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The Fed's Interest Rate Policies Can't Fix This Inflation. Here's Why.

Erin Scott | Bloomberg | Getty Images

Joggers pass the Marriner S. Eccles Federal Reserve building in Washington, D.C., on Tuesday, Aug. 18, 2020.

  • The Federal Reserve's mandate is to maximize employment and create stable prices.
  • The Fed does not believe the labor market is causing this inflation; it is waiting for it to pass.
  • Deflation may be the central bank's bigger problem over the long term.

Heading into 2022, the Federal Reserve is stuck in a game of chicken with the U.S. economy. Sectors such as energy and autos are hitting double-digit inflation rates, which are piling costs on for consumers.

The central bank first said the eye-popping inflation figures reported in late 2021 are "transitory," although it is now dropping that word from the messaging. Earlier in the year, the global supply chain was brought to its knees as traffic jams piled up along trade routes. Meanwhile, early retirements picked up and younger workers started to quit their jobs at the fastest pace on record.

Lawrence Mishel, a distinguished fellow at the Economic Policy Institute, says, "There's a lot of reasons to think that inflation is transitory. It doesn't mean it's going to be two months, it could be a year, but it's not going to be, you know, 4 or 5% a year for the next five years."

Leaders at the Fed have a long-term target of about 2% inflation. They believe that this rate could produce a healthy and stable economy. But shrinking union membership and the expansion of global trade may have made that difficult to achieve. As a result, the central bank is taking a stance that will invite slightly higher levels of inflation for longer periods of time.

Critics say the Federal Reserve's approach to policy is flawed because the underlying models are broken.

"I think it's pretty darn obvious that the Fed cannot control inflation on the downside, or the upside, given the current experience," says Danielle DiMartino Booth of Quill Intelligence.

The central bank can influence some sources of inflation, such as wages or the housing market. But if they're coming from areas beyond the Fed's reach, its policies won't necessarily be effective.

Watch the video above to see what, if anything, the Fed can do to slow inflation down.

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