Is the U.S. Fed Playing With the Wrong Levers?


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Many economists believe that the U.S. Federal Reserve has a pretty abysmal track record in forecasting inflation during recent years. Could the Budapest Business Journal’s corporate finances columnist, Les Nemethy, be among them?

First, the Fed deliberately changed policy to allow inflation to run hot at higher than 2%, saying that a certain amount of inflation would be desirable, not a threat. Then, when inflation ran hotter than expected, the Fed stated that inflation was merely “transitory.” Next, the Fed started monetary tightening too late. United States Secretary of the Treasury (and former Fed chair) Janet Yellen recently acknowledged the error.

I was amazed that at the recent Federal Open Markets Committee (FOMC) meeting of the U.S. Fed, where inflation-fighting dominated the agenda, there was no mention that the U.S. money supply had increased by 50% over the past two years.

One Twitter commentator even questioned whether silence on this issue at the subsequent Q&A demonstrated unbelievable incompetence on the part of renowned journalists or an environment where dissent is not allowed.

This column examines why interest rates alone are unlikely to tame inflation and whether money supply may influence inflation.

Increasing interest rates certainly have the effect of reducing demand. Ironically, precisely in the type of high debt environment we have today, the demand reduction effects of raising interest rates may be more dramatic than in a low debt environment because governments, corporations, and individuals must spend more on servicing their debt, leaving less for consumption and investment, depriving economies of their oxygen.

But slowing demand is not the same as slowing inflation. That’s what the whole concept of stagflation is about. The Fed might be well on the way to both recession and inflation.

As macro strategist Peter Schiff puts it: “It’s clear that investors are no longer worried about inflation, but are only worried about recession. In contrast, the Fed is only worried about inflation, but is not concerned about recession. Soon investors and the Fed will be on the same page. They’ll be petrified about both.”

The Fed was late to recognize that inflation was here to stay, hence began applying the brakes against a backdrop of already pronounced economic decline and a bear market. This has never happened before in the history of the Fed. Given that consumption, employment, and investment statistics are always reported with a lag, the rapid oxygen deprivation effect of high-interest rates in a high debt environment may plunge us into recession before the Fed can take corrective action.  

There are other aspects of inflation that interest rates cannot control.

Supply-side Factors

Energy prices are the main threat at present. There are many factors contributing to this, from the shuttering of nuclear capacity in Germany to the restriction of Russian oil and gas flows to the West. Germany has already declared it has reached stage two of its three-stage energy emergency program. Many of the higher wholesale energy prices have not even been transmitted to the retail level. I recently heard from a Hungarian energy expert that retail gas prices in Hungary are expected to go up 400-600% over the next year. Clearly, the full effect of energy price increases is nowhere near baked into current inflation rates.

While wheat prices may have come down 20% from their recent peak, it remains very expensive, and global wheat stocks are at historic lows. The Fed can print money but cannot print oil, gas, wheat or other commodities. This winter, we may see food or energy crises creating unprecedented inflationary pressure.

Psychological Factors

There is increasing evidence that people are coming to expect higher inflation, which gets translated into higher salary demands, etc., creating a spiral.

What about the importance of monetary policy on inflation? As Milton Friedman once famously said: “Inflation is always and everywhere a monetary phenomenon, in the sense that it cannot occur without a more rapid increase in the quantity of money than in output.”

During the 2008 recession, the money supply increased, but most of this was sterilized at the level of the banks, avoiding inflation. Since COVID-19, helicopter money and increased bank lending have put vastly more money into the hands of individuals and corporations, with inflationary effect.

Modern Monetary Policy (MMP) is a school of thought that says a central bank may print an infinite amount of its own currency without affecting inflation, so long as this additional money supply is absorbed by central bank bond purchases. Fed chair Jerome Powell has announced that he intends to reduce the Fed’s balance sheet (e.g., sell bonds) to the tune of more than USD 2 trillion at a time when there will be a need to finance at least an additional USD 2 tln of the federal deficit. Who will buy all these bonds, carrying large negative yields, if not the Fed? 

We are entering into the realm of voodoo economics. Markets have every right to be concerned.

Les Nemethy is CEO of Euro-Phoenix Financial Advisers Ltd. (, a Central European corporate finance firm. He is a former World Banker, author of Business Exit Planning (, and a previous president of the American Chamber of Commerce in Hungary.

This article was first published in the Budapest Business Journal print issue of July 1, 2022.

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