Are We Making a Big Mistake in How We are Fighting Inflation?

I’m not an economist, but I played one in college many years ago. I have been thinking recently about how the Fed, Congress and the President are attempting to deal with the artificially induced inflation that is the Republican’s primary talking point as we enter the fall mid-term primary season. I’m concerned.

Everyone hangs on the monthly inflation reports from the Bureau of Labor Statistics. The July BLI annualized inflation rate was 8.5%, coming down but still way too high for comfort, was partially offset by annualized wage increases of 5.7%. In other words, the standard of living for workers in private industry declined about 2.8% over the past 12 months, not great, but better than the 8–9% inflation rate that is repeated by commentators.

The underlying reasons for the current bout of inflation are unprecedented, not a word I use lightly, in economic history. What I fear is that the Fed, the President and Congress have responded with historically “customary” tools not designed to fight the original causes of the 2022 spirt in prices.

When Joe Biden took office, he faced the Covid economy. In early 2020, on the sound advice of public health experts, all but essential businesses were encouraged to shut down, laying off workers to minimize the spread of the new virus. The unemployment rate shot up, and I mean shot up like a rocket, from 3.5% in February to 14.7% in April.

People needed help, and Biden convinced Congress to give it to them. In formulating his package, I believe he had in mind the economic disaster that he and President Obama inherited in January 2009. That year, in a compromise with Republicans in Congress, they reduced their recovery package significantly, and, as a result, the US economy trundled along in a slow recovery for many years.

No one could have predicted, with any degree of precision, how the Obama recovery plan would impact unemployment, interest rates, inflation or other economic outcomes. And economic science had not become much more precise over the following 12 years.

Because of the day-to-day problems for ordinary Americans of the slow economic bounce-back from 2010 to 2020, in 2021 Biden decided to err on the side of “more” rather than “less.” Unemployment benefits were increased, everyone got cash aid and businesses were given money to stay open even though they had few customers for their goods and services. In a sense, the federal government replaced, for a few months, a significant percentage of the US GDP with deficit-financed aid.

This approach was compassionate, reasonable and probably (in hindsight) a bit more than was needed.

So, Americans had money to spend, but both here and abroad, goods to buy were not being produced. This situation became a classic “demand-pull” inflationary situation. What made the spring of 2021 different from any inflationary period in the past was that there was no underlying imbalance in our economy. The lack of goods available for sale was artificially created by our governments and governments around the world closing businesses in their attempt to limit the health crisis caused by Covid.

Conservatives now claim that Biden (and others) overreacted and should be punished in the upcoming midterm elections. What they fail to mention is the dangers we faced from Covid, that over 1 million Americans have died from the pandemic and that many more would have died had the federal and state governments not imposed the lockdowns.

That’s my version of the history of the current inflation. How should the Fed, Congress and the President respond to this spike in prices?

Not by raising interest rates, as the Fed has done dramatically this year. The goal of those increases is to reduce business activity, increase unemployment and therefore reduce demand for goods. They are following the path of Paul Volker in the early 1980s, when we threw people out of work by inducing a severe recession, causing personal hardship, leaving families without enough income to cover some of the necessities of life.

Instead, we should be using the tools available to the federal government to increase the supply of goods in the marketplace, rather than reducing demand, to restore the balance between the goods available to buy and the demand for those goods.

I am not saying this approach is simple to implement. No government can fine-tune a multi-trillion-dollar economy with the precision we would like. I believe that Biden and Janet Yellen were essentially correct when they said, initially, that the inflationary spike was transitory. Only their timing was wrong. Inflation was artificially induced by the Covid recovery deficit spending which kept demand for goods relatively stable awhile the supply of goods plummeted. Using economic tools designed for an economy that is cyclically out of balance is both incorrect and cruel to those who will suffer unemployment as a result.

There is evidence that a Fed induced recession is unnecessary. Over the past few months, we have seen increases in the supply of goods. Toilet paper, cat food and the rest are readily available. There are stories about Amazon, Target and other retailers attempting to reduce their inventory of goods as opposed to scrambling to find goods to meet demand. Supply chain disruptions continue in some sectors, driven by China’s reimposed shutdowns to combat a resurgent Covid, the increased cost of oil resulting from the Russian invasion of Ukraine, and the lack of computer chips that go into automobiles and other goods.

The Fed, Congress and the administration should be laser focused on doing whatever it takes to overcome these interruptions as soon as possible. We have seen some success in bringing down the cost of gasoline, resulting in 0% inflation in July, and the correction of other artificially created shortages should be changing in the coming months. Let’s not panic and force the American (and possibly the world) economy into an unnecessary recession if the inflationary pressures can be managed with increased supplies rather than decreased demand.

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Richard McCoy

In December 2015 I sparked lively debate when I told my adult children that The Donald would likely be the next President. Still trying to encourage discussions