Levy Economics Institute of Bard College
Levy Economics
Instituteof Bard College

Public Policy Brief
No. 157, 2022

IS IT TIME FOR RATE HIKES? THE FEDCANNOT ENGINEER A SOFT LANDING
BUT RISKS STAGFLATION BY TRYING
yeva nersisyan and l. randall wrayContents
3

Preface
Dimitri B. Papadimitriou

4

Is It Time for Rate Hikes? The Fed Cannot Engineer a Soft Landing but Risks
Stagflation by Trying
Yeva Nersisyan and L. Randall Wray

12 About the Authors

The Levy Economics Institute of Bard College, founded in 1986, is an autonomous research organization. It is nonpartisan, open to the examination of diverse points of view, and dedicated to public service.
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ISSN 1063-5297
ISBN 978-0-941276-41-2

Preface
Roughly two years into the economic recovery from the COVID19 crisis, the topic of elevated inflation dominates the economic
policy discourse in the United States. And the aggressive use of
fiscal policy to support demand and incomes—over $5 trillion ofpandemic relief spending spread between the Trump and Biden
administrations—has commonly been singled out as the culprit.
Equally as prevalent is the clamor for the Federal Reserve to raiseinterest rates to relieve inflationary pressures.
According to Research Scholar Yeva Nersisyan and Senior
Scholar L. Randall Wray, this narrative is flawed in a number ofways. The problem with the US economy is not one of excess ofdemand in their view, and the Federal Reserve will not be able toengineer a “soft landing” in the way many seem to be expecting.
The authors also deliver a warning: excessive tightening, combined with headwinds in 2022, could lead to stagflation.
Those who stress the demand-side explanation for current
inflationary pressures have at least one thing right, according to
Nersisyan and Wray: had there been a dramatically scaled backfiscal response to the pandemic crisis, inflation would likely havebeen lower—and unemployment and poverty would have ended
up significantly higher. It is difficult to see the validity of an argument that, say, those at the bottom of the income distribution
would have been better off in this counterfactual scenario.
Moreover, while this recovery looks robust in comparison
to the jobless recoveries and secular stagnation that have typified
the last few decades, in Nersisyan and Wray’s estimation there arefew signs of an overheating economy to be found in the macrodata. They observe that increases in the consumer price index are
outpacing labor cost increases by a wide margin; wages, far fromdriving this inflation, appear to be playing catch-up. Even according to the flawed measure of “potential GDP,” the economy’s
productive potential was only supposedly exceeded in 2021Q4(well after, as they note, inflation had been rising). In fact, as
Nersisyan and Wray explain, the demand side of the economy isalready going to be facing challenges in 2022: due to new strainsof COVID-19 throughout the world, the war in Ukraine, andthe expiration of the federal government’s pandemic spending,among other reasons.
In their view, this inflation is not centrally demand driven;dynamics at the micro level are playing a much more central rolein driving the price increases in question. Significant supply chain
problems have curtailed productive capacity by disrupting theavailability of critical inputs. In addition, they note that there issome evidence that firms with pricing power have taken advantage of the pandemic to boost or maintain profit margins, andthat this could be another factor contributing to rising prices.
Believing the Fed can fine tune the economy with marginal changes to interest rates is wishful thinking, they write.
Many seem to be pinning their hopes on the Fed being able topull off something it has rarely, if ever, been able to do: guidethe economy to a soft landing by gradually bringing down the
inflation rate with incremental interest rate hikes. Far more common, Nersisyan and Wray explain, is the Fed raising rates into a
recession. Monetary policy can only realistically affect inflation
by significantly increasing unemployment and lowering wages(which are not, as the authors observe, driving inflation anyway).
Meanwhile, as noted, the winding down of federal fiscal policy
is already set to act as a deflationary impulse—excess demand isunlikely to be a problem in 2022.
Furthermore, higher interest rates will not address the forcesthat are driving price pressures—the Federal Reserve can do little
about supply chain problems. If anything, rate increases could becounterproductive. As the authors argue, alleviating supply-side
constraints through greater investment would be one way of easing inflation. But rate hikes, to the extent they reduce interestsensitive spending, would have the opposite effect: constraining
the capacity to produce.
While fiscal (as well as regulatory) policy is better able tohandle the current inflationary environment, our approach to fiscal policy needs to change, in their view. Commentators may beon the wrong track in singling out the pandemic relief spendingfor creating inflation, but there is a better way to conduct policy—
one oriented around targeted investments that would increase
our real resource space. This will serve not only to address inflationary pressures, according to Nersisyan and Wray, but also thefar more pressing climate emergency.
As always, I welcome your comments.
Dimitri B. Papadimitriou, President

