Tired of inflation? The Federal Reserve’s actions won’t provide any relief for months

[CNBC, Getty Images]

• Even though the Federal Reserve is about to embark on an inflation-fighting strategy, the impact won’t be felt for months or longer.
• Monetary policy works with a lag, which means it takes time for rate moves to circulate through the economy.
• The Fed has no direct way of lowering the cost of a loaf of bread at the grocery store or a fast-food burger or even a gallon of gas.

Folks tired of paying higher prices for pretty much everything shouldn’t expect help anytime soon from the Federal Reserve.

Even though the central bank is about to embark on an inflation-fighting strategy, the impact won’t be felt for months or longer, economists say.

That’s because the Fed can’t order prices to go lower. All it can do is tighten up the money supply and trust that things will go well from there. The central bank does that through interest rate hikes, which are expected to start up in March and — ultimately — bring down the cost of living.

“What it will do is it will limit the persistence of price increases,” said Joseph Brusuelas, chief economist at RSM, an accounting service. “The expectation that we should all have is the action the Fed takes today really won’t be apparent until the fourth quarter of this year and all of next year.”

Anticipation of Fed action comes as the latest consumer price index reading, which measures the cost of dozens of everyday goods and services, grew 7.5% over the past year in January. That’s the fastest rise since 1982, when the economy was dealing with stagflation and a double-dip recession.

Prices rose across the board. In December alone, cereal increased 1.8%, ham was up 2.5% and fresh fish prices jumped 2.4%. That’s on top of ongoing surges in food, energy and housing.

In an effort to address the problem, markets expect the Fed at its March meeting to raise benchmark borrowing rates by at least 0.25 percentage points, and perhaps double that. Wall Street figures the Fed to hike rates at least five more times after that before the end of 2022.

But monetary policy works with a lag, which means it takes time for rate moves to circulate through the economy. Economists believe it’s six months to a year before those efforts really take effect.

“The Federal Reserve cannot do anything about the current surge in inflation in the near term,” Brusuelas said.

Over the longer term, though, rate hikes have proven to be an effective way to curb inflation.

A question of time’

The way it works is that higher rates make it less affordable to borrow money, so that slows credit. At the same time, the higher cost of money feeds into the dollar, raising the U.S. currency’s value and providing consumers more purchasing power.

If that sounds kind of squishy, there’s a reason for that. The Fed has no direct way of lowering the cost of a loaf of bread at the grocery store or a fast-food burger or even a gallon of gas, which has gotten 40% more expensive over the past 12 months.

There’s another problem: This is not your garden-variety inflation cycle, which is generally driven by big jumps in credit. Instead, much of the current situation has come thanks to unprecedented infusions of cash that flowed directly from the federal government through pandemic-related payments to households, and indirectly from the Fed and the amount of money it has pumped into the economy through lending and liquidity programs, along with near-zero short-term interest rates.

“We are in an asset cycle and not a credit cycle,” said Steven Blitz, chief U.S. economist at TS Lombard. “The inflation that we’re seeing is a function of these one-time infusions of equity into households and small-business balance sheets. The money was spent, and it was spent at a time when the ability to supply that demand was constrained.”

Indeed, until recently Fed officials had been using the word “transitory” to describe inflation that came about through pandemic-related factors such as surging demand for goods over services and constraints to supply chains triggered by the Covid spread.

But price increases have proven more aggressive and durable than policymakers anticipated.

After months of writing off inflation as a passing phase, Fed officials now must take delayed action that will feed into the economy but through indirect channels.

“The only way the Fed can slow this is through a stronger dollar lowering the cost of imports,” Blitz said. “It not only lowers the cost of imports. It also raises the cost of producing goods elsewhere outside the U.S. and that lowers labor demand.”

The conundrum for the Fed will be in making sure the cure isn’t worse than the disease, that its inflation-fighting rate cuts don’t send the economy reeling and hurt the people at the lower end of the income spectrum that the aggressive spending policies were aimed at helping.

“Can the Fed bring down inflation? Yes, it absolutely can,” Blitz said. “But the question is, what happens next? It’s a question of time.”

By Jeff Cox