Inflation is now increasing at an annual rate of 6.8% as of November 2021.  The Federal Reserve is getting serious about not only ending new bond purchases (quantitative easing) but also about beginning to raise interest rates as soon as March 2022.  Raising interest rates is, of course, the main tool the Fed has for combatting inflation.

President Biden blames inflation on price gouging by businesses such as meat- packers.  But businesses have to respond to market forces.

The real cause of inflation is that consumer demand is growing faster than usual while supplies are less than normal.  Why is this happening?  It is largely because of actions taken by Congress during the past two years of the pandemic.  In fiscal years 2020 and 2021, deficit spending totaled about $3 trillion each year (see chart).  Much of this spending went to individuals in the form of direct payments into their bank accounts.  Unemployed workers also received an extra federal unemployment stipend of $300 per week which served as an additional disincentive to return to work.  Furthermore, a more generous child allowance also created a disincentive to work.

These cash payments to tens of millions of individuals plus the additional disincentives to return to work helped create the imbalance between (increased) demand and (reduced) supply, exacerbated by too few workers.

There is still a 3.6 million worker gap between February 2020, right before the pandemic started, and the present, December 2021 (see chart). This worker shortage will be harder to make up because the unemployment rate (as of December 2021) has shrunk to 3.9%.  In other words, there aren’t a whole lot of workers now looking for jobs.

The demise (if it holds) of the Administration’s Build Back Better social spending plan will help to get sidelined workers back into the labor market.  The current level of almost 11 million job openings is also a big contributor to the supply chain breakdown.

Conclusion.  Inflation is harmful to the economy for many reasons.  It is a tax on the poor as well as making our national debt problem much more serious.  It has now been kicked off by blowout Congressional spending.  The Federal Reserve will have to intervene forcefully to stop inflation, risking a severe recession in the process.

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