Levy Economics Institute of Bard College

3Introduction
Many economists and pundits have been calling on the Federal
Reserve to raise interest rates to fight inflation. While the Fed
resisted earlier calls to make a move, arguing that inflation wastransitory, a consensus has emerged that the time is nigh. If history is a guide (as former Fed Chairman Alan Greenspan liked
to put it), the Fed is not going to stop with a few rate hikes.
And because a higher interest rate is not the answer to our
inflation problem, the Fed will likely stay the course through along series of ineffectual rate hikes. Given major disruptions in
the global economy due to the pandemic and war in Ukraine,
this will cause high unemployment and slower growth without
much reduction of inflation pressures. It might even bring backstagflation: policy-induced high unemployment combined withstubbornly high inflation, similar to what we experienced in theFord–Carter–Reagan years.
Those advocating for a rate hike see current inflation as aproblem of too much demand—with a lot of finger pointing at
President Biden’s last round of relief that supposedly pushed
the economy beyond full employment. But what we are dealing
with is not demand-driven inflation in an overheating economy.
The COVID-19 crisis started as a supply-side crisis that severely
disrupted production, causing income and demand to crash.
Fiscal relief partially restored income but the supply side is still
shaky due to the pandemic and now the war in Ukraine. Mostof the government’s income support has already disappeared, so
going forward it is not an important contributor to demand in
the economy.
In this policy brief we examine the causes of inflation’s
acceleration from both macroeconomic (aggregate supply anddemand) and microeconomic (firms’ pricing decisions andsupply-side disruptions) perspectives. It is undoubtedly true that
if the fiscal relief spending had never come, Americans would bemuch poorer, the unemployment rate would be higher, andinflation would be less of a problem. But this would not resolve
the persistent supply-side problems—and Americans would be
worse off. As we will argue, higher interest rates will not constrain the forces that are generating price pressure.

The Macro Picture: Supply and Demand
The Trump and Biden administrations responded to the
COVID-19 crisis with over $5 trillion of relief spending. Someargued at the time it was too much, and that view has gainedmuch more credence as inflation picked up, even as it looks as
though the supply side has largely recovered. In this section we
first examine the growth of income, spending, and output tosee whether pressures come largely from the demand side (andhence can be blamed on the relief packages); we then turn to the
supply side.
Demand SideGDP fell sharply when the pandemic hit, falling by $2 trillion
by 2020Q2, hitting wage income hard. This would have collapsed both consumption and saving even more were it not for
the relief packages (plus regular social spending, such as theusual unemployment benefits that were boosted above normal
by the relief). With government’s help, growth picked up and by
2021Q3 nominal GDP reached the level that had been forecast
for that quarter back in January 2020, and in 2021Q4 it was up
by about $2.3 trillion over the 2019Q4 level.1
Government social benefits to individuals grew by $2.4 trillion in 2020Q2 over payments the previous quarter; by 2020Q4
they had fallen from their peak by almost $2 trillion. Another$2.3 trillion in social benefit payments was added in 2021Q1—
bringing total social benefit payments that quarter to nearly$6 trillion—double what they had been in 2019. Over the next
three quarters, social benefit payments fell by over $2 trillion,
ending 2021 about $770 billion above where they had been in
2019Q4. However, taxes were also up by about $700 billion—so
the government’s contribution to personal income netted to just$70 billion at the end of last year.
Though we see large increases in relief payments in twoquarters, the extra boost to income from social benefit payments
largely had disappeared by the beginning of 2022. Government
purchases (including by state and local governments) are up
moderately compared with 2019. Investment is up, but that isdriven mostly by housing construction and inventory restocking. Inventories can help to reduce inflation pressures, andhousing construction could help dampen growth of rents if it
increased supply where there are shortages.
Disposable personal income grew by about $1.76 trillion
between 2019Q4 and 2021Q4. Total domestic demand grew by$2.7 trillion since the end of 2019, but $430 billion of that growth
was satisfied by net imports—meaning total demand for domestic output increased by about $2.3 trillion. Over that time, personal consumption expenditures grew by $1.7 trillion—equal to
the growth in disposable personal income. If we apportion net

