An inflationary fire is raging in the economy. The inflation rate is up to 7.9%, the highest since 1982. And it’s going to keep rising. Pundits and politicians are blaming all sorts of things for escalating inflation—including supply chain disruptions, corporate greed, and now the war in Ukraine. But they should be laying the majority of blame squarely where it belongs: with the Federal Reserve.
Of course, Fed officials aren’t blaming themselves for inflation. Rather, Chairman Jerome Powell blames inflation on shocks to the economy that are largely outside the Fed’s control. Powell’s statements give the impression that inflation just sort of happens somehow in the economy, then it’s the Fed’s job to extinguish it.
In reality, the root of inflation is excessive money creation by the central bank. When the money supply increases faster than the output of goods and services, people spend the excess money. This causes prices to rise and the value of money to fall.
The “inflation happens” rhetoric of Powell is similar to that of Arthur Burns back when he was chairman of the Fed during the Great Inflation of the 1970s. Burns blamed inflation on the diseases of monopolies, unions, and oil supply and wage shocks. Burns didn’t think his monetary policy had anything to do with inflation and called for price controls to fight it.
Things changed when Paul Volker replaced Burns as chairman in 1979. The Fed finally accepted responsibility for causing inflation and stopped creating new money so rapidly. Consequently, inflation slowed.
Neither the Great Inflation of the 1970s, nor the current inflation, can be explained solely, or even primarily, by supply disruptions. The reason is that, during both episodes, the overall dollar value of spending in the economy—which economists call nominal spending—increased rapidly. A negative supply shock doesn’t increase nominal spending. It causes the prices of goods to rise, but the quantity of goods bought falls by an offsetting amount, so the total dollar value of spending stays the same.
Historically, sustained inflation is always produced by higher government spending and money growth. And that is exactly what’s happening now, as evidenced by the 11.8% growth in nominal spending this year, the highest rate since 1984.
The problem is not that the Fed has been too slow to put out the inflationary fire. The problem is, the Fed is pouring gasoline on a fire it lit.•
Bohanon and Curott are professors of economics at Ball State University. Send comments to email@example.com.