Fed Can’t Fix Fiscal-Driven Inflation: Jackson Hole Paper

(Bloomberg) — The Federal Reserve won’t be able to curb inflationary pressures because they are rooted in expansionary fiscal policy, according to a paper presented at the central bank’s annual Jackson Hole conference on Saturday.

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“The fact that approximately half of the recent increase in inflation has fiscal roots poses some specific challenges for policy makers today. Not only fiscal inflation tends to be highly persistent but it also requires a different policy response,” the paper’s authors, Francesco Bianchi of Johns Hopkins University and Leonardo Melosi of the Chicago Fed, wrote.

The US central bank began raising interest rates in March, and many officials have since said they were too slow to begin doing so. Bianchi and Melosi argued that beginning to tighten sooner wouldn’t have made much difference for inflation, however.

“When inflation has a fiscal nature, monetary policy alone may not provide an effective response. To show this, we ask whether tightening monetary policy earlier on could have prevented the post-pandemic increase in US inflation,” they wrote.

“The increase in rates would have resulted in only a modest reduction in inflation, at the cost of a large reduction in output. This large sacrifice ratio arises because when inflation has a fiscal nature, the central bank is not uniquely responsible for its reduction.”