Public Policy Brief, No. 157

4

Table 1 Nominal and Real GDP Growth Rate
2019

2020

2021

Nominal GDP growth rate

4.1

-2.2

10.1

Real GDP growth

2.3

-3.4

5.7

Source: Bureau of Economic Analysis

their sales to be so high as to force them to raise prices going
forward. The Business Inflation Expectation survey by theFederal Reserve Bank of Atlanta (2022) asks firms to estimate
the percentage by which sales are above or below normal.4 At
the depths of the pandemic recession, sales were more than
31 percent below what firms thought was normal; in January2022 they were above normal by 3.3 percent for small, 1.3 percent for midsized, and 3.8 percent for large firms. Turning to
the future influence of sales levels on prices over the next 12months, the index shows that expected price pressures due tosales have already declined from a peak a few months ago. The
most important point is that there is nothing unusual about thesurvey results regarding views on the future influence of sales
on expected prices. Firms do not expect sales to be so highthat they would be pressured to raise prices. Since 2012 suchexpectations have typically been as high as, or higher than, they
are now. That would not seem to indicate that firms are feeling
unusually high pressure on capacity.
Supply Side
Turning to the aggregate supply side, we can see from Figure
1 that even though capacity utilization has substantially recovered, it has not reached the pre-pandemic levels, and is not evenclose to pre–global financial crisis levels. It’s likely that firms
are unable to utilize their operating capacity at the desiredrate, in part due to supply chain and labor market disruptions.
It could also indicate that those with the power to set prices
are purposely constraining output in order to raise and hold

Figure 1 Capacity Utilization: Total Index
90
85
Percent of Capacity

imports across all categories of domestic spending according toeach category’s share of total demand, about $270 billion might
have been spent by domestic consumers on imports. With thatassumption, consumption spending on domestic output since
the trough of the recession grew by what amounted to about$1.4 trillion.2
Total pandemic relief provided to households throughdirect payments plus unemployment benefits and food stamps
was about $1.6 trillion.3 This is approximately equal to the entire
growth in consumption spending on domestic output in therecovery. While we cannot conclude that consumption would
have remained stagnant in the absence of such relief, it is likelythat recovery would have been significantly delayed. And it isimportant to repeat that the relief has run its course. We do notsee significant continuing demand pressures coming from consumption, government spending, investment, or foreign trade.
If we were to look only at the data on output and income,the recovery seems to have been completed by the end of 2021.
While output is up slightly above what had been projected acouple of years ago (pre-pandemic), growth relative to 2019
would not have raised eyebrows if there had been no pandemic
or if one ignored the ups and downs in disposable income andsaving during the pandemic (real GDP growth averaged only
1.15 percent over 2020 and 2021). Even according to traditional
measures, we only reached and exceeded potential GDP during
the final quarter of 2021. Meanwhile, inflation has been risingsince at least March of 2021—a clue that maybe this is not ademand-driven problem.
In sum, what we find when looking at current aggregate
levels of both spending and income, there is little reason toworry that demand is growing too quickly. Real GDP growth is
not rapid, the boost from relief is all but played out, and inflation is sucking incomes out of the economy. There is no excess
income left to drive the economy beyond capacity.
The implication we draw from the macro data is further reinforced by survey data from firms that do not expect

