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Speaking of the Economy
Clouds of criticism over the Fed
Speaking of the Economy
Oct. 19, 2022

The Fed vs. Inflation: Monetary Policy Under the Microscope

Audiences: Business Leaders, Economists, Educators, General Public

Kartik Athreya responds to recent critiques of the Federal Reserve and its efforts to combat inflation. Athreya is executive vice president and director of research at the Federal Reserve Bank of Richmond.



Tim Sablik: Hello, I'm Tim Sablik, a senior economics writer at the Richmond Fed. My guest today is Kartik Athreya, director of research for the Richmond Fed. Karthik, thanks for being here and welcome back to the show.

Kartik Athreya: It's great to be here, Tim. Thanks for having me.

Sablik: Our topic of conversation today is monetary policy and criticisms of the Fed. The Fed is certainly no stranger to criticism. But I think it's fair to say that today there's a lot more attention and scrutiny of the Fed as monetary policymakers are trying to bring down inflation from four-decade highs.

In his address at this year's Jackson Hole Economic Symposium, Fed Chair Jerome Powell said that, "Central banks can and should take responsibility for delivering low and stable inflation." So, I wanted to know, in your view, how much responsibility does the Fed bear for the current bout of inflation?

Athreya: Yeah, this is a great question.

First, let me underscore that, in this instance, I'm really glad that the chair made very clear that the central bank can and should take responsibility for delivering low and stable inflation. If there's something that I think central bankers have learned over the last 30 to 40 years, it's that our conduct of policy is completely central to delivering what we view as price stability — inflation in a low and stable place that allows everybody to make decisions without thinking a great deal about what inflation is. This is an aspiration. But, in reality, we have seen inflation come in quite a bit higher than what our target of 2 percent would have asked.

Then the question is, well, how much responsibility falls on the Fed? A very honest answer is we won't know for a while exactly how much responsibility falls on the Fed. That's because we're an institution that has to react in real time to what we observe in the economy, with the best information and best thinking that we have on how exactly to tackle inflation.

Against that backdrop I'll remind our listeners that, circa March 2020, we were dealing with something completely unprecedented, both domestically in this economy as well as globally, in terms of understanding how a pandemic would shake out. The shutdown in the immediate wake of the pandemic in March 2020 very rapidly pushed unemployment up to 15 percent. That's a number that is astronomical relative to U.S. recession experience since the Great Depression. Fifteen percent is 50 percent higher than where unemployment got in the Great Recession or the 1982 recession. At that moment, it's not obvious that the right policy was for the Fed to look around the corner at an inflation that was very, very far away from potentially happening.

At the same time that this was happening, there was a very strong response from fiscal authorities that spanned two administrations, with an intent to make sure that the bottom didn't fall out for people. With the benefit of 20/20 hindsight, what you might say is that was a lot of support, a lot of fiscal tailwind that supported demand and consumption in the economy. Perhaps the Fed at that point should have taken that more directly into account in the way it set policy.

I think that's a difficult call to second guess in real time when the economy as a whole is hit by a shock of unprecedented size and scope. It was very important for us to be seen, I think, as part of the solution, not yet another confounding headwind at a time when policymakers broadly were trying to make sure that the economy didn't go into a tailspin.

That's sort of the immediate answer. The other thing that I would say is that, down the road, people will think hard about this. It may become clear that, even given the information that we had at the time, we should have or could have done something else. If that's the verdict, then I think it's absolutely the case that we have to accept things didn't turn out properly from a policy standpoint. But I think that verdict is a ways off.

Sablik: That's a good point. I guess it's something that the academics will be debating for a while.

To the extent that the Fed does bear some responsibility for the current inflation, I think critics might fairly ask why should they trust the Fed to get inflation back down to 2 percent now. How would you respond to such criticisms?

Athreya: If you look at the recent sequence of rate hikes coming out of the Fed, they look much sharper than what we've seen from the Fed in the last 40 years or so.

Yes, it's true that in the fog of war — in the pandemic period and slightly outside of that — it's looking more to be the case that there was quite a lot of boost given to the economy through both our policies and those coming from the fiscal side. When it became clear that inflation was actually fairly broad — to the point where you couldn't chalk it up to this particular component of what people buy got really expensive — I think that you saw the [Federal Open Market] Committee move extremely quickly to not just move rates the way they have — 300 basis points already this year — but to also speak as one as a committee. This is an observation that I want the listener to really take heed of.

The committee has been exceptionally clear in saying inflation is the number one problem that we face right now and that the policies that the FOMC sets in motion will be aimed squarely at dealing with that problem. I think that's a fundamental confirmation in my mind of just how quickly the committee actually moved and how clearly they have communicated their intent to stay the course. If you watched the press conference last week, you heard the chair leave essentially no doubt, at least not in my mind, about the commitment needed in order to bring inflation back to target.

