Tech Lecturer: Fed Faces Challenges, Decisions With Inflation

Economists are in a tough spot trying to get inflation under control, according to a Tennessee Tech Lecturer, because of the “sticky wage, sticky price effect.”

Federal Reserve Chair Jerome Powell admitted last week that there has been little progress in stabilizing inflation. Tech Economics Lecturer Chelsea Dowell said typically, as prices rise, wages rise with them. During this round of inflation, however, Dowell said that while personal consumption expenditures are up some 0.8 percent, wages have only risen some 0.5 percent. She said because the sectors driving the price increase are necessities like rent, health insurance, and car insurance, families cannot forgo spending needs.

“Those contracts are usually for a year or so at a time,” Dowell said. “Once you’re locked into that rent, once you’re locked into that health insurance plan for however long of a period until you can find a newer one, a cheaper one, it’s going to keep those prices at those higher levels.”

Dowell said as those contracts expire and people are able to find cheaper alternatives, prices may begin to stabilize. She cited unprecedented government spending, supply chain constraints, and a tight labor market as the factors leading to inflation.

“During the pandemic, our government spent $44.4 trillion on things like low-interest loans to businesses, stimulus checks to households, extended unemployment insurance benefits, and more,” Dowell said.

She said that level of government spending more than doubled the previous record.

Dowell said strained relations with China caused a rift in the supply chain that has been further complicated by the war in Russia and Ukraine. She said the government’s most recent foreign aid package proves government spending cuts unlikely. She said raising taxes could be a solution, but during an election year, tax hikes are unlikely as well.

She said the Federal Reserve has elected to see how inflation plays out over the coming months before making its next move.

“They can raise interest rates to combat high inflation,” Dowell said. “And that’s what we did see them do after the pandemic. Once we got our of the recession stage of the pandemic, they did start to raise interest rates and they continued to raise interest rates until about August of last year.”

Dowell said in raising those rates, however, the Federal Reserve created a lock-in effect in the housing market. She said people stopped putting their homes on the market as they feared mortgage rates on a future home would be too high. Dowell said the shortage of available houses this created pushed housing prices up even higher and applied additional pressure on inflation.

“It’s kind of this catch-22,” Dowell said. “You can raise interest rates to combat inflation, but when you do that, you’re going to drive housing prices up further, and then inflation is going to happen more.”