The Fed & Inflation

by | Jan 19, 2022 | Wealth Management

By:  Thomas Steffanci, PhD, Senior Portfolio Manager

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Has the Federal Reserve (the “Fed”) caused the burst in inflation over the past year? Not Likely.

While the Fed can influence money supply (M1) growth, they can’t control how fast it is spent. Money velocity measures how many times a dollar of money supply circulates. If M1 growth rises but it is saved (a decrease in velocity), GDP and prices will stagnate. In the 1970’s (circle) both M1 and velocity rose, causing rapid inflation. Contrast that to today, where the Fed caused an historic expansion in M1 to counter the pandemic/recession. But until recently, inflation was quiet as households and businesses hoarded cash and velocity plummeted. The supply chain wreck caused by the pandemic have been the major factors in elevating inflation, not “excessive” M1 growth.

But this speaks of the Fed’s policy impact on inflation. If/when velocity rises as Covid subsides and lockdowns end, economic activity is likely to rise, lifting velocity, and that may frustrate the Fed’s attempts to control inflation. It would largely be out of their hands at that point.

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