80
75
70
65
60

1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020

Source: Board of Governors of the Federal Reserve System

Levy Economics Institute of Bard College

5prices higher—artificially creating scarcity. Still, Figure 1 does
not paint a picture of an economy that has exceeded its productive capacity. Instead, this graph seems to be more consistent
with either a “long-term secular stagnation” thesis—aggregate
demand is chronically too low—or with an inability to expand
production to capacity because of disruptions in the supply ofcritical inputs.
Finally, while the labor market has tightened (and thatshould be celebrated not feared), it is not yet back to its pre-pandemic state based on a number of indicators. Total employment
is still two million below its 2019 level (and given population
growth, we would need even more jobs). The employment rate
for the 15–64 age group was at 70.72 percent in January 2022,
below its pre-pandemic level of 71.77 percent. And even thatwas below its peak of 74 percent in the early 2000s. The labor
force participation rate tells a similar story. At 62.2 percent as ofJanuary 2022, it is below its pre-pandemic level of 63.4 percent,which was significantly below the pre–Great Recession levels of
about 66 percent (itself well below our postwar peak).
But is the strengthening of the labor market driving ourcurrent inflation? Many report that the employment cost index
has increased (which it has, as seen in Figure 2). At the sametime, the 12-month change in the employment cost index is
not extraordinary and is comparable to that of the early 2000s.
But what is important to keep in mind is that wages are playing
catch-up with prices, as shown in Figure 2, rather than driving
the price changes. Indeed, what we see is that price increases are
outpacing labor cost increases by a wide margin. The latest datafrom the Bureau of Labor Statistics (March 10, 2022) show that

Figure 2 Employment Cost Index versus Inflation
7.0
6.0
5.0
4.0
3.0
2.0
1.0
0.0
-1.0
-2.0
2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 2021
Employment Cost Index
CPI Inflation
Source: Bureau of Labor Statistics

real average hourly earnings fell by 0.8 percent in February—
with nominal wages flat and the consumer price index (CPI)rising by 0.8 percent. Previous to February, real wages had been
essentially flat—meaning that any nominal wage increases wereoffset by inflation. Wages are—at best—simply playing catchup, not a source of inflation pressure.

The Micro Picture: Profit Margins and Supply Chain
Disruptions
Profit Margins
The macro data discussed above paints a picture of a relatively
quick recovery, but not an overheating economy. It is therefore useful to examine the micro-level explanations for priceincreases, such as profit margins and supply chain disruptions.
Many have argued that the rising prices we see are due tofirms with pricing power taking advantage of the pandemic toboost profit margins.5 There is some evidence of this. As Matt
Stoller (2021) reports, in a survey of retailers by Digital.com, 56
percent said “inflation has given them the ability to raise prices
beyond what’s required to offset higher costs.” Not surprisingly,
the bigger the firm, the easier it is to do this: 63 percent of large
firms versus 52 percent of small and medium-sized businesses
agreed with the statement. In fact, 28 percent of large firms
increased prices by 50 percent or more (Stoller 2021). President
Biden’s office (White House 2021) has also pointed its finger
at markups, which have tripled since the 1980s, as concentration of pricing power across 75 percent of America’s industries has risen. In the November 2021 Atlanta Fed’s Business
Expectations survey, 23 percent of firms indicated that theirprofit margins were higher than usual and about half of thesesaid it was because they had raised their prices. Another 44
percent of the remaining firms whose profit margins were notabove normal indicated plans to increase their prices to improveor maintain their profit margins.6
Still, the survey shows that the vast majority of firms do
not see current profit margins as higher than normal. Indeed,
far more see margins as below normal than the percent who
see them as above normal. Paradoxically, firms are optimistic
about their ability to raise margins over the next 12 months.
Indeed, they have not been so optimistic over the past decade.
This stands in stark contrast to data indicating that firms do not
expect sales to pressure them to raise prices; it is their pricing

Public Policy Brief, No. 157

6

Sources of CPI Inflation
Figure 3 shows that transport and housing account for about
4 percentage points of the measured 7.4 percent inflation rate.
The biggest contributor is transportation—oil, shipping, andpurchasing and fueling automobiles, in particular. As of January2022, according to the Bureau of Labor Statistics, the 12-monthchange in the price of motor fuel for urban consumers was 40

8
7
6
5
4
3
2
1
0
-1

21
Fe
b21
M
ar
Ap 21
r2
M 021
ay
-2
0
Ju 2 1
n20
Ju 2 1
l-2
0
Au 21
g20
Se 2 1
p20
O 21
ct
-2
02
N
ov 1
-2
D 02 1
ec
-2
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Ja 21
n20
22

