When asked the path of bringing inflation back towards the Fed's 2% target at a recent conference, FOMC member Bullard drew parallels between the Covid era and the economic impact of major wars.
"One way to think about why we ended up with so much inflation is to think about a war scenario: World War I, World War II, and the pandemic is kind of World War III. And we know by looking at historical experience across many times and places that wars are associated with inflation, both for the winning side and the losing side.
And why is that? Well, what happens during the war is that there's a social crisis. There's a lot of government borrowing without too many questions about how you're going to pay for this in the future because you're in the middle of a crisis. The central bank is requested to help with the war effort and keep inflation or keep interest rate very low. This is a recipe for inflation.
And so, what was the pandemic? It was exactly that, both in the U.S. and around the world. And no, it wasn't like a world war, but kind of was, against the virus. And so, you got lots of government borrowing with low interest rates accompanying that borrowing. And so, too much, and this led to some inflation overhang after we're all done. Now, how do you get rid of that inflation? Well, you switch back to the pre-pandemic policy or the pre-war policy, which is you don’t borrow so much on the fiscal side without the future taxes there, and you get the monetary policy guys to get on the ball and start moving the policy rate to the appropriate level for that situation.”
See charts in previous post and our Market Focus on War and Inflation from April 11th, available in the past publications section.
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