Macroscope | Federal Reserve’s dramatic fiscal expansion key to understanding US inflation surge
- While US monetary policy was too aggressive for too long, the likely culprit behind the surge in consumer prices was the Fed’s expansionary fiscal policy
- It is worth remembering that aggressive monetary policy also followed the Great Recession but did not result in a rise in inflation
When considering what caused the sharp increase in US inflation from late 2020 to today, my initial instinct was to focus on aggressive monetary policy, following Milton Friedman’s famous dictum that “inflation is always and everywhere a monetary phenomenon”. But while monetary policy is important, aggressive fiscal policy might have been more important this time.
The problem with arguing that monetary policy was the sole source of the recent inflation is that the Fed was similarly aggressive during the Great Recession and its aftermath, from 2008 onwards. Short-term nominal interest rates were fixed at close to zero from early 2009 to late 2015.
The Fed’s balance sheet grew from US$900 billion in August 2008 to more than US$4 trillion, which seemed like a big number at the time. Yet inflation remained tame, averaging around 2 per cent per year from 2009 to 2019.
