Jan 21, 2022 - Economy & Business

The high cost of bringing down inflation

Illustration of a large dollar bill sign balloon being held by a man who is floating slightly off the ground.

Illustration: Aïda Amer/Axios

Suppose the Federal Reserve had perfect foresight last year, and set out to keep inflation at its 2% target anyway — despite supply disruptions and labor shortages. What would that have looked like?

The answer: A catastrophe for growth, according to new research from the BlackRock Investment Institute. The Fed would have had to crater demand in the economy so much, that it would have pushed the unemployment rate to nearly 10%, the researchers estimate.

Why it matters: Inflation is making people miserable, but so long as it's caused mainly by supply problems, abrupt efforts to rein it in would be highly costly too — just in different ways.

  • It's a damned-if-you-do, damned-if-you-don't moment for economic policy.

The big picture: The inflation of this era is unlike that seen in the last three decades, the research arm of the giant asset manager concludes.

  • For most of that time, fluctuations in demand determined what happened to prices. When unemployment was too high, inflation was typically too low, so stimulus helped with both problems at once.

But now, inflation is largely being driven by the supply side of the economy. That means the usual economic policy tools to fight it will be underpowered, and possibly counterproductive, write Elga Bartsch, Jean Boivin, and Alex Brazier.

  • "If inflation is the noise from the economic engine, in the past it was caused by the engine revving too fast," they write. "For the foreseeable future, it is more likely to be due to the engine misfiring."

One implication: Excessive interest rate increases could actually be counterproductive for fighting inflation. That's because part of what needs to happen for inflation to come down is companies investing in areas of the economy straining under supply shortages.

The bottom line: Bringing this inflation down without causing a steep downturn will be an exceedingly delicate task.

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