The Federal Reserve's premature victory lap over inflation reveals a worrisome misunderstanding of the predicament we still find ourselves in. Unprecedented government spending and debt, combined with mounting fears that the debt can't (or won't) be repaid, played a misunderstood role in inflation's rise several years ago. As such, fiscal policy must be part of the solution.
Otherwise, expect the recent acceleration of inflation to stick around or get worse, bringing trouble for the new administration.
The pressure on the Fed to declare the race over and continue lowering interest rates is real. It would be a mistake to cave any further. Some measures show inflation holding steady. Others show it trending back up since last July. Either way, it's above the Fed's 2 percent target, and now the 10-year rate is pointing up.
To understand what's going on, remember how we got here.
When COVID-19 and the overreaction of lockdowns arrived, Washington dramatically increased spending through stimulus checks, enhanced unemployment benefits and other means. Spending rose by over $5 trillion, with the Fed accommodating much of that.
Congress and the Biden administration later added another $4 trillion in various large legislation. Unlike previous crises -- recall former President Barack Obama's promise to halve the deficit within five years of the end of the Great Recession -- there was no plan to offset the spending hikes by raising revenue or cutting other spending.
In fact, it was the opposite. The Biden administration doubled down with more plans for student loan forgiveness and talk of handing additional billions to semiconductor manufacturers through a second CHIPs Act.
When bondholders don't see a credible fiscal path to be repaid for current and future government debt, they expect that eventually the central bank will create new money to buy those government bonds, leading to higher inflation. It didn't help that the Fed kept interest rates so low for so long, including ...
No hoodwinking or hornswoggling here.
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