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Tags: inflation | psychology | prices | federal reserve

Fed Must Act Now: Inflation Psychology Is Building.

Fed Must Act Now: Inflation Psychology Is Building.
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Michael Busler By Friday, 21 May 2021 06:05 PM Current | Bio | Archive

Since January, the inflation rate has been almost 6%. The rate has been around 2% or so for the last decade. The Federal Reserve (Fed) usually sets price stability as its primary goal, so you would think they would act. Every Fed chair always wants to head off inflation. Everyone except the current chair.

In the early 1980s the Fed began to more strictly regulate the money supply. Based on their prior experiences, especially during the inflation filled 1970s, they knew to allow the money supply to grow by an amount sufficient to grow the economy, but not enough to cause inflation.

When data indicated that there were inflationary pressures building, as often noted by rising prices for housing and energy, the Fed would always be in front of it. They would take action even with the anticipation of inflation. They can, and have, reversed policy if necessary. But the primary goal was always price stability.

That does make sense. The other goals of the Fed are economic growth and full employment. The policy actions to reduce inflation could also reduce growth and reduce employment. Since unstable prices affect all of us and since slow growth with higher unemployment affects only a portion of the population, inflation was rightfully the highest priority.

Although some members of the Fed have hinted at actions, Chairman Powell continues to say that the Fed is not planning any action that reduces money supply growth or raises interest rates. In some of his speeches he has even suggested that the low interest rates could be here for more than a year.

To be fair, he has also said that his position could change. If that is true, he should realize that now is the time to change. The Fed should at least begin to reduce their up to $120 billion monthly purchase of government bonds. That continued increase in the money supply, which has already grown by 25% in the last two years, will be inflationary.

The Fed should also begin to nudge up interest rates. A quarter-point increase now and then a quarter-point increase every three or four months. That should be sufficient to reduce inflation without taking too much demand out of the economy which could slow growth. This is exactly what the Fed did in 2016-2018.

Economic growth, which was 6.4% in the first quarter of this year, will likely be in the 8% range or higher this quarter. Then we will see growth in the 10% range for the remainder of the year. That means our output level will be above pre-Covid levels and the unemployment rate, as long as there is no incentive to remain unemployed, will fall under 5%.

With energy prices rising, the federal government budget deficit in excess of $3 trillion for the second year in a row and the explosion in the growth of the money supply inflation is already rising and will rise even more in the future.

The gradual steps taken by the Fed will also reduce the risk of the currently rising inflation psychology. While all of the contributors to the inflation problem can be contained the most difficult and damaging is the problem of inflationary psychology. Once that builds inflation starts to get into higher numbers.

What is an inflation psychology?

Let’s say someone goes into a store and a new product catches her eye. She walks over, reads the package and then thinks about how she would use the product. Then she looks at the price. The item is $10. She decides to buy it because she says that this product is worth $10 to her.

The next month she comes to the store to buy the product and it costs $11. Normally she would wonder why the price went up and whether it is worth $11. Usually people will refrain from buying to perhaps looks for substitutes or to wonder if it is worth the higher price.

That’s normal consumer behavior. However, once the inflation psychology takes hold, when a higher price is encountered, the inflation-weary consumer would think that she “better buy it today, because the price will be higher tomorrow.”

This expectation of higher prices results in consumers accepting and paying the higher price. That is the inflationary psychology.

A small nudging up of the interest rates could be enough to at least slow any inflation expectations. It would also least slow the housing price inflation.

The time to act is now.

Dr. Michael Busler, Ph.D., is a public policy analyst and a professor of finance at Stockton University in Galloway, New Jersey, where he teaches undergraduate and graduate courses in finance and economics. He has written op-ed columns in major newspapers for more than 35 years.

© 2021 Newsmax Finance. All rights reserved.


MichaelBusler
Since January, the inflation rate has been almost 6%. The rate has been around 2% or so for the last decade. The Federal Reserve (Fed) usually sets price stability as its primary goal, so you would think they would act. Every Fed chair always wants to head off inflation....
inflation, psychology, prices, federal reserve
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2021-05-21
Friday, 21 May 2021 06:05 PM
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