Percentage Points

Supply Chain Disruptions
While some economists have dismissed the supply chain argument for inflation, the reality is that many firms are still facing
significant disruptions. In a February 2022 survey by the Atlanta
Fed, 71 percent of firms in the sample reported supplier delaysin the previous week, with 60 percent of these indicating thatthe disruption to their business was moderate to severe. Further,
40 percent reported difficulty locating alternate suppliers, withhalf of these reporting a moderate to severe disruption and 45
percent reporting delays in delivery/shipping to customers (52percent reporting moderate to severe disruption). While only
21 percent reported difficulty in rehiring furloughed or laid-off
employees as a source of disruption, 62 percent noted the availability of workers to work affected their operating capacity (with57 percent reporting a moderate to severe disruption).
The availability of other suppliers or inputs used to provide
goods and services affected 50 percent of the firms, with 64 percent of these reporting moderate to severe disruption to theirbusiness; 55 percent of firms expected the availability of supplies
to affect operations for 6–12 months or longer. (Data for 2021
were comparable, so these supply disruptions have been affecting firms throughout 2021, if not longer.) So as far as supply
chains go, firms are worried about supplier delays for the near
future, and worries rise the farther into the future firms look.
Firms are more worried about supply chains than about
operations impacting their business. Even availability of employees is not a serious a concern for most firms—only 25 percent
say they expect it will be a problem 12 months and beyond.
In the next section we take a look at the sources of measured inflation.

Figure 3 Contribution to Inflation by CPI Component,
January 2021–January 2022

Jan-ability that they believe will cause prices to rise. Firms say current mark-ups are not extraordinary but expect to be able toraise them in the future. At the same time, they say that it is notsales—excess demand—that is pressuring them to do so.

Water, Electricity, Maintenance, andRepair of Dwellings
Other
Miscellaneous Goods and Services
Restaurants and Hotels

HealthImputed Rentals for Housing
Actual Rentals for Housing
Clothing and Footwear
Food and Nonalcoholic Beverages

Education
Transport
Source: OECD Stat and authors’ calculations

percent. With sanctions on Russia, transportation prices mightrise further on the expectation of substantial cuts to supply.
The next most important component is imputed rentals
for housing,7 adding about 1 percentage point to inflation asof January 2022. This is not a “market price”—it is not directlybased on house prices or the cost of owning a house. It is imputed
based largely on rents paid for “comparable” rented housing. Itis frequently the largest contributor to measured inflation andcan be quite misleading as a measure of pressure on prices coming from aggregate demand or as a measure of how inflation
actually affects people’s pocketbooks. Actual rents account for
about 0.25 percentage points of the measured inflation rate—up
from about 0.15 percent at the start of the year. It is probablethat both rents and imputed rents will continue to rise over thisyear, especially as moratoria on evictions and rent hikes havebeen eliminated. There are housing shortages throughout thecountry—especially for low and moderately priced housing—and the construction sector has been hit hard by the pandemic(as well as by the global financial crisis).
Food is typically the third component of the basket in termsof contribution to measured inflation. There have been significant disruptions in supply chains (especially for meat), compounded by industry consolidation that increases the power to

Levy Economics Institute of Bard College

7

boost prices. Restaurants and hotels represent the remaining
big contributor to measured inflation, at 0.6 percentage points.
Obviously they have faced higher costs both because of safetyconcerns and higher pay for workers (which is also in part due
to safety concerns). They might also be raising prices to makeup for lost profits during lockdowns. The war in Ukraine willalmost certainly lead to a boost to food prices as Ukrainian production of grain will fall and Russian production is sanctioned.

