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The U.S.- Did the use of monetary policy solve inflation or postpone it?

By Sukeerthi


The dual mandate of the Federal Reserve is to pursue the economic goals of maximum employment and price stability. When the pandemic hit, the Fed were worried about growth and employment. As the economy was recovering from 2 waves of Covid, inflation had already started its upward trend. However, the Fed assumed it was transitory and maintained a loose monetary policy to focus on growth and employment. The article aims to explore the implications of the Fed’s assumption on the U.S. economy. 


In the past two years, the Covid-19 pandemic and the Russia-Ukraine war have been two pivotal events that have hit economies worldwide. However, they affected the United States because of the Federal Reserve’s policy decisions. The dual mandate of the Fed is to pursue the economic goals of maximum employment and price stability. Essentially once the policy response came into effect, the final result was inflation hitting a 40-year high of 9.1% by June of 2022. This article aims to discuss whether the use of monetary policy has addressed inflation or postponed it. To answer that effectively, the article has been split into two parts: the Covid-19 pandemic and post the Russian invasion.

Covid 19

With business shutting down and individuals losing their jobs and livelihood, the pandemic resulted in an economic meltdown. According to a report by the Bureau of Labour Statistics, unemployment had increased to 14.8% in April 2020. Given that one of the Fed’s economic objectives is maximum employment, the United States spent almost 27% of their GDP on fiscal stimulus to address the pandemic induced unemployment. 


If we look at 2020 specifically, we can see the U.S. Real GDP/capita decreased. The increase that was seen post-2020 was a result of the fiscal package, the use of expansionary fiscal policy and increased government spending. Under normal economic theory, the expected outcome of providing financial aid is that the demand for and consumption of goods and services increases, forcing businesses to increase their production. As a result, businesses would be required to hire more workers, thus increasing employment and the GDP/Capita. This ultimately puts an upward pressure on prices.

Simultaneously, the Fed also responded through Quantitative Easing (QE)to stimulate economic activity. QE is essentially a loose monetary policy wherein the supply of money is increased, and the long-term interest rates are lowered. The combination of expansionary fiscal policy (the fiscal stimulus itself) and loose monetary policy is why we can see the trajectory of the GDP/capita going back to its pre-pandemic path. However, this induced an increase in demand that was seen when there were already supply chain constraints, causing prices to shoot up and thus inflation.

From this graph, we can see that in all 3 instances, the Personal Consumption Expenditures (PCE) – a measure of inflation based on changes in personal consumption, dipped in April of 2020 when the pandemic hit. Though the Fed’s expected inflation to increase, it miscalculated its magnitude due to three “temporary” factors: pent-up demand, supply chain disruptions, and the base effect (if the inflation rate is really low in the previous year, a minor increase in Price Index can give rise to inflation).

Furthermore, the Fed had a lapse in judgement in assuming that the inflation would be transitory and cool down once the economy recovers from the impacts of the Covid-19 pandemic. Little did it know a storm was brewing that would really leave their economy in a compromising situation.

The Russian Invasion

Statistics: May 2020: 0.6%, July 2021: 5.4%, Feb 2022: 7.9%, June: 9.1%.

As a result of Russia’s invasion of Ukraine, we can see from the above graph that the CPI is on an increasing trend from 7.9%. Prior to the war, inflation was on an upward trend because of the Fed’s policy response to the pandemic. The war resulted in hiked prices of food and energy, which further stressed the CPI. This ultimately resulted in a 40-year high inflation rate. The Fed was behind the curve in terms of inflation.

During the pandemic, the US government was focused on putting money in the hands of individuals due to the loss of livelihood induced by the lockdown. Without doubt, this was important for the government to do at the time. When signs of inflation started showing the Fed should have picked this up and not concluded that inflation was transitory. Massive Fiscal Stimulus increased money supply but there was no corresponding increase in the output of the economy (GDP). More money was chasing less output and naturally the inflation increased. Ideally, the Fed should have analyzed the cause of post covid inflation better and should have started tightening its monetary policy. As explained earlier, the federal monetary policy was behind the curve in addressing the inflation during Covid-19. When the Russo-Ukrainian war hit there was a spike in food and energy prices which put further pressure on the existing, growing inflation that caused the Fed to fall even further behind the monetary policy to address inflation. 

It was only in June that the Fed started pushing for a more aggressive monetary policy to help combat inflation. It began hiking the interest rates in March and again in July to a benchmark ranging between 2.25%-2.5%. The last time the interest rates were this high was in 1994.

In a dollarized world, the United States unilateral monetary policy is affecting economies across the world. Moreover, the Fed mentioned that it was going to continue aggressively hiking interest rates until the inflation comes down. The Fed’s aggressive monetary policy puts pressure on other countries to now increase their interest rates. The only difference in objective is that this time around, is that the Fed is not focused on economic growth but on damage control. The uncertainty and impact resulting from the Fed’s aggressive policy is a result of postponing the use of a tighter monetary policy when the economy started exhibiting signs of inflation post the second wave of the pandemic. 

Sukeerthi Vijayaraghavan is a final year B.A. Economics student at Jindal School of Government and Public Policy. Her interests include exploring practical applications of economic concepts in the field of finance specifically and how policy decisions affect individuals at a grassroot level. She is also currently a columnist at Center for New Economic Studies.

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