The Fed ignores the dangers of inflation – and risks repeating history


Until 2008, all central banks were afraid of inflation. This shows how long it can take to overcome a shock. The shock came in the 1970s when the inflation rate hit double digits. The whole thing came unexpectedly for the central bank. Inflation averaged 1.2% in the first half of the 1960s and averaged 2.3% throughout the decade. But then the upward trend continued.

In the summer of 1979 Paul Volcker became Federal Reserve Chairman. He was tough. He identified the money supply as an evil and raised interest rates. Suddenly credit was no longer cheap, it was hardly available at less than 20%. That led to two recessions. These were accepted. In return, inflation was brought under control. Since then, inflation has been relatively stable.

Stable inflation has many advantages. It is no coincidence that monetary policy has been stable since Volcker, the frequency of recessions has decreased, prosperity is growing and the stock market is booming. High and volatile inflation leads to an unstable economy. In the 1970s the unemployment rate was high, as was poverty. The stock market stagnated for 10 years. High inflation is just not optimal for the economy.

After 2008 that all changed. Suddenly central banks were no longer afraid of inflation, but of deflation. They tried to fuel inflation through low interest rates and QE. It didn’t work, it couldn’t. If the money stays in the financial sector and does not reach the real economy, there will be no demand. Without higher demand, there will be no inflation either.

Central banks are now desperate. Price stability is secondary. The US Federal Reserve is focusing more on the labor market and capacity utilization. The inflation target was not only raised. Higher inflation is desirable.

The central bank learned from 2008. A glut of money alone does not create inflation or full employment. Therefore, the current glut of money differs from the one after 2008. The central bank has practically and explicitly promised the state to finance the expenditure.

It seems to be the only way out that the central bank can still see. In doing so, however, she is repeating the mistakes of the 1960s, which in the end turned into a disaster in the 1970s. The central bank then gets its inflation, but risks repeating history.

The central bank consciously accepts this. Deflation is simply perceived as a greater threat. The fact that the economy is more stable when inflation is low and that the US achieved full employment for the first time in 50 years seems to be disappearing. After having had an irrational fear of inflation for decades, central banks now have a completely misguided fear of deflation.

The state financing will turn around 180 degrees and provoke a repetition of history. We won’t feel the consequences tomorrow or 2022. As it was then, the process is just getting started. It takes years for the full effect to develop. Hence, it is a monetary policy mistake that will preoccupy a generation.

Clemens Schmale

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Fed ignores dangers inflation risks repeating history


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