It seems that someone told Congress that deficits cause inflation, but forgot to mention why (or Congress wasn’t listening to the explanation). How else can you explain the Inflation Reduction Act of 2022 with a straight face?
The massive spending package that Senate Democrats are set to vote on Saturday, which allocates funding for health care, fighting climate change and controlling prescription drug costs in exchange for raising some taxes, focuses largely on deficit reduction that will have no effect on inflation.
The “inflation reduction” label is being used to justify a hodgepodge of special interest spending that has absolutely nothing to do with inflation.
It’s excessive money creation — the printing of more bills at the direction of the Federal Reserve, reducing the spending value of those already in circulation — and not the deficit that causes inflation. Controlling inflation demands controlling the supply of money.
Yet, Sen. Joe Manchin, D-W.V., the driving force behind the Inflation Reduction Act, claims he torpedoed an earlier spending package (Build Back Better) with some of the same components over fears it would contribute to skyrocketing inflation — and now claims the bill on the table will help rein it in.
Instead, the “inflation reduction” label is being used to justify a hodgepodge of special interest spending that has absolutely nothing to do with inflation. Beyond the unneeded tax hike to reduce the deficit, the act proposes coercing drug companies to lower prices. The money that will now remain in people’s pockets will still be in circulation, though, so even if successful in reducing drug costs, this will have zero effect on overall inflation. Similarly, though it leads to heated discourse, global warming does not cause inflation, either.
It’s true that deficits — how much more money the government spends each year than the revenue it receives, primarily from taxes — can sometimes cause inflation because they can exert pressure on the Federal Reserve to print money to help cover the gap. But that isn’t why Federal Reserve Chairman Jerome Powell printed the excess money that led to our current predicament.
Instead, he printed money beginning in March 2020 because he feared the Covid pandemic would crash the economy, and he didn’t think printing that money would create inflation. He was wrong on both counts.
Powell has increased the money supply by some $6.2 trillion since the start of the pandemic (a 40 percent rise in cash and other assets easily convertible to cash in the economy). A 40 percent rise in money will lead to a roughly 30 percent rise in prices over three years, according to my calculations, which is about 10 percent inflation for three years. Unfortunately, we seem to be on target for the first year.
The Inflation Reduction Act purports to reduce the deficit by $300 billion. Even if plugging the deficit mattered, $300 billion won’t amount to a hill of beans in that calculus.
Though some students of history want to point to former Federal Reserve Chairman Paul Volcker’s complaints about the deficit when he famously tried to tame inflation four decades ago, that wasn’t central to his policy. And indeed, the deficit grew from 1.55% of gross domestic product in 1979 to 5.72% by 1983, so he clearly did not count on deficit reduction to lower inflation.
Instead, Volker reduced the supply of money, via an interest rate rise from 13.77% in October 1979 to 19.08% in January 1981. Controlling the deficit doesn’t control inflation, not then and not now.
But the Inflation Reduction Act isn’t just misnamed because it won’t do what its title promises — it will likely make inflation worse by raising the cost of producing goods and services and lowering their overall supply. The higher cost and consequent lower supply of goods means that money circulating in the economy is used to purchase fewer goods, thereby pushing up the price of goods, leading to higher inflation.
For instance, the push to remove carbon from production specified by the act is exactly the type of wasteful spending that raises the cost of producing goods. And while receiving the bill’s subsidies for green-related spending will lower the cost of purchasing these types of goods, the rise in demand will likely push the price back up.
It’s difficult to understand why Congress thinks this would reduce inflation. What’s needed is more supply or less demand, not higher demand. The act seems to get this point exactly wrong.
The one part of the act that might help reduce inflation is ironically the one part that most Democrats don’t want in there: encouraging fossil fuel production. That could help to lower prices by creating more supply and reducing the cost of producing goods, which allows lower prices to be set.
Manchin’s opposition to Build Back Better on inflation grounds was just as specious as his support for the Inflation Reduction Act on inflation grounds now. It seems inflation is the new buzzword, used to justify any action whether or not it actually lowers prices.
Powell is largely responsible for the inflation mess, and only he can truly fix it. But he’s unlikely to do so anytime soon, as he has a lot of money to remove from a fragile economy, and his chief concern is likely not tipping the economy deeper into a recession by raising interest rates too much.