Whipping Inflation

Whipping Inflation

May 02, 2022

Ultimately, inflation is always and everywhere a monetary phenomenon, as the late great economist Milton Friedman used to say.  And so the key to reducing the inflation we're experiencing today – the highest inflation in forty years – is the Federal Reserve raising short-term interest rates, like it will do on Wednesday, as well as pursuing an aggressive course of Quantitative Tightening.

But the central importance of monetary policy doesn't mean other policies can't play any role at all wrestling inflation under control.  Central banks don't just exist on the blackboards of academic macroeconomists; they exist in the real world where other officials adopt policies that sometimes make central banks' jobs easier and sometimes make them harder.

One key issue is the size of government, both spending and regulation.  When the federal government spends money like a drunken sailor, as it did during COVID lockdowns, a central bank policy that sets short-term interest rates at essentially zero is going to generate a larger increase in the money supply and, in turn, a larger increase in inflation, than would otherwise be the case.  Think of extra government spending as monetary kindling.  It doesn't create fire by itself, but it does make it easier to spread.