The Fed’s Inflation Trolley Problem

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One of the more interesting philosophical and ethics experiments is the trolley problem. It’s a fictional scenario with varying mechanics, but let’s use this one.

  1. You are a driver of a trolley.
  2. The trolley brakes fail.
  3. You are heading toward a switch in the tracks.
  4. On the current tracks, there is a stroller with a baby that will die if you don’t switch tracks.
  5. However, if you switch tracks, you will kill 5 adults.
  6. Which do you choose?

This is not some ethereal experiment about existence, reason and knowledge. It is an important problem to solve when it comes to both autonomous vehicles and Federal Reserve policy. For today, let’s focus on the central bank. 

By now everyone in the country, from traders to politicians to nurses to grocery shoppers, knows there is a problem with inflation. When CPI and PPI are running at levels not seen in decades, it means there’s too much money chasing too few goods. Economics 101. The problem is apparent to all. The dilemma is how to fix it. 

This is where the trolley problem shows up. The Fed must decide on two paths. Number one, they can act slowly to reduce money flowing through the financial system and let everyone on the planet know this is what they are going to do. Number two, they can act aggressively to reduce the money flowing through the financial system and surprise the planet. Like all choices, these come with consequences. 

Choice number one’s consequence allows inflation to continue onwards while slowly removing the stimulus, slowly increasing interest rates and slowly engaging in balance sheet reduction. The subtext is trusting that most current inflation is transitory. The risk is that the current high level of inflation becomes embedded in expectations impacting labor and consumer behavior. People make decisions today on how much they want to get paid or what they want to buy based on today’s inflation and thinking this will extend into the future. This is procyclical and drives inflation to last longer and remain higher. Remember, inflation impacts low to middle income workers the most as they spend the highest amount of their income on groceries, gasoline and housing. 

Choice number two’s consequence attacks inflation by rapidly reducing the stimulus, rapidly raising interest rates and rapidly decreasing the balance sheet. The subtext is that inflation needs to be addressed before it becomes embedded and difficult to reverse. The risk is that the sharp increase in monetary tightening kills the recovery and plunges the economy into recession. In turn, this would risk a sharp downward move in the stock market and cause a sharp drop in household wealth. This is procyclical and drives inflation lower, faster. Remember, a recession will impact low to middle income workers as they have the least savings to draw upon and are likely to be first in line to lose their jobs.

This is the Fed’s inflation trolley problem. Choice one allows inflation to grow, risking higher inflation and hurting most at risk consumers. Choice two stops inflation from growing, risking a recession and hurting most at risk consumers. 

The central bank has chosen number one. They chose not to address inflation when it rose in the spring of 2021. They chose to not stop stimulating the economy after the 2021 fiscal stimulus was approved. They chose to not act when financial speculation (NFTs, GameStop, SPACs, house flipping) was indicating too much money was flowing in the financial system looking for a home. They chose to hope inflation is transitory. 

If they are wrong, they will do what other Feds have done and this is to change course by raising rates more aggressively. Then, we’ll have both inflation and a recession. 

They’ll solve the inflation trolley problem by not only killing the baby, but the 5 adults as well.










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I'm Andy Busch

If things feel crazy in the world today, that's because they are. We are seeing huge shifts in risk and reward, leading to a lot of economic uncertainty and confusion about where we go from here.

As an economic futurist, I do things a bit differently than your typical economist — going beyond analyzing how today's financial policies impact economic growth, to focus on the super-charged trends driving much of today's global chaos and change.

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