The consumer price index was recently released, showing inflation of 8.3%, year-on-year. The number is not particularly surprising, just a little better than in March. We have probably passed the month of the “peak” inflation for this cycle.
The reason is simply that the March inflation numbers were reported early in the oil price effects of Russia’s invasion of Ukraine and before the Federal Reserve raised rates.
The Federal Reserve is now tightening the money supply and the sharp spikes in oil prices have eased slightly. Nevertheless, this leaves open the question of how long abnormally high inflation will last, what causes it and how to fix it.
The cause of inflation is an excess supply of money in the economy. The way we measure it includes other forces that temporarily affect prices, so we’re stuck with imperfect measures of the problem.
The headline rate of inflation in March was 8.55%, which is as high as it has been since December 1981. But, if you exclude food and energy prices, which are at least partially attributable to transitory effects, inflation is a little better. at 6.4%, which is about where it was in 1982. Not much relief there.
We can also look at what is known as the “sticky price” index, which measures when prices are not at risk of falling. This index puts inflation at around 4.6%, about where we were in 1991 – better, but not great. It also tells us that at least half of the price increases we’ve seen are permanent.
The way to think about this is the exchange equation, where M*V = P*Y. Here, M is the money supply, V is the velocity of money, P is the price level (inflation), and Y is the size of the economy (usually measured in GDP).
This little equation may seem daunting but is easy to interpret. If the money supply (M) increases, then either V must fall by an equal amount, or P or Y will increase. Because the size of the economy is based on real things, like worker productivity, it must be P that is affected. Thus, an increase in the money supply causes inflation.
Similarly, an increase in the velocity of money or the frequency with which it moves through the economy can also fuel inflation. To limit the damage of the pandemic, the Trump and Biden administrations have asked Congress to dramatically increase spending. They did, and the result was the biggest fiscal stimulus in history.
At the same time, the Federal Reserve has both reduced borrowing costs and increased the money supply in several different ways. Together, these increased the money supply (M) and its velocity (V). This initially helped the economy recover, but once the effects of the pandemic were over, our economic growth slowed and we had inflation.
We should all be humble in our criticisms of Congress and the Trump and Biden administrations for causing inflation. The slow recovery from the Great Recession has not resulted in inflation, despite dire warnings that it would. I was one of those inflation-warning economists. For many people, the risks of inflation seemed lower than the risk of too low a stock. They were wrong. Inflation is here and will be with us for many more months, if not longer.
Another reason for humility is that of the magnitude of guilt. It is perfectly acceptable for Republicans to blame a highly partisan vote in Congress last year for contributing to inflation. However, the Indiana General Assembly gave rebates and lowered taxes in 2022, months after inflation was an obvious problem. The effectiveness of state tax cuts can be debated; that they contribute to inflation is an undeniable fact. In a more honest world, voting for tax cuts during a time of inflation should require you to remain placidly silent about inflation guilt.
There’s plenty of room to retrospectively criticize federal and state policymakers who contributed to the root causes of inflation in early 2021, but the strongest criticism relates to the bad decisions that are still being made on inflation. Again, note should be taken of states that granted tax cuts or lowered taxes during periods of already high inflation. As tempting as that has been politically, it only compounds the problem.
Most surprising to me is the lack of immediate action taken by the Biden administration to stem inflation. Several options were available to the president, which would have at least made clear the commitment to reduce inflation. Here’s what a more aggressive anti-inflation stance would look like.
First, the Biden administration could suspend all Trump tariffs on manufactured goods. This would have boosted the profitability of much of the supply chain, reducing the prices of imported components. It only requires action from the president and would have reduced federal tariffs by some $300 million a year.
The administration could have waived some lease restrictions and expedited permits for oil and natural gas. This would have had the effect of shifting future production to the present, when prices are higher. This would not have immediately affected prices, but it would have stabilized futures prices and given confidence to consumers and businesses.
The administration could also have asked Congress to repeal the Jones Act, which, among other costly measures, prevents international shipping companies from delivering products to multiple US ports. It’s crude protectionism that was bad public policy in 1920 and just plain stupid in 2022.
The administration could introduce a comprehensive immigration bill to Congress. Basing this bill on the compromise that failed in the 2000s would result in a guest worker program that would alleviate labor supply problems in much of the country.
The president could also have waived or relaxed some rules on interstate trucking and transportation. Reducing restrictions on cross-border transportation, as well as allowing drivers to rest in two shorter blocks with more cumulative rest, would reduce congestion in many cities. It could also authorize a pilot program allowing young interstate drivers based on training and driving history.
Some of these policies would reduce prices immediately, others would not impact the economy for months, but all would improve the feeling that inflation is taken seriously by the administration. And yes, they would anger some voters (e.g. the longshoremen’s union, protectionist industries, those pushing zero carbon emissions, and those who don’t like immigration expansion), but that’s what the moment demands.