Thursday, August 4 2022

Since the skyrocketing rate of inflation in the United States is greatly boosted by shortages on the supply side, it will not be reduced by monetary policies that suppress demand. The situation calls for measures to alleviate supply-side bottlenecks and increase the number of available and willing workers.

NEW HAVEN – As inflation in the United States reaches new heights, economists are debating the level to which the Federal Reserve will need to raise interest rates to dampen demand and dampen price growth. Some commentators believe that the Fed will have to be as aggressive as Fed Chairman Paul Volcker in the early 1980s, who ended up raising interest rates as high as 20%.

Such figures naturally raise fears that efforts to contain inflation could lead to a recession and a sharp rise in unemployment. As a recent Peterson Institute for International Economics guidance note observes, reductions in job vacancies caused by restrictive policies are empirically associated with increases in unemployment.

Worse still, while interest rate hikes would likely increase unemployment over time, they will be insufficient to contain inflation in the near term. Recent price increases may have been triggered by extraordinarily high demand in the wake of the pandemic, but supply-side factors – particularly labor shortages and the energy crisis caused by the war of Russia in Ukraine – also played an important role. Inflation can only be contained if these factors are also taken into account.

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