However, the average length of the time lags argues for high inflation for some time to come. The Fed’s stimulus was huge in March and April of 2020. That is, no doubt, driving current inflation in 2022. But 2021’s stimulus was very strong from February through November, with less stimulus—but still stimulus—planned in 2022. So 2022’s inflation is probably baked in the cake, with 2023’s inflation substantially determined by monetary policy that has already occurred.
When the Fed slows it’s purchases of long-term bonds and mortgage-backed securities, and then raises short-term interest rates a bit, inflation will appear to be unresponsive to monetary policy. The Fed, having tapped the brakes to no effect, will have to press down harder and on a sustained basis. Jerome Powell’s Senate testimony made clear that the Fed was not about to stomp hard on the brake pedal. That means that inflation will probably remain high through 2024.
Eventually the Fed will react. Powell testified that inflation exacts a toll especially on people less able to deal with “higher costs of essentials.” Whether that’s actually true or not, it is an argument that the Fed will respond to. More broadly, people who feel good about a big pay raise also feel ripped off by higher prices at the store and gas station. Public sentiment to fight inflation will rise.
Those pesky time lags of monetary policy, however, will probably lead the Fed to wait too long and then fight inflation in a way that leaves the economy in recession. It’s not a happy outcome, and it won’t happen right away, but business leaders should prepare for a downturn in the next few years.
“The average transmission lag is twenty-nine months ….” They also found the time lag to be longer, on average in developed countries such as the United States.
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