The Fed Needs Help


Kevin Gale, Managing Director, Head of Fixed Income

Inflation has reached its highest levels since February of 1982, with the year-over-year CPI reading coming in at 7.5% in January 2022. How did inflation get to where it is in such a short time? Just prior to the nationwide shutdown in early 2020, inflation was running in the 2.0% to 2.5% range, right where the Fed would like it to be. The shutdown briefly pushed inflation to near zero, but that did not last long.

Once the nation went into pandemic-induced lockdown, both the Federal government, in the form of fiscal stimulus, and the Federal Reserve, in the form of monetary stimulus, took swift and decisive action. Since January 2020, the Federal Reserve’s balance sheet has exploded from $4.1 trillion to $8.9 trillion, as of February 7, 2022. In addition, Congress passed approximately $4.5 trillion in aid packages for American businesses and individuals in many different forms such as monthly checks and loan forgiveness.

In the fourth quarter of 2019, annual domestic GDP was running at a rate of $21.7 trillion. GDP plunged to an annual rate of $19.5 trillion in the second quarter of 2020 because of the nationwide shutdowns. With the significant stimulus and gradual re-opening of the economy, GDP began to recover and reached an annual rate of $24 trillion at the end of 2021, but about $8 trillion in different forms of stimulus had already been thrown at the economy. In hindsight, it appears more and more likely that the amount of stimulus provided was well more than what was needed.

After the global shutdowns in 2020, the “great resignation” ensued, causing labor shortages across just about every industry around the globe. Total employment in the U.S. alone dropped 3.1% from 157.5 million individuals at the end of 2019 to 152.7 million at the end of 2021. Getting workers to come back to the employment force is a difficult task that the Federal Reserve cannot control with interest rates. The lower employment has led to companies being forced to lower production, leading to supply chain bottlenecks around the world.

With Russia invading Ukraine, inflation will likely see further pressure to the upside. Oil and other commodities that come from that region have seen significant volatility since the invasion, as investors try to determine the likely impact on production and availability. Already challenged supply chains could see additional pressures, putting certain products at risk of shortages such as car parts, computer chips, oil, and agricultural commodities.

Raising interest rates may help tame inflation a little, but until the global supply chain is fixed, inflation is likely to remain elevated. By raising rates, the Fed can only hope to weaken demand, not increase supply. Congress initially helped put the Fed in this precarious situation and they need to help get them out of it. There are a few things Congress can do to help the Fed lessen inflation; pursue a balanced energy policy (we can pursue dual objectives of energy abundance and a clean environment), fix the immigration process so that workers that want to come to the U.S. can get here quickly, legally and easily, reduce the Trump-era tariffs (at least temporarily), amend or suspend certain regulations that could lead to increased costs for companies and finally provide incentives for businesses to bring production back onshore to lessen our reliance on (and transportation costs of) importing from other countries.

The Federal Reserve finds itself in an unenviable situation in that it is facing rising inflation, but can only influence the demand-side of the equation. Even so, everyone is looking to the Fed for answers. Until the supply side begins to increase, inflation is likely to remain elevated. The middle class is clearly feeling the impact of inflation as real wages (after inflation) are down 3.1% year-over-year. This puts strain on the consumer as more money goes to necessities such as food, gas, and housing, leaving less money for savings and other ancillary consumption items. It is time that Congress puts political party lines aside and takes action to help reduce inflation. It is all hands-on deck. We need to come together as a nation to meet the moment.

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