In the recent easing of inflation, the spotlight should be on the Federal Reserve’s decisive monetary actions, not the often-cited supply chain improvements, suggests Alexander William Salter, a senior fellow at the American Institute of Economic Research. In a revealing piece published by the think tank, Salter credits the Fed’s aggressive tightening campaign for reining in U.S. demand and subsequently slowing inflation.
This perspective challenges the commonly held belief that the primary driver of current disinflation is the repair and expansion of supply chains. Salter’s argument stands in contrast to narratives from figures like Treasury Secretary Janet Yellen and a September report from the Roosevelt Institute, which attributed the majority of the price downturn to supply-side developments.
Salter points out a critical inconsistency in this supply chain narrative. While it’s true that alleviating supply constraints can slow down price growth or even lead to price drops, this hasn’t been the primary factor behind the recent inflation slowdown. Even as shipping and energy costs have decreased post-pandemic, goods prices have stayed high, defying the expected symmetry.
Analyzing the relationship further, Salter explains that a 1% increase in total supply growth should theoretically lead to a similar decrease in the inflation rate. However, current GDP growth rates, a basic indicator of supply, don’t support this scenario. “The gap between the theory and the actual data is too wide to attribute the inflation slowdown to supply-side improvements alone,” he asserts.
Instead, Salter suggests looking at the Federal Reserve’s role in all this. He argues that the post-pandemic inflation spike is more logically linked to the increase in federal spending during COVID-19. The counterbalance to this, and the subsequent disinflation, is primarily due to the Fed’s interest rate hikes totaling 5.25 percentage points over 16 months, coupled with reductions in the central bank’s balance sheet. These measures have effectively shrunk the national money supply, with a notable 3.3% decrease from the previous year.
“If we’re looking for a demonstration of demand slowdown, this is it,” Salter emphasizes.
His analysis reaffirms traditional macroeconomic principles connecting total demand growth with inflation, principles that have been under scrutiny as price growth seemed less tied to demand and employment in recent times. “This experience with inflation could be seen as a validation of the macroeconomic theories we’ve been teaching since the 1980s,” he notes.
However, Salter acknowledges that the debate is far from settled. Emerging research points to a more prolonged and significant impact of supply chain challenges than initially believed, potentially playing a bigger part in driving up prices. This ongoing conversation suggests that while the Fed’s actions are undoubtedly influential, the complexity of economic dynamics means that multiple factors could be at play in the current state of inflation.