Inflation is not an increase in one commodity’s price. It is a general increase in prices. Inflations tend to begin quickly and end slowly.
- Fiscal policy is enacted by the legislative branch of government and deals with tax policy and government spending.
- Monetary policy is enacted by a government’s central bank and deals with changes in the money supply by adjusting interest rates, reserve requirements, and open market operations.
- Monetary policy involves changing interest rates and influencing the money supply.
- Fiscal policy involves changing tax rates and levels of government spending to influence aggregate demand in the economy.
Congress and the President have given the Federal Reserve a mandate for maximum employment and price stability.
Given the Fed’s limited control over consumer and business pricing, this is akin to giving the shortstop a mandate for the team to win the World Series.
Any single business will raise its prices based on several factors, which include:
- Increased costs
- Reduced competition
- Product improvements
- New markets open up
The Federal Reserve, being a monetary organization, views inflation as being a monetary problem. So, it attempts to fight inflation with a monetary solution: Increased interest rates.
The Fed’s hypothesis is that increasing interest rates will discourage buyers, thus reducing demand. The demand reduction supposedly forces businesses to reduce prices to capture the remaining customers.
This, in turn, forces a reduction in business profits available to spend on employment, marketing, production, and research/development.
The formula for Gross Domestic Product (GDP), one of the most important measures of our economy is:
GDP = Federal Spending + Non-federal Spending – Net Imports
The United States is a huge consumer of goods and services so it tends to import more than it exports.
Thus, for real (inflation-adjusted) GDP to grow, either Federal Spending or Non-federal Spending must grow enough to overcome inflation and Net Imports.
However, if the Fed’s interest rate increases are successful in reducing demand, two things will happen:
- Non-federal Spending will decline and
- Business costs will rise
The first will cause a recession unless Federal Spending increases enough to overcome inflation and the dollar losses from Net Imports.
The second will exacerbate inflation.
However, the consensus among economic pundits — including the Fed — is that increased Federal Spending causes inflation.
No matter what the Fed’s interest rate hikes do — raise business costs or cut consumer spending — the result will be inflation and/or recession.
Only if the Fed’s rate cuts don’t work will we be spared inflation and/or recession — unless Congress and the President keep pumping growth dollars into the economy.
To cure inflation, without recession, the economy needs more growth dollars that address the true cause of inflation: Shortages of critical goods and services.
The Fed’s website says, “The Federal Reserve The Federal Open Market Committee (FOMC) judges that an annual increase in inflation of 2 percent in the price index for personal consumption expenditures (PCE), produced by the Department of Commerce, is most consistent over the longer run with the Federal Reserve’s mandate.”
Two inflation measures, the Consumer Price Index (CPE-red), and Personal Consumption Expenditures (PCE-blue) track similarly. It’s not clear why the blue line is more “consistent with the Federal Reserve’s mandate.”
Another strange comment from the Fed: “Although food and energy make up an important part of the budget for most households–and policymakers ultimately seek to stabilize overall consumer prices–core inflation measures that leave out items with volatile prices can be useful in assessing inflation trends.”
Really? Look at this graph and see if you can see why so-called “core inflation” is useful.
Does anyone believe the Fed’s predictions are so precise that the blue line is more “useful in assessing inflation trends”? I mention this only to demonstrate how the Fed’s historical beliefs sometimes ignore facts.
No matter which measure the Fed leans toward, one thing is clear: To succeed, the Fed must fail.
- Its interest rate increases must fail to increase business costs (or prices will increase).
- Its interest rate increases must fail to reduce Non-federal Spending (or GDP will decrease).
- Its cajoling of Congress to reduce Federal Spending must fail to cause a recessionary reduction in GDP
In short, the Fed must fail in everything it does, and if it fails, and the recession ends despite what the Fed does, Chairman Powell will boast that he took the economy to a “soft landing.”
Powell is the player who after he strikes out, the catcher drops the ball, and the winning run scores. So he brags about his winning the game.
The facts:
- The best way to cure a problem is to cure the cause of the problem.
- Inflation is caused by shortages, most often shortages of oil, food, and/or labor.
- The cure for shortages is Federal Spending to encourage the production of, and/or access to, the scarcities that cause inflation.
- Federal deficit Spending adds growth dollars to GDP, thereby curing inflation while preventing recession.
No “soft landing” was necessary. No “landing” at all was needed. Congress and the President control the fiscal policy that controls supply.
The economy does not need or want increased interest rates. The federal government should:
- Increase Federal Spending to support oil drilling and refining. and increase support for research, development, production, and distribution of such renewables as wind, solar, geothermal, tidal, and nuclear fusion (not fission).
- Increase Federal support for businesses raising wages by making hiring cheaper. Federal funding of all health care insurance by instituting comprehensive, no-deductible Medicare for every adult and child in America. This would relieve businesses of the payroll cost and reduce the expense of illness-related absences.
- Reduce payroll costs by eliminating FICA and funding more generous Social Security benefits for every American. This also would reduce the payroll cost of employer-funded retirement plans.
- Stop fobbing off the responsibility for inflation on the Fed. Instead, take responsibility for preventing/curing the shortages that cause inflation.
- Stop pretending that the federal government “can’t afford” to pay for benefits or that the federal deficits and debt are dangers to our Monetarily Sovereign economy.
Federal deficit spending is necessary to prevent/cure inflations and for economic growth. The Fed’s interest rate increases must fail to succeed.
Rodger Malcolm Mitchell
Monetary Sovereignty
Twitter: @rodgermitchell Search #monetarysovereignty
Facebook: Rodger Malcolm Mitchell; MUCK RACK: https://muckrack.com/rodger-malcolm-mitchell
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Great article! Good luck getting it through congress! The Inflation Reduction Act unintentionally did a lot of the right things at the right time, effecting much of what we see as a soft landing. 0 chance Biden would ratify your suggested measures on energy, though they are attempting to do it by selling our seed corn.
And, you are dead wrong on fission.
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The problem with fission is the storing of leftover, radioactive material. The problem with fusion is we don’t know how to do it, yet.
I’d focus on solar, wind and geothermal R&D. If we can figure out how to transfer energy from solar collectors in space, above the clouds, it could be a solution to the energy problem.
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