Urgent Fed Action Needed to Combat Rising Inflation Risks
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Chapter 1: Analyzing the February Jobs Report
The recent February jobs report reveals that the US economy added a remarkable 678,000 jobs. While this figure would typically be viewed positively in a stable economy, the looming threat of skyrocketing inflation shifts the perspective. With inflation rates projected to reach double digits, this job growth indicates an overheated economic environment.
In January, the economy saw an addition of 467,000 jobs, with upward revisions for the prior two months. Such robust job creation is indicative of an economy expanding at a rate faster than previously estimated.
Section 1.1: CPI Release Expected to Shock
Economists generally agree that the economy is currently growing at a rate of less than 3%. However, the rapid job increases suggest a much more vigorous growth. The first official estimate for the gross domestic product (GDP) growth for the first quarter will not be available until late April.
Other data points to accelerated growth, which is welcome news if paired with price stability. Sadly, inflation is at its highest level in four decades and is anticipated to worsen. The upcoming release of the Consumer Price Index (CPI) will likely reveal a significant surge, with elevated rates expected to persist for the next three to four months, potentially leading to double-digit inflation by late spring.
Subsection 1.1.1: Understanding the Drivers of Inflation
While supply chain challenges contribute slightly to inflation, the primary culprits are energy and wage inflation. On the demand side, excessive government deficit spending and the Federal Reserve's reckless expansionary monetary policy have created substantial excess demand. Since the current administration shows no intent to reduce spending, the Fed must take decisive action to mitigate impending inflationary issues.
Section 1.2: Anticipating Fed Actions
Next week, the Federal Reserve is set to convene. Chairman Jerome Powell has indicated that the Board of Governors might consider a 25 basis point interest rate increase. However, given the current inflationary pressures and strong economic growth, a more substantial rate hike may be necessary.
Recall that the economy expanded by 5.7% last year after a contraction of 3.5% in 2020. Presently, economic output has surpassed pre-pandemic levels. There is no justification for the Fed to merely conclude its bond-buying program this month while maintaining near-zero interest rates. A 25 basis point increase is unlikely to sufficiently curb excess demand.
Chapter 2: The Consequences of Inaction
The Fed has claimed that its primary goal for the past two years has been achieving full employment. This means ensuring the economy can create enough jobs to meet demand, a target it reached last summer when job openings outnumbered the unemployed.
Had the Fed acted last spring by tapering bond purchases and gradually raising interest rates, current inflation could have been approximately half of what it is today.
To avert a potential wage-price spiral, aggressive action from the Fed in its upcoming meeting is critical to indicate that maintaining price stability is now their foremost concern.
If the Fed hesitates, inflation could escalate, leading to significant wage inflation as labor unions may demand raises of around 9.5% in response to a 7.5% inflation rate. Increased labor costs will force employers to raise prices, perpetuating the cycle of inflation.
The Fed's inaction could allow inflation to soar into double-digit territory. Once inflation reaches a certain threshold, the Fed will have no choice but to respond forcefully, risking substantial interest rate hikes. The last instance of such aggressive action in 1981 was followed by a recession.
Prompt and decisive Fed action is far more desirable.