The Fed’s “7% Solution” Won’t Work This Time

Just recently, James Bullard, President of the St. Louis Federal Reserve, suggested the central bank might need to employ the “7% solution” to ensure the complete destruction of inflation. As we have discussed previously, the fear is repeating the policy errors of the late 1970s that led to entrenched inflation.

While the “7% solution” is supported by the likes of Larry Summers and others, there are vast differences between the economy today versus then. Trying to increase the Fed funds rate to 7%, 2.5% higher than they are currently, risks triggering a catastrophically deep recession.

The reason is the 2020 inflation was the result of one-time artificial influences versus the 1970s. As we noted previously in“That 70s Show:”

“The buildup of inflation was in the works long before the Arab Oil Embargo. Economic growth, wages, and savings rates catalyzed ‘demand push’ inflation. In other words, as economic growth increased, economic demand led to higher prices and wages.”

7% solution, The Fed’s “7% Solution” Won’t Work This Time

“Furthermore, the Government ran no deficit, and household debt to net worth was about 60%. So, while inflation was increasing and interest rates rose in tandem, the average household could sustain their living standard. The chart shows the difference between household debt versus incomes in the pre-and post-financialization eras.”

7% solution, The Fed’s “7% Solution” Won’t Work This Time

What was most notable is the Fed’s inflation fight didn’t start in 1980 but persisted through the entirety of the 60s and 70s. As shown, as economic growth expanded, increasing wages and savings, the entire period was marked by inflation surges. Repeatedly, the Fed took action to slow inflationary pressures, which resulted in the repeated market and economic downturns.