The Unintended Consequences of a War on Inflation


August 2, 2023 2:46PM

Over the last three years, high inflation has been a thorn in the side of Americans trying to make a living. While the phrase “high inflation” feels commonplace today, many may not realize what goes on behind the scenes in the attempt to fight it.

The Federal Reserve (Fed)—the U.S. Central Bank—conducts monetary policy and regulates the banking system. Since the 1970s, the Fed has operated under a “dual mandate,” a commitment to maintain low inflation and maximum employment.

Today the Fed is still working to mitigate the economic impact of COVID. In June 2022, inflation in the United States hit record highs not seen since the 1980s, and the Fed has been working to reduce it ever since. A year later in May 2023, Fed Chairman Jerome Powell announced that the Fed has increased banks’ interest rates to 5% and is continuing to reduce its securities.

In layman’s terms, by increasing the interest rates between banks, the Fed is discouraging demand among banks to borrow money. Similarly, the process of reducing securities means the Fed sells treasury bonds to remove money from the economy, reducing inflation and increasing individuals’ purchasing power. Through these avenues, the Fed hopes to return inflation to its 2% target rate.

Despite the Fed’s seemingly abstract actions like selling treasury bonds and changing interest rates, their policies have concrete consequences for the lives of everyday Americans. For example, in the U.S. housing market, acquiring affordable loans or mortgage rates becomes more difficult when banks have to work with higher interest rates. As a result of this, people struggle to find and purchase affordable housing. From 2022 to 2023 the U.S. experienced housing sales falling 20.4%. Despite these negative effects, the Fed hopes that their actions, while causing temporary difficulties in the housing market, will be made worth it by further reductions in inflation.

The housing market isn’t the only place people have made sacrifices in order to reduce inflation. The labor market has struggled as well. While current Fed policies have somewhat reduced inflation, they anticipated a corresponding shift in unemployment which would help achieve their dual mandate . However, this was not the case. Today, the labor market remains tight, meaning that more people are hiring than looking for jobs.

So why is this the case? Since 2020 unemployment decreased while job openings increased, leading to a shortage of workers–1.9 million to be exact. However, the solution to this shortage has not been found through the Fed’s efforts to reduce inflation. This is a prime example that, while the government may try, they cannot predict the future. Not only that, but government policies do not always result in their intended effect.

Understanding Fed monetary policy helps to anticipate economic trends and provide insight into financial climates. In this respect, the economy is kind of like the stock market: You can do your research, but you may not always luck out… Moving forward, the Fed acknowledges they plan to pursue further inflation-reducing policies to give Americans more bang for their buck. But only time will tell what the true impact of these policies will be on the American economy.