Fed Can’t Solve Tax-Driven Inflation: Jackson Hole Paper

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(Bloomberg) — The Federal Reserve will not be able to curb inflationary pressures because they are rooted in an expansionary fiscal policy, according to a paper presented at the central bank’s annual Jackson Hole conference on Saturday.

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“The fact that about half of the recent rise in inflation has fiscal roots poses some specific challenges for today’s policymakers. Not only is fiscal inflation often very persistent, it also requires a different policy response,” wrote the paper’s authors Francesco Bianchi of Johns Hopkins University and Leonardo Melosi of the Chicago Fed.

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The US central bank started raising interest rates in March, and many officials have since said they were too slow to start. Bianchi and Melosi argued that tightening earlier would not have made much difference to inflation.

“If inflation is fiscal in nature, monetary policy alone cannot provide an effective response. To demonstrate this, we question whether a previously tightening monetary policy could have prevented the rise in US inflation after the pandemic,” they wrote.

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“The increase in tariffs would have resulted in only a modest decline in inflation, at the cost of a major decline in production. This large sacrifice ratio arises because when inflation is fiscal in nature, the central bank is not solely responsible for its reduction.”

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