Bernanke: Slow Fed Response Helped Inflation Surge

Did government spending and monetary policy cause the post-pandemic inflation spike? Or did chance events like supply chain disruptions and the war in Ukraine trigger runaway inflation that couldn’t be stopped? 

According to former Federal Reserve Chair Ben Bernanke, inflation was caused by a culmination of these factors but big government checks and poor timing on interest rate hikes fanned the flames that pushed prices higher and kept them there.  

In a paper Bernanke co-authored with Olivier Blanchard of the Peterson Institute for International Economics, the economists argued that the Federal Reserve was too focused on keeping employment high by keeping interest rates low, losing sight of inflation that was down the pike after large government spending packages.

“In retrospect, the failure to forecast the inflation burst reflected in large part the fact that, in focusing on the labor market, both the Fed and its critics underestimated the inflationary potential of developments in goods markets, that is, from increases in prices given wages,” the paper said.

Bernanke spoke at a Brookings Institute debate on the paper, discussing centered on the role that both fiscal policy, mainly centered around government spending, and monetary policy, regarding interest rates set by the Federal Reserve, played in the role of high inflation.

In the paper, the economists noted that federal spending during the pandemic was 4.5 times higher than the inflation-adjusted spending in 2008's response to the fiscal crisis. Critics have argued the Federal Reserve should have raised interest rates before March 2022 to attack inflation sooner.

For example, Bernanke said that gas prices helped inflate people’s expectations for pay, prompting them to ask for higher wages from their employers, who in turn raised their prices to help cover higher labor costs. 

“We do find that food and energy costs had a bigger effect than their share, both because they have some longer-term effects on other goods and services, but mostly because of these indirect effects that are going on,” he said.

Harvard University economics professor Jason Furman said while he agreed with many of the paper’s findings, he didn’t think it ultimately answered the question of what is behind the enduring inflation. 

Fed forecasts couldn’t have foreseen some events, like the war in Ukraine. However, while the government may have spent too much money on pandemic programs, the Federal Reserve’s failure to act quickly in response to inflation made it more responsible for the higher prices of goods and services that followed, Furman said.