Section 1.1: Consequences of the Fed's Pause

The Federal Reserve's premature relaxation of its tight monetary policy is concerning. After ceasing 75-basis point hikes last year, the Fed has now completely halted any increases. This inaction is likely to fuel excess demand and drive inflation rates even higher. More alarmingly, it fosters a mindset where Americans may start to view significant price and wage increases as the new normal, making it challenging to reverse.

As previously discussed, the inflation witnessed since January 2021 stems largely from excessive demand. Over the last four years, the federal government has engaged in deficit spending amounting to $9 trillion—an astonishing figure for a $24 trillion economy.

Meanwhile, the Federal Reserve's monetary policy has been shockingly lax. With the economy growing at 6% in 2021, the Fed kept interest rates at near-zero levels throughout the year and into mid-2022, despite the massive governmental deficit spending.

In an effort to stabilize the markets, the Biden administration was spending around $250 billion monthly, while the Fed bought $240 billion of that debt each month by creating money electronically. Such an increase in the money supply has led to further excess demand.

By June 2022, the Fed finally recognized that maintaining price stability is essential for its monetary policy—a realization seemingly overlooked for over a year. With inflation peaking at a 9% annual rate, urgent measures were necessary. I have maintained that the Federal Funds Rate needs to reach at least 6% to combat inflation effectively. The longer we delay achieving this target, the more deeply inflation becomes embedded in our economy.

Had the Fed opted to delay its pause on the 75-basis point rate hike for just another month, we might have already seen a 6% Federal Funds Rate, leading to a more controlled inflation environment.

As Ronald Reagan famously stated, inflation is akin to a cancer that must be addressed promptly and decisively. Because the federal government hesitated in 2021, inflation is now infiltrating the thought processes of consumers and workers, instilling an inflationary mindset.

Section 1.2: Consumer Behavior and Price Increases

As inflation psychology takes hold, consumers become less rational in their purchasing decisions. Typically, a rational consumer would resist a price hike. For instance, consider someone who regularly buys a bottle of red wine priced at $10. If the price rises to $12, they would likely question this increase and explore alternative options.

However, once inflation psychology sets in, consumers may think, “Prices are rising everywhere, so I should buy now before it goes up again.” This mindset increases demand and pushes prices even higher.