The Fed may have to blow up the economy to get inflation under control. It’s also time to start thinking about how you and I might make our own decisions when it comes to investing, consumption, investment and debt.
The Fed’s monetary policy committee has finally agreed to consider the possibility of winding down its monthly bond purchases. If you go through the math, then yes, the Fed may actually have to let the economy free itself from its inflation trap.
Before doing so, however, the Fed would have to either have to drastically reduce its $85 billion monthly bond purchases (which were a lifeline for the system for more than two years) or raise interest rates to get the inflation rate below the 1 to 3 percent target.
That’s the case the central bank is looking at. And to make it happen, the Fed will have to increase interest rates substantially (although the Fed would have to do a lot of that) and/or sharply cut its bond purchases (although the Fed would have to do that as well).
It’s a lot to digest, so let’s start with this simple math:
We’ve reached an all-time record low for the unemployment rate. The economy hasn’t even begun to expand yet, and the unemployment rate is at 5 percent, which means it’s not even close to starting to recover.
The Fed is still very unlikely to cut bond purchases to get us toward the goal of 2 percent inflation, at least not in the near term. But in a worst-case scenario, a much smaller amount of money is being pumped into the system through the bond purchases — around $50 billion a month.
At that pace of spending (which would require an unprecedented change to economic policy), the Fed would be able to get inflation on track to below 3 percent for the foreseeable future.
Of course, to get inflation down to a rate of 2 percent or below, the Fed will have to cut the amount of money it pumps into the system by at least half the amount it is pumping into it now.
To do that, the Fed would have to either increase interest rates all the way up to 4 percent or cut the amount of money it’s pumping into the economy by at least $40 billion a month.
But as we said above, the Fed hasn’t decided how much of the money it’s pumping into the system it