Driving Inflation Rates Up: The Federal Reserve’s New Monetary Policy
Inflation has always been the Federal Reserve’s boogeyman. For four decades, the bank has employed preemptive rate rises to keep inflationary pressure in check. Now, as a result of the Covid-19 pandemic, the Federal Reserve has reversed this policy and will tolerate higher periods of inflation in order to maintain low unemployment rates.
What caused this policy shift?
According to an analysis by the Federal Reserve Bank of San Francisco, the inflation rate in February was 1.9%, just under the Federal Reserve’s target rate of 2.0%. In April, economic shutdowns and other forces from the coronavrius pandemic made that rate fall to 0.9%, the lowest rate since the Great Recession. Countries like China, Japan, and the UK are also experiencing a disinflationary shock in their economies.
This disinflationary shock could have several negative impacts on the U.S. and world economy. As prices plummet on goods and services like hotel rooms and plane fares, households may put off purchases in anticipation of further disinflation. According to Bloomberg News, the “ebbing pricing power makes it harder for companies that piled on debt in the good times to meet their obligations”, and may lead to businesses declaring bankruptcy (Bloomberg News, 2020).
What will the Federal Reserve do differently?
The Federal Reserve will continue to keep interest rates low in order to incentivize investment and borrowing by households and firms. The Fed will also tolerate higher levels of inflation — even above the target rate of 2% — in order to focus on keeping unemployment rates low. They are hoping that increased investment and low unemployment will help lift the economy out of recession.
What does this mean for consumers?
Maintaining low interest rates will have a variety of effects on consumers. Short-term debt on credit cards or personal loans are at their lowest levels in years due to the Fed’s shift. This can boost consumer spending and kickstart economic recovery. This can offer some relief to people who have become unemployed during the pandemic by creating temporary relief on debts. Alternatively, the policy can affect how much income high-yield savings accounts make. As interest rates remain low, savings accounts will not produce high amounts of interest-earned income. Consumers with higher incomes will likely suffer more from this new policy as the value of interest-earned income will decrease.
Some economists doubt that the Federal Reserve can raise inflation rates any higher than they are now. Unfortunately, only time will tell if the Fed’s shift was successful in stimulating economic recovery and avoiding a long-term disinflationary shock on the national economy.
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