Re-evaluating the Federal Reserve’s Inflation-Focused Approach: A Critical Analysis
Was the Federal Reserve Correct to Focus so Much on Inflation?
The Federal Reserve has faced a dilemma in the past year or so. Should it tighten monetary policy to cut down on inflation, or should it ease up to promote economic growth and prevent a looming recession? These tools to cut inflation also slow down economic activity, further complicating the situation.
The Fed eased monetary policy drastically during and immediately after the pandemic but changed course sharply in early 2022 to push up market interest rates no fewer than ten times. However, the challenge lies in determining whether the Fed did the right thing by focusing almost exclusively on inflation, taking its eyes off the real economy.
Inflation Affects Low-Income People
Inflation can prove hard on people with low incomes. Prices do not rise evenly across all goods and services and typically grow faster for the essential items that low-income people buy more, such as gas, groceries, and rent. Conversely, recessions impact people who lose jobs or hours because of them and young people who enter the labor force but cannot find jobs. These groups are disproportionately poor, and the consequences of a recession are especially dire in a country like the United States, which has a limited and frayed economic safety net.
With Republicans in control of the House but a Democratic president, efforts to expand that safety net if a recession occurs are likely to be very limited, if they happen at all. Given this, our reluctance to endorse further Fed tightening, which may have gone too far, is influenced by our opinions on why the inflation is happening and our concern that it will be particularly damaging to people with low incomes.
Post-Pandemic Recession versus Previous Recessions
We did not have high inflation after the Great Recession of 2008-2009, despite a similarly aggressive Fed monetary policy response. But we did have a very long period of high unemployment. Despite the Great Recession officially ending in the summer of 2009, the unemployment rate did not drop below 5% for almost six years after that, despite the Fed’s monetary policy response.
In contrast, the short-but-steep pandemic recession officially ended in the spring of 2020, with the unemployment rate nearly hitting 15%. However, the rate dropped below 5% within a year and a half in the early fall of 2021. Millions of people returned to their jobs or found their first jobs much faster than after the Great Recession, and an enormous amount of hardship was avoided.
Fed policy was not the only reason for the quick recovery in the unemployment rate. The peculiar causation of the pandemic recession played a role, coupled with a very aggressive fiscal policy response. Even so, whatever the reasons, all those unemployed people got their jobs and purchasing power back pretty fast. At the same time, the rest of the economy roared ahead to all-time highs, making it arguable that fighting inflation should have been a second-order concern.
- The Federal Reserve had to balance controlling inflation with its mandate to promote maximum employment and stable prices.
- Inflation can erode purchasing power, taking a toll on low- and fixed-income households.
- The COVID-19 pandemic’s effects on the economy differ from the long recovery period following the Great Recession.
- Though Fed policy did play a role in the quick economic recovery post-covid, the peculiar causation of the recession and aggressive fiscal policy response were also significant contributors.
The Fed’s focus on controlling inflation amid rising prices has tipped the scales too much in one direction, risking harm to low-income people and the broader economy. While the Fed must fulfill its mandate to control inflation, it must be mindful of other macroeconomic factors such as employment and growth. As we navigate the post-pandemic economic landscape, prioritizing the needs of low-income households and supporting their economic well-being must form a critical part of policymakers’ decisions.
The Federal Reserve’s focus on inflation is understandable, but its exclusive emphasis may have unintended consequences. As we contemplate policy choices, including prioritizing the needs of low-income households and promote economic recovery, it will be vital to recognize the complex interplay of factors at work and make decisions that address multiple objectives. Only then can we establish macroeconomic stability and balance economic growth by ensuring equality regarding access to necessities such as housing, food, and healthcare.