The Consumer Price Index was released this week, showing inflation at 8.3%, year over year. The number is not especially surprising, just a tad better than March. We have probably passed the month of ‘peak’ inflation for this cycle.
The reason for this is simply that March’s inflation figures were reported at the beginning of the oil price effects from the Russian invasion of Ukraine and prior to Federal Reserve raising rates.
The Federal Reserve is now tightening the money supply, and the large oil price spikes have eased slightly. Still, this leaves open the question of how long unusually high inflation will last, what are its causes and how might it be remedied.
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, and so we are stuck with imperfect measures of the problem.
The overall rate of inflation in March was at 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 transient effects, inflation is a bit better at 6.4%, which is about where it was in 1982. Not much relief there.
We can also examine something known as the ‘sticky price’ index, which measures those cases when prices are unlikely to drop back down. This index puts inflation at about 4.6%, or roughly where we were in 1991-better, but not great. This also tells us that at least half the price increases we’ve observed are permanent.
The way to think about this is the equation of exchange, where M*V = P*Y. Here, M is the money supply, V is the velocity of money, P is the level of prices (inflation) and Y is the size of the economy (typically measured as GDP).
This little equation may seem daunting but is easy to interpret. If the money supply (M) increases, then either V must go down an equal amount, or else P or Y will increase. Because the size of the economy is based on real things, like worker productivity, it must be P that’s affected. So, an increase in the supply of money causes inflation.
Likewise, an increase in the velocity of money or how often it moves through the economy can also fuel inflation. To limit the damage from the pandemic, the Trump and Biden administrations asked Congress to vastly increase spending. They did, and the result was the largest fiscal stimulus in history.
At the same time, the Federal Reserve both dropped borrowing costs and expanded the supply of money through several different avenues. Together, these increased by the supply of money (M) and its velocity (V). This initially helped the economy recover, but once the pandemic effects ended, our economic growth slowed and we got inflation.
We should all be humble in our criticism of Congress and both the Trump and Biden administrations in causing inflation. The slow recovery from the Great Recession saw no inflation, despite dire warnings that it would. I was among those economists warning of inflation. To many people, the risks of inflation seemed smaller than the risk of too little action. They were mistaken. Inflation is here and will be with us for many more months, or longer.
Another reason for humility is that the breadth of culpability. It is perfectly fine for Republicans to blame a highly partisan Congressional vote last year for contributing to inflation. However, the Indiana General Assembly gave rebates and cut taxes in 2022, which was months after inflation was an obvious problem. One can debate the efficacy of state tax cuts; that they contribute to inflation is an undeniable fact. In a more honest world, voting for tax cuts during an inflationary period ought to require that you remain placidly silent about culpability for inflation.
There’s plenty of room to retrospectively criticize federal and state policymakers who contributed to the root causes of inflation back in early 2021, but the strongest criticism belongs to the poor decisions that are still being made about inflation. Again, we must note the states that gave tax rebates or cut taxes during already high periods of inflation. As politically tempting as it was, it merely worsens the problem.
Most surprising to me is the lack of immediate action taken by the Biden administration to stem inflation. There were several options available to the president, which at least would have made clear the commitment to curtailing inflation. Here’s what a more aggressive anti-inflation posture would look like.
First, the Biden administration could suspend all the Trump tariffs on manufactured goods. This would’ve boosted profitability across much of the supply chain, reducing prices for imported components. This requires only the president to act, and would’ve cut some $300 million per year in federal tariffs.
The administration could have waived some leasing restrictions and fast-tracked oil and natural gas permits. This would’ve had the effect of moving future production to the present, while prices are higher. This would not have affected prices immediately, but it would have stabilized futures prices and offered confidence to both consumers and businesses.
The administration also could have asked Congress to repeal the Jones Act, which, among other costly measures, limits international shipping firms from delivering products to multiple U.S. ports. It is raw protectionism that was poor public policy in 1920, and plain stupid in 2022.
The administration could take 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 ease labor supply issues across much of the country.
The president could have also waived or lessened some rules on interstate trucking and transport. Reducing restrictions on cross-border transportation, as well as allowing drivers to rest in two shorter blocks with more cumulative rest, would ease congestion in many cities. He could also allow a pilot program authorizing younger inter-state drivers based upon training and previous driving records.
Some of these policies would reduce prices immediately, others won’t impact the economy for months, but all would improve the sense that inflation is taken seriously by the administration. And yes, they would anger some constituents (e.g., the longshoremen union, protectionist industries, those pushing for zero carbon emissions and those who dislike immigration expansion), but that is the what the moment demands.