Figure 4 Unemployment and the Federal Funds Rate,
1960–2021
25
20
15
10

2020

2016

2012

2008

2004

2000

1996

1992

1988

1984

1980

1976

1972

1968

0

1964

5

1960

What Is the Possible Impact of Fed Rate Hikes?
We have placed our collective trust in the Fed’s ability to solve
the inflation problem. Economists such as Paul Krugman havebeen more dovish on the fiscal stimulus, partly because of
their belief in the Fed’s ability to bring inflation under control.
Others, such as Larry Summers (2021, 2022) have continuously
chastised the Fed for not raising the rates sooner (or raisingthem more aggressively once they start on that path). But what
can the Fed do about supply-side problems, including labor
shortages, oil, shipping delays, the war in Ukraine, and housing
shortages? Importantly, even if the Fed could affect demand, it
is unlikely we will have a demand problem in 2022.
Pundits suppose that the Fed can engineer a soft landing—i.e., lower inflation without hurting economic growth—througha steady stream of small rate hikes spread over a year or two tosignal to markets that it is serious about fighting inflation. But
the Fed has never managed to guide the economy to a soft landing with rate hikes. Many point to Fed Chairman Paul Volcker’s
interest rate hikes in the 1970s—to 20 percent and beyond (andabove 15 percent for a couple of years)—as an example of using
monetary policy to quell inflation. But the economy crashedinto deep recession, and a series of financial crises (the thrift
crisis of the early 1980s, the developing country debt crisis laterin the 1980s, and the big bank crisis at the end of the 1980s) can
all be traced to Volcker’s experiment. Chairman Greenspan’s
tightening in the early 1990s brought on a recession followedby our first jobless recovery, and his tightening in 2004 helped
to bring on the global financial crisis and another, even longer,jobless recovery.
The believers in monetary policy are not advocating
Volcker-level hikes precisely because they believe policy to be
powerful even with marginal changes to rates. That is wishful thinking. A 1–2 percentage point hike is unlikely to have amajor impact on interest-sensitive spending, whether it is car

Unemployment Rate
Federal Funds Effective Rate
Source: FRED

purchases, college education, or investment. People do not usually borrow to buy fuel for their cars, purchase groceries, or pay
rent—the categories currently driving inflation. Indeed, raisingrates can even be perverse by reducing home purchases andpushing up rents.
As Figure 4 shows, the Fed always raises rates as the economy moves into recession, and the unemployment rate thenrises significantly. It is rare for the Fed to raise rates without
unemployment following closely on the heels of the tightening.
The first time was in the late 1960s when the unemployment
rate continued to fall as rates were raised; the second was in
the aftermath of Volcker’s devastating rate hikes, when anotherinterest rate hike to nearly 12 percent did not overcome theReagan recovery in 1984; and the final case was a rate hike in
1995, to almost 6 percent at the beginning of the “Goldilocks”
years. In each of these cases, strong economic growth continued, and unemployment continued to fall. Outside those cases,
the Fed’s timing was impeccable and the outcome was assured:
rates are always raised before recessions and recessions always
increase unemployment.
Realistically, the only way in which monetary policy canaffect inflation is by significantly slowing down the economy
and raising unemployment sufficiently to alleviate wage pressures—which, as we have argued, are not now driving inflation,
but are simply trying to catch up to price increases. Small rate

Public Policy Brief, No. 157

8

hikes do not reduce inflation; it takes large rate hikes that create financial crises, insolvency, and bankruptcies severe enoughto crash the economy—followed by jobless recoveries. In otherwords, the Fed would be using unemployment as a tool to control the rate of inflation. Killing the recovery also means reversing the progress made recently on raising incomes at the bottom(see Galbraith 2022).
There is one more interesting pattern: in an expansion,
as income and employment grow, the federal budget deficit
declines, as shown in Figure 5. The reduction of the deficit pulls
demand out of the economy, slowing growth and increasing
unemployment. At approximately the same time—although the
decline in the deficit usually takes precedence—the Fed chooses
to raise rates to add to the economic headwinds. The combination of a falling deficit (smaller net injection of government
demand into the economy) plus the Fed’s rate hike is sufficient
to cause a recession that increases unemployment—as shown in
Figure 4. When the recession hits, the deficit increases sharply,
as job losses reduce tax revenues (and some kinds of social
spending increase).
According to the most recent Bureau of Economic Analysis
data available, the federal government net lending/borrowing fell
from $4.4 trillion (20 percent of GDP) in 2021Q1 to $2.3 trillion (10 percent of GDP) in 2021Q3. The Office of Management
and Budget projects a budget deficit of 7.6 percent in 2022, falling
further to 5.3 percent of GDP in 2023. If the past is any guide