Sablik: I'll have some more policy-related questions for you. But I'm going switch gears a little bit and have you put on your economist hat and get your perspective as director of research here at Richmond.

Do you think that economists fail to anticipate how persistent inflation would be? If so, why do you think that might be, and would that require any sort of revision to the economic models based on what we've seen over these last two years?

Athreya: One thing we can always ask is, "What could we have known better?" This relates to what we were talking about earlier, in terms of the amount of responsibility that the Fed bears for the current level of inflation.

It's been a question of prolonged interest in the economics profession regarding how persistent inflation is. One of the things that we've seen is that the departures in inflation from any kind of target – implicit or the more explicit ones that we've had since 2012 — that level of persistence has been dropping over time. That's a piece of evidence that suggests that people understand us to be good enough at our job that we will bring it back down. When they see inflation move away from target, we'll get it back down.

I'm not ready to endorse any kind of wholesale revision in the models that we have, simply because what hit us was very unprecedented and had a huge sectoral component. Let me explain what I mean by that.

At the beginning of the pandemic, it made certain kinds of economic activity way more difficult than would have been the case, anything that involved what I've called communal consumption: getting together to go to a restaurant, traveling somewhere for a vacation, accessing other kinds of events like sporting events and so on. All those things essentially became very risky. This is at the same time that being at your home became critical to protect yourself and to maintain your livelihood if you're able to work more remotely. So, you had this seismic shift in the structure of economic activity that happened in a very short period of time.

The economy, broadly speaking, responded with a tremendous amount of what I might call rationality in terms of prices moving in the directions exactly to reflect what was becoming scarce and what was becoming plentiful. We saw durable goods prices rising at this time, pretty dramatically relative to other kinds of prices. This is because people were hunkering down at the time and moving away from a lot of services. So, our general models of macroeconomic adjustment I don't think were necessarily off. I think they allowed for exactly this kind of response.

What was harder to know in real time was how best to calibrate a policy response. That goes back to the huge uncertainty that prevailed at the time. Would the policy response that was in place — both from the Fed and from the fiscal side — be too little, just right [or] too much from an inflation or economic activity standpoint? So, I think it's more [about] uncertainty about understanding the size of those responses against the size of the shock than it is about changing the model itself. Sometimes it's just too bad that you don't know more than you do about what's happening in the real economy at the time that it's happening.

Sablik: As you said, hindsight is always 20/20.

Kartik, we'll continue our conversation in just a moment. This seemed like a good time to mention that you'll be part of a panel discussion on demystifying inflation at the Richmond Fed's next District Dialogues. The free event will take place in our Richmond office and virtually on Monday, November 7, from 6 to 7:30 PM. You and the other panelists will tackle questions like, "How are people impacted by inflation in different ways? What are the causes of inflation? How does inflation impact people in their everyday lives?" You also be talking more about the topic that we've been discussing on today's episode: How is the Fed working to reduce inflation?

Registration ends on Oct. 31 for in-person attendance and Nov. 7 for virtual attendance. You can just go to our website,, click on "Economic Research" in the main menu and then select "District Dialogues" to find out more about the event series and to register for the Nov. 7 session.

Getting back to the monetary policy side of things, we mentioned Chair Powell's recent press conference following the September FOMC meeting. In that conference, he repeatedly warned that getting inflation down could entail some pain in terms of lower economic growth and maybe higher unemployment. One of the Richmond Fed's research focuses is thinking about how to improve labor force participation and get more workers off the sidelines. I'm wondering if there's maybe a conflict between that goal and restoring price stability or if you see a conflict or tension between those things, and how you might think about that tension.

Athreya: Sure. I don't see a conflict directly between those two things. I think of us as a central bank always being responsible for thinking about how the labor market is functioning and how it can function to its potential.

A big part of what our president, Tom Barkin, has been thinking about — and has engaged both economists here and the business community at large — has been to understand what stands between you and work, what stands between you and a job that you might want to go to, what stands between you and building a career that you might choose. These are questions that I think are really critical for us to resolve, often because they are connected with the broader set of policy stances that we've taken.

At this bank, along with the Atlanta Fed, we've talked and thought about things like benefits cliffs. We've talked about things like child care. These are things that ultimately determine people's willingness to say, "Yeah, it's worth it for me to go and try to build a career." When those impediments are in place, especially when they're not intended, it's implausible that the economy is performing at potential. It's implausible that we can say that we've achieved a broader notion of maximum employment, which is part of our mandate.

For me, it's always important to have our thinking be focused on [whether] the labor market is functioning the way it could be. That's something that's going to be in our minds, both when the economy's doing really well and in times when the economy is not doing so well. Hopefully, that helps square the tension in your listeners minds.

Sablik: Yeah, thanks very much.

