The US labor market is doing quite well despite the war in Ukraine and the lingering presence of Covid-19. The recent jobs report showed payrolls rose by 431,000 while the unemployment rate fell to 3.6%, slightly above the pre-pandemic rate of 3.5%. But there is also a looming problem: inflation. The Fed has been acting more politically lately, and if it fails to get inflation under control, it will undermine its credibility, foster animosity between states, and make stagflation more likely.

The inflation tax is wreaking havoc on American consumers. The average American household will spend $5,200 more in 2022 compared to last year for the same products, as they face higher prices on everything from copper to chicken. The annual cost of gas increases by the same amount as $1,000 depending on vehicle and driving habits. Meanwhile, the Biden administration is distracted by counterproductive policies like suspending student loan payments.

Stagflation — low economic growth and high inflation — is not here yet, but the federal government is doing all it can to create it. Inflation has been above the Fed’s 2% target for nearly a year. During the same period, the Biden administration weighed on the economy with more regulation and threats of higher taxes. So far, the final cost of Biden’s regulatory agenda is $197 billion and it created 134 million hours of new material. That’s more than double the cost of President Obama’s final rule at the same time in his presidency and more than 50 times that of President Trump.

There are dozens of things President Biden could do to spur economic growth. He could suspend the Jones Act to free up US shipping or deregulate geothermal and nuclear energy to promote energy abundance. Instead, he opts for more obstruction over more production.

Too much money due to accommodative monetary policy and reckless government spending is driving demand from the economy as the pandemic and Biden’s policies continue to restrict supply. Combined, these create an environment conducive to inflation that the Biden administration initially ignored, despite warnings from economists such as Larry Summers and John Cochrane.

Throughout 2021, Fed Chairman Jerome Powell argued that inflation was transitory and would come down on its own. That’s not happening, so Powell and other Fed officials must now find a way to get inflation under control without causing a recession – the so-called “soft landing”.

It’s unclear why Fed officials didn’t see higher inflation coming. One possible reason is that they, in cooperation with the Biden administration, were too busy thinking about how they could use their power to manipulate the economy to achieve political goals.

Throughout the first half of 2021, Powell argued for “patiently accommodative monetary policy” with the explicit goal of creating a boiling labor market, which many progressives also wanted. Powell subsequently played down inflation, and his reluctance to rein in by raising interest rates and ending quantitative easing gave us the highest inflation rate in 40 years.

Monetary policy is not the only means by which the Fed can influence the economy. It also has broad regulatory powers, which was highlighted in the appointment of Sarah Bloom Raskin as vice president of oversight. Raskin recently withdrew her nomination, but before that she has always argued that the Fed should take an active role in climate policy, primarily by integrating climate risks into Fed oversight activities. As she wrote, “financial regulators need to rethink their own role so they can play their part in the broader reinvention of the economy.”

The Fed is supposed to be non-partisan and focused on its dual mandate of full employment and stable prices. Unfortunately, many people currently at the Fed and recently appointed to key positions, like Raskin, seem increasingly interested in politics.

Several Democrats, including Maxine Waters (CA) and Elizabeth Warren (MA), appear to support this change and want to use the Fed’s regulatory and supervisory powers to promote racial equality in employment, access to credit and small business loans. The US banker noted that this would add a third leg to the Fed’s dual mandate.

More economic opportunity for minority groups and low-income people is a noble goal, but the Fed is not the appropriate vehicle to achieve that goal. A significant degree of central bank independence is widely recognized as crucial for a stable and growth-friendly monetary policy. Open politicization, on the other hand, carries both short-term and long-term risks.

In the short term, greater Fed politicization creates uncertainty in financial markets, as banks and other businesses find it harder to predict the Fed’s regulatory actions and monetary policies. Uncertainty hurts investment and therefore hurts economic growth.

Greater politicization may also cause the Fed to lose sight of inflation as policy objectives override its dual mandate or cause it to prioritize maximum employment over price stability, as we are experiencing. currently.

In the longer term, more politicization will undermine confidence in the Federal Reserve. Democrats and Republicans will accuse the Fed of pursuing political goals whenever their side is not in power. The public will lose faith in the Fed’s ability to keep prices stable.

Already, Americans expect inflation to be 6% a year from now and 3.8% in three years. This is proof that the Fed is failing to anchor expectations about its ability and resolve to bring inflation down to 2%. The loss of control over expectations makes periods of hyperinflation more likely. Such events cause severe economic damage and disproportionately affect low-income people.

More politicization also means the Fed’s watchdog policies will swing with the election. This will make it difficult for banks to execute long-term lending strategies and businesses to execute long-term investment strategies. Capital markets will be less efficient, the cost of capital will rise, and political connections will be more likely to impact lending decisions, thus amplifying clientelism.

Industries disadvantaged by the Fed, which will often depend on the ruling party, will struggle to access capital to expand or hire new employees. To the extent these industries are lumped together — like tech in California or oil in Texas — specific local economies will bear the brunt of the economic pain. This is likely to cause more resentment between the people of Central America and the coasts, as each side portrays the other as waging economic war against them.

With Biden and the Democrats in power, the currently disadvantaged industry is energy, particularly fossil fuels. However, if the Republicans take control, the underprivileged industry could easily become “Big Tech”, “Big Pharma” or “Big Finance”. This would disproportionately hurt the economies of California, Massachusetts or New York, where many companies in these industries are located.

Animosity between Democrats and Republicans is already high, so the last thing we need is a politicized Fed picking winners and losers via industry-specific regulations.

The Fed’s main objective is to keep prices stable, but Chairman Powell and others seem to have gotten sidetracked by politics. Now inflation is slipping away from them. It’s time for elected officials to stop politicizing the Fed and for Fed officials to ignore politics. Otherwise, we could be entering a new normal characterized by higher inflation, greater regulatory uncertainty and, consequently, slower economic growth. If that happens, stagflation will be right around the corner.

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