Writer explains what is being done to reduce inflation.
BY GEORGE BERNARD ’23
When speaking at the Brookings Institution on Nov. 30, Federal Reserve Chair Jerome Powell said that he believes that he and his colleagues can successfully thread the needle between bringing inflation down and hampering growth. Many people have at least a basic understanding of how inflation works: the overall price of goods and services through the economy increases, reducing the purchasing power of a fixed amount of money. But understanding of how monetary policy is being used to fight inflation is much less widespread.
Maximum Employment
This is generally self-explanatory, but maximum employment does not mean 0% unemployment. The unemployment rate is currently 3.7%, which is mildly low, the Federal Reserve estimates that it will level off at 4%. Too much employment is bad because companies are prevented from growing and hiring if too few people are looking for work.
Price Stability
Price stability is really just code for 2% inflation, which is optimal for growing an economy. When inflation rises, consumers are hurt because everything gets more expensive, stretching people’s wallets thin. If inflation gets too low and becomes negative it is called deflation, which causes money to become worth more. This may initially sound appealing, but because most people have debt, whether it is student loans, a mortgage or credit cards, deflation causes the amount of money people owe to effectively increase while wages stagnate, which is very dangerous to the economy.
On the ground
Despite the troubles of inflation, the labor market is doing exceptionally well, especially for workers. For every unemployed person, there are 1.7 job openings and there are 4 million more jobs than workers. Job growth also remains strong. Most encouraging of all, wage growth for low earners is exceeding inflation due to competition for workers.
What is being done?
As highlighted in Powell’s speech, the Federal Reserve has raised the Federal Funds Rate by 375 basis points since March (100 basis points = 1%). The Federal Funds Rate is the interest rate used by banks when they lend to each other overnight to meet their reserve requirements, and it forces banks to have higher interest rates on loans they offer. These higher rates make it more expensive to buy a house or car, start a business, or attend post-secondary education, causing people to spend less, slowing the speed that money travels through the economy and thus lowering inflation.
“We need to raise interest rates to a level that is sufficiently restrictive to return inflation to 2 percent,” Powell said.
Powell is working to find the point where inflation starts to decrease expeditiously without moving so fast that they overshoot, excessively restricting borrowing and slowing the economy more than needed.
Who is helping?
The Federal Reserve is a government entity created by Congress with two jobs (1) price stability and (2) maximum employment. There are 12 members on the Board, which makes decisions on policy; it is led by Chair Jerome Powell.