There’s not a ton that most politicians can do to push inflation down. The few, limited tools they have available might carry some political risk. So maybe it’s unreasonable to expect them to try, and perhaps pundits like me should stop fussing.

But can we at least agree that politicians shouldn’t do things that will make inflation worse?

“Inflation relief” check proposals, which have been proposed or adopted by several states, are likely to be actively harmful in the fight against inflation. That’s because these and other tax cuts or rebates will make red-hot demand even hotter.

Inflation has lately reached 40-year highs because demand is strong while supply remains constrained. Consumers have a lot of cash on hand, thanks to both pandemic-forced savings (delayed vacations, fewer restaurant outings, etc.) and federal policies that pumped a lot of money into their pockets as well as the broader economy.

Meanwhile, global supply chains are still snarled and worker shortages persist across many sectors. Companies simply can’t ramp up production quickly enough to give consumers everything they want. So, the prices for the products that are available get bid higher.

The best, least painful way to fix this mismatch between demand and supply would be to dramatically expand supply. That’s easier said than done, however.

How do you untangle global manufacturing and food supply chains, which are being disrupted by war, COVID-19 lockdowns and other freak events? How do you nudge more people into the labor force? How do you encourage oil companies to increase refinery capacity – which would help increase the supply of gasoline – when doing so requires expensive, long-term investments that these companies don’t think will pay off?

These objectives are all challenging, to put it mildly.

There are a few, more modest things federal policymakers could do to help with supply-side problems. These include allowing in more competition from foreign suppliers and ships. Or, fixing bottlenecks in our legal immigration system could increase the supply of workers.

So far, the Biden administration and federal Democratic lawmakers have been reluctant to adopt such measures. Perhaps they fear alienating crucial allies (such as organized labor). Maybe they worry about providing fodder for right-wing attacks about being “soft on China.”

The other obvious way to deal with that demand-supply disparity involves reducing demand. This is precisely what the Federal Reserve is doing. By raising interest rates, the central bank is making borrowing more expensive, which in turn cools spending, particularly on big purchases (such as houses and cars).

This is undoubtedly a more painful way to deal with inflation. It’s a risky one, too: The Fed might overshoot and raise interest rates so much that it not only slows demand but accidentally tips us into full-blown recession. (This has happened most of the times when the Fed has raised rates to stomp out inflation.) Blunt as this instrument is, though, monetary tightening remains the most effective tool available at present to curb price growth.

Unfortunately, both federal and state politicians have lately decided to make the Fed’s already hard job even harder.

The main lever politicians seem to want to pull in times of economic turmoil is to cut taxes or otherwise send out money. And, look, in some scenarios sending out checks is helpful – if we’re in a recession, say, and facing the risk of deflation. Then it’s useful to give households cash to support their spending, particularly if those households have suffered job losses.

But now is not one of those times. Usually these checks are referred to as “stimulus payments” because they’re designed to “stimulate” the economy. If the problem now is overheating, what exactly are we trying to stimulate?

Federal politicians are also weighing other measures that might, on the margin, juice demand and thereby make inflation worse, such as a gas tax “holiday” or broad-based student debt forgiveness. Some federal Democrats are even pushing punitive measures that might reduce supply, such as price controls, or penalties for energy producers that have any drilling permits sitting unused.

All of these measures would make that demand-supply mismatch a bit worse. Which would, to varying degrees, drive prices higher. And could ultimately force the Fed to raise interest rates even more aggressively than it already plans to – which would in turn raise the likelihood that we fall into recession.

Sending out yet more checks, and avoiding supply-side interventions that could anger some allies, probably looks politically smart in the near term. Longer term could be a very different story.

Copy the Story Link

« Previous

Another view: State bans may not be the final word on abortion

Next »

Commentary: ‘Hardening’ school security is the wrong answer