond prices is lower interest rates due to their inverse relationship.
Now, the aggressive stance on lower for longer has ended and they have expressed their plans to raise rates continually through 2024. If you follow the Fed, this may come as a bit of a surprise. To say they were adamant on having low interest rates for a couple more years would be an understatement. The thing is, the Feds job is to keep Americans participating in the economy as much as possible and to do that, they might use a little psychology to keep us calm.
The 'lower for longer' talk over the past year and a half gave America the reassurance it needed to keep the economy afloat and promote borrowing. Now, the Fed is speaking of increasing rates through at least 2024. How do we know they won't change their mind again?
While higher rates are needed to slow inflation, they are also needed to ease the minds of people worried about their quality of life. Nobody wants to see their dollar shrink and the perception of lasting inflation could self-perpetuate it. Macroeconomics is a game between mathematics and psychology and the Fed is the referee. As the Fed changes their game plan, progressives are combatting inflation through infrastructure bills.
Biden's Build Back Better Plan vs. Inflation
The Build Back Better bill has conservatives up in arms about the growing concerns of inflation. On the other hand, liberals are insisting that the bill is the key to fighting off inflation. The truth is, as usual, somewhere in the middle.
In the short term, the bill would slightly add to inflation because the bill isn't immediately paying for itself. The bill would add hundreds of billions to the deficit in the short term with plans to pay them in the future. As shown in the figure below, the costs of the bill are front loaded (CFRB.org, 2021).
Inflation in the short-term, therefor, would slightly increase, worrying economists as inflation is already the highest it has been since the 1990s. In the long term, however, the bill would decrease inflation due to an increase in jobs and an overall improvement of infrastructure. The risk of enacting such a bill now is that any increase in inflation, no matter how short-term, brings us closer to inflation spiraling out of control.
Overall, though, the bill would stimulate the economy through creating free pre-k systems for 3 and 4 year olds, increase the scope of the affordable care act, and bring child tax credits to families in need. In addition, the bill would eventually pay for itself through tax increases on the rich. The net affects of the bill would be minuscule for inflation in the long run and gigantic for families in need of support.
In conclusion, inflation may be on everyones mind today but do not let it scare you away from the benefits that the Build Back Better bill would have on our economy. Inflation comes and goes and there are tools we can use to fix it, so let your Senator know they should use them.
Follow inflationary developments by subscribing to El Newsletter today.