"US Inflation Easing Requires Accompanying Tight Fiscal Policy"

Professor from Rochester University at Coachella Kota Delivers Keynote Speech at 'BOK International Conference'

In a situation where real interest rates fall below growth rates, it has been argued that to alleviate inflation in the United States, contractionary fiscal policies such as revenue increases or reductions in transfer payments should accompany tight monetary policies rather than relying solely on the latter.

Narayana Kocherlakota, former president of the Federal Reserve Bank of Minneapolis and a professor at the University of Rochester, stated this in his keynote speech at the 'BOK International Conference' held on the 1st at the Bank of Korea Conference Hall in Jung-gu, Seoul. This conference was held in person for the first time in four years under the theme 'Policy Challenges After the Pandemic.'

Professor Kocherlakota assessed that the sharp rise in U.S. inflation experienced over the past three years was mainly due to increased supply costs caused by the pandemic and the Ukraine-Russia war, as well as a rise in profit margins resulting from reduced competition among firms, rather than excess demand stemming from accommodative monetary and fiscal policies after the COVID-19 crisis. Although large fiscal spending in response to the COVID-19 crisis and the Federal Reserve's zero interest rate policy have been cited as major causes of recent high inflation due to excess demand, he expressed the view that evidence supporting these accommodative policies causing excess demand is limited.

Professor Kocherlakota explained, "Considering that there was little difference in unemployment rates and real wages before and after the pandemic, it is difficult to conclude that accommodative macro policies caused excess demand," adding, "Long-term expected inflation, which captures the extent to which monetary expansion translates into inflation, has only risen by 0.5 percentage points compared to before COVID-19."

He viewed the recent high inflation as primarily resulting from cost increases due to supply disruptions caused by the COVID-19 crisis and the Ukraine-Russia war, as well as profit margin increases due to reduced competition among firms. Despite rising production costs from supply shortages, corporate profits in the U.S. increased by more than 20% compared to before the COVID-19 crisis due to reduced competition among firms caused by lockdown measures during the pandemic, allowing high prices to be maintained.

In particular, based on theoretical analysis using a new macroeconomic model, Professor Kocherlakota argued that to lower inflation to a desirable level, it would be more appropriate to implement contractionary fiscal policies rather than relying solely on monetary tightening. He pointed out, "When responding to high inflation with contractionary monetary policy, there is primarily a demand reduction effect at the current time through intertemporal substitution, which lowers inflation; however, on the other hand, increased interest income from government bonds held by households may stimulate future demand and potentially raise inflation."

Conversely, he explained that responding to high inflation with contractionary fiscal policies such as reducing transfer payments can lower current consumption and inflation by reducing disposable income, and simultaneously reduce future demand and suppress inflation by decreasing government debt and thus lowering future household interest income.

Professor Kocherlakota stated, "Recent high inflation is more attributable to rising production costs from supply disruptions and increased profit margins due to reduced market competition than to excess demand caused by accommodative monetary and fiscal policies," adding, "To address this, priority should be given to measures that reduce production costs through supply chain improvements and expand supply by enhancing competition among firms." He also emphasized that, as experienced by major countries over the past 30 years, in situations where real interest rates fall below growth rates, fiscal policy should be utilized alongside monetary policy for macroeconomic stabilization such as price stability, rather than relying solely on monetary policy.

This content was produced with the assistance of AI translation services.