How to Fix Inflation — Now at its Highest in 40 Years

The U.S. inflation rate hit its highest point in nearly four decades, reaching 6.8% in November, because people who are saving money are essentially financing others who are buying expensive houses and cars.

Stoked by the Federal Reserve’s “quantitative easing” policy plus super-low mortgage rates, inflation has returned as one of the most vexing problems facing economists at Federal Reserve officials who set interest rates to the Biden administration and Congress. 

This year, a big reason for rising prices has been factors that neither lawmakers nor central banks can do much about. 

• Prices for natural gas, lumber, corn, soybeans, wheat, and other building blocks of modern commerce surged to multiyear highs in some cases records because of fire, freezes, flood, drought, hurricanes, and some of the hottest weather ever. 
• The shortage in the labor market is also a contributing factor in causing labor prices to rise, and workers have been quitting their jobs for better pay, and some have not even bothered to return to their old jobs. 

The titanic money supply

Because of the meltdown in the subprime mortgage market between 2008-09, the Federal Reserve printed more than $3.5 trillion in new dollars. To put that in perspective, it’s roughly triple the amount of money that the Fed created in its first 95 years of existence. So the Fed crammed three centuries’ worth of growth in the money supply into a few years.

And since then, the Fed has had a further four rounds of quantitative easing. (Quantitative easing is a form of unconventional monetary policy in which a central bank purchases longer-term securities from the open market to increase the money supply and to encourage lending and investment.)

The textbook definition of inflation has been “too many dollars chasing too few goods.” But with the Federal Reserve increasing the money supply, they have created their own Armageddon by keeping rates so low for such a long time it has made it nearly impossible to raise interest rates without causing panic. 

At the Federal Reserve Board meetings concerning qualitative easing, only one board member out of twelve consistently voted against easing. That was Thomas Hoenig, President of the Federal Reserve Bank of Kansas City. The record shows that Hoenig was worried primarily that the Fed was taking a risky path that would deepen income inequality, stoke dangerous asset bubbles and enrich the biggest banks over everyone else. He also warned that it would suck the Fed into a money-printing quagmire that the central bank would not be able to escape without destabilizing the entire financial system. In 2011 Hoenig retired from the Fed. (As he predicted, the round of quantitative easing he voted against was just the beginning).

In late 2018, for example, the stock and bond markets fell sharply after the Fed began steadily raising rates and reversing quantitative easing by selling off the assets it purchased (a maneuver it dubbed “quantitative tightening”). Fed Chair Jerome Powell, chairman of the Fed since 2018, quickly halted those efforts.

Who benefits?

The question Americans should be asking now is “Cui Bono” which means “To Whose Benefit?” So let’s examine Cui Bono and see who comes out ahead on keeping interest rates low

• The only part of the economy that seemed to benefit was the market for assets. The stock market more than doubled in value during the 2010s. Corporate debt was another super-hot market, stoked by the Fed, rising from about $6 trillion in 2010 to a record $10 trillion at the end of 2019.
• Mortgage rates, according to Bankrate, are 2.756% for a fixed rate while bank certificates of deposit for five years are just above 1% — which doesn’t give much incentive to savers. These low rates allow borrowers to purchase more expensive houses while paying lower mortgage fees, causing home prices to rise.

The Federal Reserve’s unwillingness to raise interest rates these past ten years has now come back to where they have no choice whether it causes a jump in inflation or not. The prospect of high-interest rates or high inflation is something the Fed must face soon.  

How to stop inflation

In 1979 President Jimmy Carter named Paul Volcker as the new chairman of the Fed. Volcker’s defining achievement was his success in ending an extended period of high inflation. He prevailed by delivering shock therapy and raising rates that peaked at 21.5% percent later that year. Even though his policy created a deep recession in 1980-81, he succeeded because Americans abandoned their entrenched expectation that prices would keep rising rapidly. 

His victory inaugurated an era in which the leaders of both political parties primarily deferred to the central bank, allowing technocrats to chart the course of monetary policy with little political interference. While driving up interest rates, saving rates also kept pace, with some saving rates going as high as 15.5%, finally paying savers what they deserved. 

These past ten or more years, savers have been subsidizing low-interest rates so that people can buy a more expensive house or car while causing savers to lose money by saving because saving rates have not outpaced inflation. It’s time for savers to be paid a fair price on their savings while borrowers should also pay a fair price for borrowing.