According to new research by the Cato Institute’s Center for Monetary and Financial Alternatives, the answer to the question “Can the Federal Reserve control inflation?” is no. Jai Kedia writes at Cato:
Research by Cato’s Center for Monetary and Financial Alternatives (CMFA) shows that there is not much empirical support for the notion that the Fed can precisely control inflation.
Earlier this year, Cato published a paper that suggested monetary policy was the least important contributor to inflation, far behind both demand and supply factors in the economy. However, that paper used a simple approach (known as a VAR methodology) to study the sources of inflation. Cato CMFA’s newest research paper addresses this weakness and provides more robust evidence that the Fed cannot precisely control inflation.
Unlike the previous approach, the new working paper uses a sophisticated macroeconomic model, one that includes a variety of features to capture facets of the US economy accurately. The results are very similar to the first study—supply factors dominate the overall changes in inflation, both when looking ahead at inflation forecasts and when analyzing actual inflation in the US since 1960.
Figure 1: Main Driving Forces of US Core PCE Inflation, 1960 to 2019
As Figure 1 shows, from 1960 to 2019, monetary policy has had a limited impact on inflation, increasing with the horizon of the forecast but never exceeding 5 percent. Supply factors— particularly goods market supply factors in the short run and labor market wage factors in the long run—affect most of inflation. Supply factors together account for 85 percent to 90 percent of inflation. As Cato scholars have pointed out for decades, monetary policy is particularly helpless in the face of supply‐driven inflation.
Action Line: Trying to use price controls on money to manipulate the economy probably works about as well as other price controls on goods and services do, i.e., not well. You can’t rely on the Federal Reserve to clean up a problem it helped create. Instead, save til it hurts and try to avoid big mistakes with your money. Click here to download my free special report on the Top 10 Investing Mistakes to Avoid.
E.J. Smith is Founder of YourSurvivalGuy.com, Managing Director at Richard C. Young & Co., Ltd., a Managing Editor of Richardcyoung.com, and Editor-in-Chief of Youngresearch.com. His focus at all times is on preparing clients and readers for “Times Like These.” E.J. graduated from Babson College in Wellesley, Massachusetts, with a B.S. in finance and investments. In 1995, E.J. began his investment career at Fidelity Investments in Boston before joining Richard C. Young & Co., Ltd. in 1998. E.J. has trained at Sig Sauer Academy in Epping, NH. His first drum set was a 5-piece Slingerland with Zildjians. He grew-up worshiping Neil Peart (RIP) of the band Rush, and loves the song Tom Sawyer—the name of his family’s boat, a Grady-White Canyon 306. He grew up in Mattapoisett, MA, an idyllic small town on the water near Cape Cod. He spends time in Newport, RI and Bartlett, NH—both as far away from Wall Street as one could mentally get. The Newport office is on a quiet, tree lined street not far from the harbor and the log cabin in Bartlett, NH, the “Live Free or Die” state, sits on the edge of the White Mountain National Forest. He enjoys spending time in Key West (RIP JB) and Paris.
Please get in touch with E.J. at ejsmith@yoursurvivalguy.com
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