Powell Must Choose: Fiscal Restraint or Runaway Inflation

by James L. Caton
The American Institute for Economic Research

Federal Reserve Chair Jerome Powell initiated a program of quantitative easing (QE) in March. QE programs have typically combined monetary expansion with the payment of interest on excess reserves to offset the expansion’s influence on economic activity. But, unlike past QE programs, Powell’s expansion has allowed for an increase in M2 of more than 18 percent.

The aggressive expansion supported price increases after a sharp decline in annualized inflation of 5 percent in March and nearly 10 percent in April. In June, annualized inflation rose above 6 percent, a stark reversal. If this trend continues for a few months, Powell must make a choice. As nominal income returns to trend, owing largely to support from monetary policy, Powell will either have to increase interest rates or else allow inflation to increase. While allowing interest rates to rise might be painful in the short term, allowing inflation to get out of hand could unanchor inflation expectations, leading to irreversible damage.

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