The inflation we are experiencing today is the result of economic and social engineering caused by the Federal Reserve. The COVID crisis in particular was the main source that incentivized the Federal Reserve to intervene in the economy by monitoring the money supply.
During the pandemic, the U.S. economy experienced a supply shock. It particularly experienced a negative supply shock. Negative supply shocks occur when the level of output decreases, which causes prices to increase. A negative supply shock occurred because the pandemic halted the supply chain. This then decreased the level of production, as the level of output declined, prices would logically rise. What the Federal Reserve did was trying to create a demand shock instead of going along with market forces.
Market forces indicated that during the pandemic, output decreased due to an interruption in the supply chain. The logical action that should follow in such events would be for demand to be reduced as well so that prices would get back into equilibrium. But the Federal Reserve did the very opposite. The central bankers tried to stimulate aggregate demand by creating a positive demand shock.
Money Supply (M2), 2019-2022
Source: Board of Governors of the Federal Reserve System
Demand shock occurs when there is a sudden unexpected event that dramatically increases or decreases demand for a product or service, usually temporarily. What the Federal Reserve did was to engineer a positive demand shock while the economy was experiencing a negative supply shock. In order to engineer this positive demand shock, the Federal Reserve increased the money supply by nearly 40% and slashed interest rates to near zero, and began buying trillions of dollars in Treasury bonds and mortgage-backed securities from 2020 to 2021.
These actions were intended to provide liquidity to the financial system and support the economy during the pandemic, and that was the crucial mistake that the Federal Reserve made, which triggered the levels of inflation we had since the late 1970s and early 1980s. The main question that any person would ask is why did the Fed stimulate demand when the correct course of action to take was to not interfere with market forces and let demand adjust itself?
The Fed stimulated demand despite the economy experiencing a negative supply shock because the U.S. economy is based on consumer spending and credit. Central bankers believed that the ability to encourage consumer spending by putting more money at their disposal would cure the negative supply shock, and that was a terrible mistake. Jerome Powell and his acolytes tried to defy the laws of economics through social engineering.
They believed that their monetary policy would correct economic laws and that was a fatal mistake to make.
The imminent result of that social engineering was inflation because the excessive money printing led to an increased demand for goods and services that suppliers could not offer to consumers. In other words, there was a discrepancy between supply and demand, and this discrepancy was engineered by the Federal Reserve. Thus, the increase in the money supply has been cited as the leading factor contributing to the recent rise in inflation. When there is more money in circulation, it leads to higher prices, as people have more money to spend, which makes demand outpacing supply.
The Fed is now in the process of withdrawing some of the excess money from the economy by raising interest rates and reducing its bond purchases. The current inflationary situation that the economy is experiencing is the proof that economic planning does not work. There is a reason why economic laws exist, and these laws shall not be defied because they were not created by legislation but by human incentives.
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