Inflation has now become a very serious problem for the U.S. The annual rate is averaging above 8% (8.5% in March, 8.3% in April, and 8.6% in May). The Hoover Institution’s John Cochrane has given an excellent analysis of the underlying fiscal and monetary policies related to inflation. Consider:
- The current inflation was sparked by fiscal policy – during 2020 and 2021 the government printed or borrowed $5 trillion and sent checks to people and businesses.
- The Federal Reserve’s monetary policy tools to cure inflation are blunt. By raising interest rates, the Fed pushes the economy toward recession. It hopes to push just enough to offset the fiscal stimulus boost. But monetary brakes and a floored fiscal gas pedal mistreat the economic engine.
- Higher interest rates will directly make deficits worse by adding to interest costs on the debt. Each percentage point interest rates are higher means $250 billion more in inflation-inducing deficit.
- Many governments, including the Biden administration, want to address inflation by borrowing or printing even more money to help people pay their bills. That will only make matters worse.
- Monetary policy alone can’t cure sustained inflation. The government will also have to fix the underlying fiscal problem. Short-term deficit reduction, temporary measures, or accounting gimmicks won’t work. Neither will a growth-killing high-tax “austerity.”
- A favorable outcome requires economic growth, which raises long-run taxable income. The U.S. also needs spending reform, especially on entitlements. And it needs to break the cycle that each crisis will be met by a river of printed or borrowed money, bailouts for the big financial firms, and stimulus checks for voters.
- The good news is that inflation can end quickly, and without a bruising recession, when there is joint fiscal, monetary and economic reform. In the U.S. tight money in the early 1980s was quickly followed by tax, spending and regulatory reform. Without these reforms, the monetary tightening might have failed.
Conclusion. A very serious inflation problem is facing the United States. It is clear (as described above) what needs to be done to address it. Does the Biden Administration have the political will to get the job done? Or will Biden flounder like Herbert Hoover did after the stock market crash of 1929 and allow inflation to remain a damaging economic issue all the way into the next presidential campaign?