Some Federal Reserve governors want to make the economy run “hot” by rapidly increasing the money supply to cause inflation. They mistakenly believe that higher inflation will force consumers to overconsume and that will trigger economic growth. This is wrong because consumers and business managers won’t be fooled by inflation and will not sustainably increase spending and investing. As the Fed increases its degree of interference with and disruption of the economy then business managers will have to adjust for this which will include assigning a higher risk premium (a hurdle rate used to decide if a project is going to be successful) to business activities. When that happens the cost of capital will be higher that it otherwise would be, thus dampening economic growth even though interest rates were driven lower! The purpose of increasing inflation is to make real interest rates lower, thus allegedly providing a bigger incentive to borrow more and spend more. However, a business expansion decision uses a cost of capital that includes both interest rates and a risk premium. The rising, volatile, unpredictable interference would raise the risk premium more than the benefit from an interest rate cut. The economy might get trapped into a downward spiral.
This phenomenon has been documented during QE when the Fed started a new round of QE bond buying then interest rates actually went up because the marketplace anticipated inflation and thus discounted for rising interest rates, exactly the opposite of the Fed’s goal of using QE to lower rates. When the Fed stopped QE then rates dropped!
The lower real income experienced by retirees on fixed income will cause them to respond as if they were experiencing a depression where they have lower real income. They would then reduce spending and consumption, contributing to a recession. Higher inflation can warp income tax rates causing people to pay higher taxes even though their real income didn’t increase. Yes, the tax code is indexed for inflation, for simple things like wages, but it is not comprehensively indexed for every type of income. For example, the $3,000 annual loss limit for stock market losses has been unchanged for over 60 years, it should be ten times than that to adjust for inflation. When tax is paid on interest income, it is not adjusted for inflation, thus the taxpayer pays tax on phantom income caused by inflation.
The only way for the Federal Reserve to improve the economy is to stop disrupting the economy with attempts to increase inflation (which triggers fears of rising interest rates, resulting in the marketplace raising interest rates.) The Fed should become an advocate of sound money or hard money so as to attract and reassure investors and savers instead of scaring them away.
Investors need independent financial advice about the risks of a runaway Fed monetary policy that makes the economy get weaker as a result of QE bubble making.