The debate over inflation is getting more intense.
At the end of July, yearly price increases reached 5.4%, fueling a new round of debate between inflation doves and inflation hawks. Doves suggest price hikes are a temporary blip that will recede once the production bottlenecks caused by the pandemic resolve. Hawks think a plummeting dollar is here to stay, pointing to the massive increase in the money supply since 2020. We’re in the middle of the hottest economic controversy since the battle over the causes of the 2008 financial crisis.
Unfortunately, few in either camp understand why inflation is a problem. Until we get to the root cause, the inflation debate won’t yield solutions for public. As my co-authors and I argue in our new book, Money and the Rule of Law, our real problem is that America’s central bank, the Federal Reserve, largely operates as a law unto itself. This means monetary policy, and hence inflation, is inherently unpredictable.
The contest between hawks and doves illustrates this perfectly. The whole point is that we don’t know what’s going to happen to the purchasing power of the dollar because we can’t anticipate how the central bank is going to respond. Will the Federal Reserve continue its asset purchases? Or will it scale back in response to popular outcries over inflation? Despite occasional gestures toward rulelike behavior, the Federal Reserve isn’t bound by any criterion that guarantees purchasing power predictability. That’s a problem for millions.
To see why, consider why our money’s purchasing power is so important. The dollar is like a yardstick. It’s a measure for comparing economic values, including the prices of goods and services, the price of rented labor (wages), and the price of rented capital (interest). When the dollar’s purchasing power is predictable, households and businesses can effectively plan for the future. Everyone knows how much of their wealth to split between short-term cash holdings and long-term savings or asset purchases. But when the dollar’s purchasing power is unpredictable, as when inflation spikes, a wrench gets thrown in the economy’s gears. Markets operate less efficiently. Everyone is forced to devote scarce resources to protecting themselves against inflation. We’re all poorer as a result.
Blame the Federal Reserve for the frenzied dance of the dollar. Our central bank never truly committed to a rules-based framework, which would help stabilize the purchasing power of money. Instead, our central bank prefers vague and self-adopted guidelines. The Federal Reserve says it’s shooting for 2% inflation in the long run. That means it promises to make up for mistakes today by correcting course tomorrow. But that only works if central bankers are very good at their jobs. As we’ve learned the hard way since 2008, monetary policymakers often don’t make the right calls when the stakes are high. And when they err, it’s not they who suffer, but ordinary families and businesses.
The inflation debate is the perfect time to shift our public conversation to what really matters. Whether the doves or the hawks are right in the short run isn’t important. Setting up better rules for the Federal Reserve is. The public deserves monetary policy that is both predictable and fair.
Alexander William Salter is an economics professor in the Rawls College of Business at Texas Tech University, a research fellow at TTU’s Free Market Institute, and a senior fellow with AIER’s Sound Money Project. He is the author, with Peter Boettke and Daniel Smith, of Money and the Rule of Law: Generality and Predictability in Monetary Institutions.