Figure 5 Federal Government Deficit/Surplus and theFederal Funds Rate
20

Percent of GDP

15
10
5
0

(borrowing Greenspan’s phrase again), the reduction of the deficit
is likely to push the economy into another recession. Hence, theFed’s prospective rate hikes will—again—be impeccably timed.
In addition to the “normal” deficit reduction and Fed tightening, we face continuing supply-side disruptions caused bysuccessive waves of COVID-19, exercise of pricing power, andsanctions on Russia. Together these threaten to cause not only
a recession but also high inflation. This is a recipe for stagflation—an even more dangerous cocktail than the forces thatworked to bring on the stagflation of the 1970s. Further, as we
mentioned, the US economy has been prone to secular stagnation for the past half-century, only temporarily relieved largely
by financial bubbles—the dot-com bubble of the Clinton years,
the combination of the housing, stock market, and commodities
market bubble that preceded the global financial crisis, and thelong run-up of equities markets over the past decade.
Today’s financial markets are seriously bloated—unfazedby the pandemic and other worrying developments (i.e., failure
to make significant progress dealing with the oncoming climate Armageddon, attempted coup in Washington on January
6, 2021, and the war in Ukraine). It is difficult to foresee how
financial markets might react to another recession in conjunction with rising interest rates. We know that the financial sector has become accustomed to 15 years of unprecedentedly low
borrowing costs. Will it unravel when faced with negative GDP
growth and substantially higher interest rates?
The appropriate solution to inflation would be to work to
alleviate supply-side constraints. That, however, cannot really beachieved by monetary policy. In fact, cutting interest-sensitive
spending, such as investment, would work to constrain ourcapacity to produce (i.e., supply) in the future. The pandemic
has taught us that the United States must become less reliant on
foreign production, and we need massive investments in alternative energy projects to free us from the grip of OPEC-Plus,
which includes Russian oil production. We need more domestic
investment, not less.
The Fed seems to be embarking on a dangerous experiment.

-5
-10
-10

1970

1980

1990

2000

2010

2020

Federal Funds Effective Rate
Federal Surplus or Deficit [-] as Percent of Gross Domestic ProductSource: FRED

Levy Economics Institute of Bard College

9Conclusion
It appears to us that what the United States faces is not a problem of too much demand, but a situation in which demand andjob growth has not been slow to recover like it has been in past
recoveries. This recovery only seems remarkable because joblessrecoveries over the past 30 years have become our new normal.
In any event, the high inflation we see today is not due to excess
demand. One could go much further and argue that both of ourhigh inflation periods (the early and late 1970s) were not periods of high aggregate demand. But that is too obvious to require
embellishment: these were, famously, called periods of stagflation. There is some danger that inappropriate tightening by the
Fed now could reproduce stagflation. We already have significant headwinds in the form of periodic outbreaks of new strainsof COVID-19 (and frequent lockdowns in China), what is likely
to be a drawn-out war in Ukraine, the winding-down of the lastremnants of the federal government’s pandemic relief programs,
and rising tax revenue and falling budget deficits. Growth projections are already being reduced.
We must find a better way to think about, and deal with,
inflation. What the pandemic has shown is that the real issue
in the economy is the availability (or lack thereof) of real
resources. So, the task of policy is to enhance our real resource
space, something monetary policy cannot do. Fiscal policy ismore fit for the purpose, but that requires rethinking how we
implement it.
Indiscriminate stimulus spending of the type we engaged inover the past couple of years is not the best approach. Instead,
we need to use a more-targeted approach to spending, where
demand is directed to the unemployed through a job guarantee program and to the parts of the economy where demandis insufficient. Further, fiscal policy can be used to direct
investment into particular areas of the economy with the goalof increasing our real resource space for the long term. Most
importantly, we must tackle climate change to prevent a catastrophe that threatens human survival. Hiking interest rates is, atbest, counterproductive.

Notes
1. See Nersisyan and Wray (2022) for a detailed discussion of
GDP data.
2. See Nersisyan and Wray (2022) for details. Import prices
have, of course, been rising—for many of the reasons
already discussed: much higher oil prices, higher shipping
costs, and supply chain disruptions. Perhaps demand playedsome role, too. However, the point is that imports havesucked demand out of the domestic economy that might
have otherwise gone toward pushing up inflation at home.
3. See Parlapiano et al. (2022) and Committee for a Responsible
Federal Budget (2022).
4. See Nersisyan and Wray (2022) for a detailed analysis of thesurvey data.
5. See Nersisyan and Wray (2022) for further discussion of
examples of use of pricing power.
6. See Nersisyan and Wray (2022) for further discussion of thesurvey data.
7. See Papadimitriou and Wray (2022).