Another area where the Fed has gotten some criticism is regarding its balance sheet, which grew from about $4 trillion before the pandemic to nearly $9 trillion at the start of this year. How is the balance sheet policy conducted by the Fed related to the outbreak of inflation that we're having?

Athreya: That's an excellent question.

I think a critical place to start is to remember that the balance sheet expansion was driven by considerations of what is known in the economics jargon as the effective lower bound problem. One of the things that the Fed has had to deal with — and central banks worldwide have had to deal with — is how to conduct monetary policy when the interest rate that you set would ideally be less than zero, but for institutional reasons and otherwise you don't get to set them below zero.

That leads you pretty quickly to thinking about alternatives, including how to target the interest rates that are further out into the maturity spectrum. Things like quantitative easing and balance sheet policy come in. This is essential for your listeners who aren't paying attention to the nooks and crannies of implementation of monetary policy — we buy bonds and assets of various kinds. How do we pay for them? We pay for them with liabilities that we issue that you can think of as central bank money. An observer will point out correctly that in times when we buy a lot of assets, we've done so by issuing a lot of central bank money.

If we think inflation is really centrally about lots of money chasing goods, you might very reasonably at this point say, "Well, that's why we're having inflation." The reason that that doesn't quite work is that the institutional setting in which we do policy was changed precisely to allow us the ability to do quantitative easing, [based on] notions of letting the money supply grow in ways that were not well controlled.

The key tool there is the tool of interest on reserves. We used to not pay interest on the money that we issued that was held by the banking system. We do now. What that allows us to do is to have a balance sheet that meets our needs for making sure that the economy has the interest rate that it needs to function efficiently, without giving banks the incentives to create a private money supply that in conjunction with our money supply would really cause a lot of money to chase a lot of goods.

This first was done during the Great Financial Crisis [of 2007-2009]. In that period, the balance sheet expanded very dramatically and there was absolutely no inflation for eight or more years after that. For me, this was a pretty clear, real world, robust experiment in saying, yes, interest on reserves allows you to think about your balance sheet on the one hand serving a set of purposes while not losing control of inflation on the other hand.

Sablik: Another thing that's come up as a criticism or critique is a number of commentators have been comparing the current episode to the Great Inflation of the 1970s. That's a period when the Fed struggled for more than a decade to get inflation under control. He keeps coming up in our conversation, but I think it's appropriate — Chair Powell has said that the Fed is keenly aware of the lessons of that period and is fully committed to bringing inflation back down and will not stop until the job is done.

What do you think are the key lessons from the 1970s and have economists and policymakers internalized those lessons in a way that will avoid those past mistakes?

Athreya: First of all, I think it's good that the chair keeps coming up because the chair has been central to reassuring the public and the private sector as a whole that the Fed understands its role in getting inflation back to target in no uncertain terms.

You mentioned him talking about not stopping until the job is done. In some sense, that harkens back to language that was used to describe the '70s as "go-stop" or "stop-go" policy. If you were going to be clever, you might say this is "don't stop" policy. The way that the chair has spoken, especially at the last press conference, is really aimed at saying, "No, we actually have to get to a place where we're very good and convinced that inflation is not an issue." The first hint of a deterioration in the real economy, should that happen, is not going to be enough to get us to back off. That's not where the bar is set right now.

I think a lot of policymakers now look back at the '70s and see its ambiguity with respect to what [the Fed's] aims ultimately are. The chair and the FOMC members have emphasized credibility. I'm not a historian, but I think this is a word that very likely was not at all used, at least with any kind of frequency, in the '70s. In particular, the committee as a whole wasn't talking to the world as a whole in the '70s. Now that we are, the committee appears to have used this to really underscore the message of it is important to get inflation, it is the highest priority, and that we must manage it so that our credibility remains intact.

We've internalized the lesson that says people look forward when they think about price setting. When people ask for wage increases at their workplaces, when store managers have to think about how to reset the prices for the goods on their shelves, these are all forward-looking decisions. They're inevitably about what people think is coming down the pike. It's of the essence not to allow people to expect an inflation rate that is far away from target because that, by itself, if we do nothing else could actually make that come to pass. So, the chair and the rest of the committee are very clear about saying that's not the right expectation to have and if you have that expectation, you're not going to be correct.

Sablik: Chair Powell had a good line at the end of his press conference where he essentially said that whatever we end up doing will be enough to stop inflation.

Athreya: Right. And I think this is really taking into account the expectational channel for inflation. If inflation control is the job of the Fed, expectation control is an immediate adjacent to that job.

Sablik: Kartik, thanks very much for taking the time out of your busy schedule to come talk with me today. Hopefully we can have you on again soon.

Athreya: Thanks a lot, Tim.

Sablik: And to our listeners, as always, I'll remind you that if you're interested in keeping up with the latest Richmond Fed research, you can head on over to If you enjoyed the show, please consider leaving us a rating and review on your favorite podcast app.

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