The Fed is facing a dilemma: Whether to tighten monetary policy or not. This has been the subject of debate in the wake of the new omicron variant of the coronavirus. Even though the unemployment rate isn’t quite where the Fed wants it to be, the Fed is being forced to end their bond buying program to combat inflation. The question is: was it the right choice?
The stimulus program and inflation
The omicron variant of the coronavirus is making people come to a slow realisation: The coronavirus is here to say. Nobody can say for how long exactly and in what intensity, but one thing is certain, it is here to stay for longer than many people thought.
When the coronavirus pandemic started, it did two things: It halted the production (and thus the supply) of goods and restricted the availability of services, because coming too close to each other was considered a severe threat. This made firms and by extension, consumers, lose money. When firms were concerned about the virus, they restricted production. When production is restricted, many workers are not needed. The workers that were not needed were fired and were at risk of becoming permanently unemployed. Hence, the rising unemployment. To combat a massive economic crisis and extreme poverty, governments around the world stimulated the economy to keep everyone happy. This was done using stimulus packages and bond-buying programs. This kept the economy relatively stable, but it also had another consequence: After the first wave of the pandemic, demand outpaced supply, people still had money to spend because of the stimulus programs and as a result, products became more expensive. This is the inflation everyone is currently talking about. In fact, it has recently hit a 39-year high.
To keep people calm, the Fed (the central bank of the USA) said that it was sure inflation would recede naturally. Unfortunately, this was not the case. It kept rising as the supply-demand problem still wasn’t solved. The Fed slowly realised that it had to do something but was still incredibly hesitant. But, why were they so hesitant? Can inflation measures backfire?
Inflation measures and the consequences
When people talk about inflation measures, it usually means raising interest rates or tapering asset-purchasing programs. Both of these measures are used to stop the availability of money in the economy. The Fed could have made use of these measures earlier. However, the omicron variant has complicated things. Even without a new variant, the pandemic makes imposing measures incredibly risky.
Let’s look at the good consequences of inflation measures: It actually does work. Inflation is fuelled by an ample supply of money in the economy. This causes raised prices which results in a chain reaction of raised prices until the public runs out of money. However, by making it clear that the USA would stop this increase of money in the economy, firms would realise that they should keep prices stable, because if there isn’t more money, no one will actually by your product. This could have a grave consequence on the unemployment rate, though. The unemployment rate has been rising for two reasons: the aforementioned firms wanting to fire people because of restricted production and because of something called the great resignation. The great resignation describes what many people have experienced in the pandemic: They finally thought about what they want to do. Before the pandemic, many were in a “rut” in which they saw little change in their lives and accepted it, but the changes that were brought on in the pandemic has left many thinking about what they really want to achieve. Many people have resigned from their job and still need to get back into the workforce. These people are thinking about potential areas which speak to them more than what they had previously been doing.
All of this had its effect on the unemployment rate, which has reached 4.2%. This number doesn’t take into account the people that participated in the great resignation. It still hasn’t reached pre-pandemic levels (3.5%), which has the Fed worried. Imposing measures might stall the return of the unemployment rate to pre-pandemic levels. Even worse, it may rise and the great resignation could continue. With the pandemic still ongoing, restricting money supply could force firms to fire even more workers.
This creates a dilemma for the Federal reserve: If it doesn’t impose measures, inflation could rise immensely which would be bad for the economy. Prices would rise until no one could afford anything without huge sums of money. On the other hand, it could impose measures. This would however also pose a threat for the economy, since the pandemic is still ongoing and the unemployment rate may be severely affected because of those measures.
Recently however, the Fed has made a decision: It has opted to impose measures on the pandemic this year. There are supposed to be 3 interest rate hikes in 2022 (the interest rate is the rate at which central banks lend money to other banks). Also, the end of the Fed’s asset purchasing program is supposed to be accelerated. This shows just how desperate the Fed is. They have taken the risks into account. The question is: was it worth it?
Did the Federal Reserve act correctly?
All things considered; it does look like the Fed made a good decision. The thing to keep in mind is, we have come pretty far when it comes to the Corona virus. The Omicron wave might be the last or one of the last waves of the pandemic. While extreme unemployment is a threat, the Coronavirus will eventually be weaker and weaker (herd immunity). Inflation could be here for years, so it was wise of the Federal Reserve to act against it. Unemployment is solved much more easily than inflation. Right now, the goal of the Fed shouldn’t be to solve both problems in the pandemic. It should be to stall until the pandemic is somewhat manageable throughout the whole year. Then, the Fed can make clear decisions without having to worry about extreme risks. The accelerated end of the Fed’s asset-purchasing program, is a sign that we ought to prepare for long-term inflation.
Comments