References
Committee for a Responsible Federal Budget. 2022. “COVID
Money Tracker.” Interactive site. Available at:https://www.covidmoneytracker.org/
Federal Reserve Bank of Atlanta. 2022. “Business Inflation
Expectation.” February 26. Available at:https://www.atlantafed.org/research/inflationproject/bie
Galbraith, J. K. 2022. “How the Left Should Think About
Inflation.” The Nation, February 18.
Nersisyan, Y., and L. R. Wray. 2022. “What’s Causing
Accelerating Inflation: Pandemic or Policy Response?”
Levy Institute Working Paper No. 1003. Annandale-onHudson, NY: Levy Economics Institute of Bard College.
Papadimitriou, D. B., and L. R. Wray. 2021. “Still Flying Blindafter All These Years: The Federal Reserve’s Continuing
Experiments with Unobservables.” Public Policy Brief
No. 156. Annandale-on-Hudson, NY: Levy Economics
Institute of Bard College. December.
Parlapiano, A., D. B. Solomon, M. Ngo, and S. Cowley. 2022.
“Where $5 Trillion in Pandemic Stimulus Money Went.”
New York Times, March 11.
Stoller, M. 2021. “Corporate Profits Drive 60 percent of
Inflation Increases.” BIG by Matt Stoller blog, December 29.
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Summers, L. H. 2022. “Opinion: The Fed is Charting a Course to
Stagflation and Recession.” The Washington Post, March 15.
———. 2021. “Opinion: The Fed’s Words Still Don’t Measure
Up to the Challenge of Inflation.” The Washington Post,
December 16.
White House. 2021. “Fact Sheet: Executive Order on
Promoting Competition in the American Economy.”
July 9. Available at: https://www.whitehouse.gov/
briefing-room/statements-releases/2021/07/09/factsheet-executive-order-on-promoting-competition-in-theamerican-economy/

Levy Economics Institute of Bard College

11About the Authors
Research Scholar yeva nersisyan is an associate professor of economics at Franklin and MarshallCollege in Lancaster, PA. She received her BA in economics from Yerevan State University in Yerevan,
Armenia in 2006, and her MA and Ph.D. (2013) in economics and mathematics from the Universityof Missouri–Kansas City.
Nersisyan is a macroeconomist working in the Modern Money Theory, Post-Keynesian, andInstitutionalist traditions. Her research interests include banking and financial instability, and fiscal
and monetary theory and policy. She has published a number of papers on shadow banking, liquidity
creation, the Glass-Steagall Act, and government deficits and debt. Her current research is focusedon the affordability and inflationary impact of the Green New Deal. She is also coediting the Elgar
Companion to Modern Money Theory with L. Randall Wray.
Senior Scholar l. randall wray is a professor of economics at Bard College. His current research
focuses on providing a critique of orthodox monetary theory and policy, and the development of analternative approach. He also publishes extensively in the areas of full employment policy and, moregenerally, fiscal policy. Wray’s most recent book is A Great Leap Forward (Academic Press, 2020).
Wray is the author of Money and Credit in Capitalist Economies: The Endogenous Money
Approach (Edward Elgar, 1990), Understanding Modern Money: The Key to Full Employment andPrice Stability (Edward Elgar, 1998), The Rise and Fall of Money Manager Capitalism: Minsky’s Half
Century from World War Two to the Great Recession (with É. Tymoigne; Routledge, 2013), Modern
Money Theory: A Primer on Macroeconomics for Sovereign Monetary Systems (Palgrave Macmillan,
2012; 2nd rev. ed., 2015), Why Minsky Matters: An Introduction to the Work of a Maverick
Economist (Princeton University Press, 2016), and Macroeconomics (with W. Mitchell and M. Watts;
Red Globe Press, 2019). He is also coeditor of, and a contributor to, Money, Financial Instability, andStabilization Policy (Edward Elgar, 2006) and Keynes for the 21st Century: The Continuing Relevanceof The General Theory (Palgrave Macmillan, 2008).
Wray taught at the University of Missouri–Kansas City from 1999 to 2016 and at the Universityof Denver from 1987 to 1999, and has been a visiting professor at the Universities of Paris andRome (La Sapienza). He holds a BA from the University of the Pacific and an MA and a Ph.D. from
Washington University, where he was a student of Minsky. He has recently completed a FulbrightSpecialist Grant at the Tallinn University of Technology in Estonia.

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