The ‘wage-price’ spiral is a symptom of Inflation, not the cause
In June, the Bureau of Labor Statistics (BLS) announced that the Consumer Price Index (CPI) had risen by 8.6 percent in the year to May. This was “the largest 12-month increase since…
He superficially understands the “why” but has it all backward on the “what now.”
A Pew Research poll last month found that 70% of Americans view inflation as a very big problem for the country “and no other concern comes close.” It is easy to see why. Last week the Bureau of Labor Statistics announced that the year-over-year inflation rate had hit a four decade high of 8.6%. So, a year after claiming that “no serious economist” was worried about “unchecked inflation,” President Joe Biden felt moved to outline “My Plan for Fighting Inflation” recently in the Wall Street Journal. It offers little hope for hard-pressed Americans.
Any plan for fighting inflation has to start with an understanding of what caused the inflation in the first place. Biden argues that inflation has been “exacerbated by Russian President Vladimir Putin’s war in Ukraine” and “supply chains that haven’t fully healed [which] are causing shortages and price hikes.”
This is dreadfully superficial. Gas prices increased by $1.15 per gallon — 48% — between Biden’s inauguration and Russia’s invasion of Ukraine. “Supply chains” is one of those catchall phrases that can mean almost anything, but real gross domestic product (GDP) — the amount of goods and services produced in the economy — was 2.7% higher in the first quarter of 2022 than in the fourth quarter of 2019, suggesting that “supply chain” issues were largely resolved.
To find the causes of such a broad phenomenon — 90% of CPI items saw greater than 2% inflation — we need to think more fundamentally. The economist Milton Friedman wrote that: “Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.” We’ve seen that output — real GDP — is up 2.7% since the pre-COVID-19 peak but the quantity of money on the M2 measure is up by 42% over the same period. Our current inflation shouldn’t surprise us, then. As more money chases each unit of output, the prices of those units is bid up: inflation.
This diagnosis suggests a cure. Crudely put, the problem arose from increasing the amount of money relative to the amount of output there is to spend it on — real GDP — so our cure will need to decrease the amount of money relative to the amount of output.
First, the Federal Reserve should stop pumping up the quantity of money — indeed, the monetary base has shrunk by 8.2% since December. Second, policymakers need to adopt supply-side measures that will make it easier to produce goods and services to soak up this new purchasing power. Manhattan Institute economist Brian Riedl offers some sensible ideas: promote domestic oil and gas; open ports; repeal tariffs; repeal Buy America rules; suspend Davis-Bacon; repeal new NEPA regs; repeal new ethanol rules, and suspend the Jones Act. In fact, the Biden administration could learn a lot from the Carter administration.
None of these is a magic bullet, but magic bullets do not exist. There is no painless way out of this, but there is a way out.
President Biden’s plan nods in this direction. “My plan has three parts,” he writes, and after noting that “the Federal Reserve has a primary responsibility to control inflation” — which, while true, hardly amounts to a plan — he explains: “Second, we need to take every practical step to make things more affordable for families during this moment of economic uncertainty — and to boost the productive capacity of our economy over time.”
But Biden’s suggestions for doing this are just a rag bag of spending proposals: “clean energy tax credits,” “building more than a million more [housing] units,” “lower[ing] the cost of child and elder care,” all by spending more money. How this squares with the third part of his plan — “reducing the federal deficit” — is a mystery.
A persistent failing of Biden and his Democratic colleagues at both the federal and state level is diagnosing every economic malady as either a demand-side problem, requiring more spending to cure, or a problem with prices themselves. We don’t need the president’s Housing Supply Action Plan, we just need the taxes, fees and regulations that make affordable housing effectively illegal to build reduced. We don’t need a “price gouging” bill to fix the baby formula shortage, we just need the government to allow the import of perfectly safe formula from overseas.
If there is one principle that policymakers need to keep in mind as Americans grapple with the highest inflation rate in four decades it would be: “It’s the supply side, stupid.”
This op ed appeared in the Star Tribune on June 15, 2022