top of page
  • thomas

Reasons why inflation in the US is still runninghot despite Fed’s aggressive rate hikes

On October 13, 2022, the Bureau of Labor Statistics released another higher-

than-expectation Consumer Price Index (CPI) data. It came in at 8.2 percent

implying that the price of goods and services increased by 8.2 percent compared

to the price 12 months ago. The index for all other items less food and energy

which are more volatile rose 6.6 percent. The Fed Chair Jerome Powell

announced another 75basis points rate hike and dismissed the idea of slowing the

pace of tightening soon on Nov 2 after the Federal Open Market Committee

(FOMC) meeting. So, why is the inflation still stubbornly high despite the US

Fed hiking the interest rate to its highest level since early 2008?

What Causes the Inflation at First

Demand Side

On March 11, 2020, the World Health Organization (WHO) declared

Covid-19 a global pandemic. Countries across the globe responded with

lockdowns, quarantine measures, and social distancing to contain the virus.

Economic activities slowed down quickly and the market plunges due to the

uncertainty. Since then, the unemployment rate raised sharply with economies

across the world experiencing the worst recession since the Great Depression.i

The Fed

Mandated to keep unemployment low, the Fed cut rates to zero and

launched a massive quantitative easing program to boost the economy. The

Fed’s balance sheet increased quickly as trillions of dollars are pumped into the

market. The low rates allowed businesses and consumers to invest and consume

with borrowed money at a cheap price. The stock markets surged from the low

on April 7, 2020, alongside with price of different assets such as real estate,

cryptocurrency, etc. Thanks to the wealth effect, a theory that says people tend

to spend more as the value of their assets rises, the demand increased as the Fed

loosen its monetary policy.

The US Government

On the other hand, the US government responded to the crisis with relief

packages and stimulus. For example, the 2.2$ trillion Coronavirus Aid, Relief

and Economic Security Act (CARES) signed on March 27, 2020, provides

direct cash payment, unemployment benefits, tax credits for firms, and

investment in the healthcare sector. The debt ceiling increase signed into law in

2021 by President Joe Biden is another firm evidence that the fiscal policy by

the US government is enormous. Hence, the demand in the US economy

quickly rises and is perhaps higher than the pre-Covid level.

Chart showing the correlation between inflation with low interest rate and Fed’s balance sheet.

Source: Refinitiv Datastream, Reuters, Sept. 21, 2022, By Vincent Flasseur

Supply Side

Due to the Covid-19 prevention and control measures in 2020, most non-

essential businesses are required to close their physical operation. As the firms

are importing raw materials and producing their product in different countries,

the lockdown and closed border no doubt cause disruption in their supply chain.

Besides, the production lines are also affected by labour shortage as workers are

required to stay at home after tested positive for the virus. Fortunately, the

supply-side pressure is slowly easing as countries loosen their control measure.

However, is that the case?

China’s zero-Covid Policy

China has positioned itself as ‘the world’s factory’ since joining the

World Trade Organization (WTO). According to UN Comtrade, China alone

accounted for 13.45 percent of global export in 2018. As other countries are

easing their Covid-19 control measures, the Chinese authorities are still firm

with their goal to eradicate the virus with lockdowns and quarantine measures.

The supply chain of firms importing raw materials and producing their products

from China is also affected. For evidence, thousands of factory workers at

Foxconn, the major assembler of iPhones for Apple, quit their jobs to escape the

deteriorating working environment due to the lockdown by the Chinese

authorities.ii The pressure on the supply side remains as there’s still no sight of

the Chinese policymakers easing the policy.

Russia-Ukraine War

On February 24, 2022, Russian President Vladimir Putin addressed his

nation, announcing a “special military operation” against Ukraine. Before the

war, Ukraine was known as “the food basket of the world”. It is the world’s top

producer of sunflower meal, and oil as well as a major exporter of grains,

chemicals, and petroleum products. The production in Ukraine dropped

drastically since the war causes the price of agricultural products to surge across

the world. Furthermore, the US and its allies implemented a series of sanctions

on Russia from the energy sector to the financial sector to cripple the Russian

economy. As Russia is one of the largest oil and natural gas producers, the

sanctions worsen the initially high oil price and caused the energy prices to

skyrocket with both Brent and US oil topping 100 dollars. The situation is not

getting better in the short term as both the Russian President and the Ukrainian

President rule out a peace deal.

Reasons for the High Inflation

After realizing that inflation is not transitory, the Fed started to increase

the Federal Funds Rates to 0.5 percent on March 16. It also raised the rate by 75

basis points three consecutive times after the Federal Open Market Committee

(FOMC) meeting in June, July, and September respectively. Higher rates

strengthen the US Dollar and lowered the price of imports from foreign

countries easing inflation. Starting in September 2022, the Fed also started

quantitative tightening by rolling off treasuries and mortgage-backed securities

without reinvesting them. With these policies, the cost of borrowing is now

higher and asset prices dropped drastically with S&P 500 plunging 20 percent

year-to-date. The demand of households and firms should start to slow down

since then. However, why is the inflation still unacceptably high at 8.2 percent

compared to 12 months ago?

The US Dollar Currency Index is up 15.75% year-to-date. Source:

One of the main reasons is the time lag of monetary policy. For

example, it takes time for the increase in the overnight policy rate to pass

through into other rates such as mortgage rate, personal loan rate, and business

loan rate. Research also shows that it takes over a year before monetary policy

actions have their peak effect on inflation.iii Furthermore, inflation may have

been transmitted into wages and rent which are harder to curb. In the worst case,

a wage-price spiral may occur which elevates inflation repeatedly. To prevent

the wage-price spiral and to restore its credibility, the Fed is aggressively

tightening its monetary policy to bring inflation down.

In August 2022, President Joe Biden signed the Inflation Reduction Act

and the CHIPS Act funded by taxing the rich. The provisions include numerous

investments in climate protection and clean energy, research and development

in the semiconductor supply chain, and medical insurance to bring down

prescription drug prices to cool inflation. These policies aimed to reduce the

dependence of the US on foreign countries, especially in manufacturing

semiconductors. These investments aim to create more jobs and increase the

long-run supply hence cooling inflation. However, massive government

spending will also increase the demand in the economy further, it is

questionable whether the policies help in reducing inflation with strong

consumer spending and unemployment level at a historical low. Some also

suggested that President Biden should encourage peace talks between Russia

and Ukraineiv

, or perhaps persuade the Chinese authorities to ease their zero-

Covid policy instead of continuing his expansionary fiscal policy.


The Fed is expected to maintain its hawkish stance on combating

inflation as the unemployment level in the US is still low. On the other hand,

President Biden is expected to continue his expansionary fiscal policy to remain

politically famous in the coming mid-term election. Inflation in the US should

start to fall soon with a higher rate and a stronger dollar. Nevertheless, other

countries are still not out of the woods yet due to the strong dollars. As the

saying goes, ‘it’s our dollar but your problem’.


i Gopinath, G. (2020, April 14). IMF BLOG. Retrieved from


ii Lew, L. (2022, October 31). Bloomberg. Retrieved from


iii Nelson, N. B. (2002, January -). Retrieved from



iv Clark, J. (2022, October 24). The Washington Times. Retrieved from


bottom of page