How Fed-Induced Inflation Hits Your Wallet

A common sound bite today is that the Federal Reserve’s recent interest rate hike is pushing the country into recession. But that’s like starting a book on page 813. The root of today’s economic malaise is prolonged and massive federal budget deficits, combined with a Fed willing to fund those deficits. This is precisely what we have seen over the past two years.

Many on the political left flatly deny this reality, but many on the political right also misunderstand what is going on. The combination of fiscal and monetary policy is more subtle and complex than simple but superficial policy talking points.

One of those hackneyed phrases is that the Fed “fixes” interest rates. Not exactly. The Fed sets the rate it charges for short-term loans to financial institutions, but it can only target other rates outside of its direct control. This means that the Fed is acting to influence rates, not to set them, with the most watched interest rate being the rate that banks charge each other for short-term loans.

The Fed influences this rate by buying and selling financial securities (debt instruments). When everyone buys and sells those same securities, money simply changes hands, but when the Fed does, money is made or extinguished.

>>> The Fed’s monetary embezzlement will cost you dearly

This phenomenon occurs because the Fed’s money account has no balance, so when the Fed issues checks from its account, money is literally created, like cashing out a printing press. Likewise, when money enters the account from outside, the money disappears, like cash in a fire; the account balance is perpetually zero.

Through this mechanism, the Fed can theoretically flood the market with liquidity in times of crisis, thus avoiding bank runs. Similarly, the Fed can then absorb this excess liquidity as soon as the financial markets have stabilized, thus avoiding inflation.

But today’s Fed lacks the discipline to turn theory into reality.

No man can serve two masters, and the same goes for institutions like the Fed. Instead of maintaining a laser focus on inflation, he has been preoccupied with placating Congress and the Biden administration, kowtowing to leftist talking points on topics such as diversity. Worse still, the Fed funded excessive spending in Washington by creating money for two years, and that caused inflation.

Even as the Fed moves slowly to put out the inflationary fire it has ignited, it is working against the grain to continue federal deficit spending. This is because the Fed targets interest rates, not inflation rates – another subtle difference.

As the federal government continues to pile up debt, it constantly borrows billions of dollars, draining that money from the capital markets. As savings (loanable funds) become scarce, their price increases; this price is known as the interest rate.

When the government borrows more money, it drives up the interest rate and the Fed has to add liquidity (print more money) to keep interest rates from rising above its target. As a result, the Fed’s approach of targeting interest rates in the face of rising government deficits and debt has had minimal impact on inflation. The Fed robs Peter to pay Paul.

But the Fed is slowly catching up, as it has in the past, and aiming for ever-higher interest rates in response to endless borrowing by Congress and the President. Extracting excess money from the economy will reduce inflation, but the collateral damage, as has always been the case under the Fed, is recession. The slowdown will be borne by American families.

>>> Let them have inflation

As interest rates rise, borrowing costs rise. When people with adjustable rate mortgages see their monthly payments soar to unaffordable levels, these homeowners quickly realize that they ultimately don’t own their home.

Seizures are already increasing. Credit card debt, which has been growing at some of the fastest rates ever, is also becoming unaffordable as interest charges on unpaid balances soar.

American families, already strapped for cash after inflation ate away at their disposable incomes, now have less money to cover ever-increasing interest charges on car loans, mortgages, credit card debt credit, student loans and more. Unable to afford as much as before, the consumer must cut spending, which Washington should do.

Since consumer spending accounts for about three-quarters of GDP, this contracts the economy, leading to layoffs and unemployment. The unemployed have even less money to spend, which compounds the problem. Thus, we come to the downward spiral, which is already underway.

Ultimately, Fed-funded government borrowing breeds higher interest rates, which in turn breeds recession. The tree of a profligate federal government bears its rotten fruit, and Americans will be forced to eat the bitter produce.

About Alexander Estrada

Check Also

Time to Listen to Farmers, Ministry of Agriculture

AT the final Ongpin (Disclosure: An Ateneo School of Government Annual Lecture in memory of …