The Fed Can’t Stop Supply-Side Inflation
The Fed and other central banks have zero control of supply-driven inflation, period.
America’s financial punditry is bewitched by four fatal fantasies:
1. Inflation is demand-driven. If the Federal Reserve (or other central banks) reduce demand with monetary tools like raising interest rates, inflation will cool.
2. Substitution of high-cost goods with lower-cost goods reduces inflation, and substitution is infinite: there’s always cheaper chicken if beef gets too pricey.
3. Higher prices will lead suppliers to increase production, which will increase supply and reduce prices.
4. The Federal Reserve has control of all these inflation-reducing dynamics via interest rates and its balance sheet (buying or selling various durations of Treasury bonds).
All of these are fantasies, fantasies that are fatal because they’re flat-out false. The Fed has no control over supply-driven inflation, which is what we have now. Consider eggs. The price has skyrocketed not because consumers suddenly ramped up demand that is now outstripping supply, but because essential inputs to supply such as feed and energy have soared in price and constraints that have nothing to do with interest rates such as the spread of bird viruses.
These essential inputs are going up in cost due to factors completely unrelated to interest rates or monetary policy. Drought and weather extremes are constraining the supply of animal feed stocks, and energy prices are being driven by geopolitical forces completely outside central bank control.
Infinite substitution is also false. What’s the substitute for eggs? Silkworm goo squeezed into plastic eggs? Well, not yet… there are no substitutes for eggs. And with the soaring input costs of producing chickens, chicken is no longer that cheap.
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