The Federal Reserve And The Inflation Problem

Economy, Inflation Problem

During the 2008 recession, the rate of inflation for the country dipped shortly and has remained below the 2% target set by the Federal Reserve ever since. The lower rate of inflation was initially explained away as being caused by the weak economy but as the economy continues to strengthen the true cause of the still low rate of inflation is becoming a source of puzzlement.

Perhaps the answer lies in the fact that the Federal Reserve is using inept models for economics that provide no real life effect on fiscal policy.

The model of choice for current Federal Reserve chairperson Janet Yellen is the Phillips Curve. According to this model, inflation is the result of pressure placed on wages and price by tight labor markets. The theory goes that inflation will fall during recessions because it is at these times that unemployment is higher.

The failure of inflation to rise as the models have predicted has caused a great search from Yellen and others at the federal reserve for an explanation as to why.

The answers to the riddle that the federal reserve seeks answers for quite possibly rest in the mirror.

The first question that should be asked is for what reason would the Federal Reserve take on the task of establishing an acceptable number for inflation.

Members of the federal reserve believe that inflation is a direct function of monetary policy. Historically, the evidence has proven this to be true. So this would mean that the root cause of inflation remaining so low for such an extended amount of time is due to Federal Reserve policies that are instigating this situation. Ultimately it is the Federal Reserve that sets the policies that will influence the rate of inflation.

If Yellon and other reserve members want to see inflation rates travel past the 2% mark they would do better to jettison the Phillips Curve model and pay close attention to how actual response of the economy to fiscal policy decisions.

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