Central banks including the Federal Reserve will fail to curb inflation unless governments start to be responsible for spending, according to a study presented to central bankers at a Jackson Hole conference in Jackson Hole, Wyoming.
The authors of the study, Francesco Bianchi of Johns Hopkins University and Leonardo Melosi of the Chicago Fed, warned that increasing interest rates would end up in stagnation without adequate constraints on government spending.
If governments are not spending money responsibly, inflation will be driven up by the private sector's expectations of high inflation while at the same time the economic output is reduced by hawkish monetary policy, they explained.
Spending Spree Is BackAfter a short pause following the wave of COVID-related stimulus spending, government spending is back in the United States.
President Joe Biden signed the Democrat-backed "Inflation Reduction Act" on Aug. 16, which includes around $433 billion in new spending. The Democrats claimed that the bill will reduce the deficit by around $292 billion annually through stricter tax code enforcement.
The president also announced a massive student loan cancellation plan on Wednesday.
According to the plan, individuals earning less than $125,000 a year or families earning less than $250,000 will be eligible for up to $10,000 in debt cancellation. Pell Grant recipients who meet those income standards will be eligible for relief of up to $20,000.
Factors Uncontrolled by Federal ReserveIn the last few months, the Federal Reserve has increased the federal fund rate by 225 basis points to 2.5 percent.
Data shows that inflation may have peaked.
According to a Commerce Department report Friday, consumer prices rose 6.3 percent in July from a year earlier after posting an annual increase of 6.8 percent in June.
However, economists and central bankers are worried about other factors beyond the money supply behind inflation.
One main factor is supply chain bottlenecks for some products.
Federal Reserve Chair Jerome Powell admitted at the Jackson Hole retreat that it's not covered by the monetary policy.
Another worrisome factor is the tightening labor market, which is apparently driving up the costs in almost all sectors.
"The labor market is particularly strong, but it is clearly out of balance, with demand for workers substantially exceeding the supply of available workers," Powell said.