The Fed Is Giving Americans a Harsh Lesson in Lag Time
Monetary policy isn't like flipping a switch. Inflation has seeped into the economy’s bones, and interest rates will need to go higher for longer to turn the tide.
To state what is now especially obvious, there’s still a lot we don’t know about how monetary policy works, and perhaps more crucially, when it will work. The Federal Reserve has been tightening for about six months now and inflation still doesn't seem to be budging. At least some things are clear: This bout of inflation isn't transitory — it's seeped into the bones of the economy. This makes knowing when monetary policy will begin having a noticeable effect even more unpredictable. Markets seem to expect the Fed to start easing next year, but Fed officials have been adamant they will keep rates high, and keep raising them, until inflation comes down. So when will that be?
Monetary policy takes time to work its way through the economy; some estimates say it takes about a year or might need up to three years to have much impact on inflation. After all, wages are often dictated by contracts, and rents are set for a year or more in advance. Raising rates increases the cost of borrowing, which reduces investment, slows hiring and wage growth and eventually increases unemployment before inflation comes down. It's far from an exact science.
Allison Schrager is a senior fellow at the Manhattan Institute and a contributing editor of City Journal.
This piece originally appeared in Bloomberg Opinion