You have heard that the Federal Reserve is trying to cure inflation by raising interest rates slowly.
And you may repeatedly have read on this site (here, and here, and here, and here) that the Fed does not have the best tools to stop inflation, and that despite their best efforts, inflation will continue and be joined by recession..
The Fed has two tools: Raising interest rates and to some degree, reducing money-supply growth.
Contrary to popular belief, neither can cure inflations, but both are very good at creating recessions.
Sadly, a recession is not the opposite of inflation. (Deflation is.) A recession is the opposite of growth and prosperity. The Fed is trying to cure inflation via recessionary means.
Today, as we predicted, the Fed is failing miserably in its assigned task.
The annual inflation rate for the United States is 9.1% for the 12 months ended June 2022, the largest annual increase since November 1981 and after rising 8.6% previously, according to U.S. Labor Department data published July 13.
Since the Fed doesn’t have the tools to cure inflations, who does? As you will see, Congress and the President have that power. But, out of ignorance, intent, or political chicanery, Congress and the President won’t use their power of the purse to prevent or end inflation.
To explain this, we first must discuss the myth that raising interest rates cures inflation.
Interest Rates Go Up Soon — How Does Raising Rates Help Fight Inflation? By Kathryn Underwood, MAR. 11 2022
It isn’t a secret that prices have risen over the past year. Americans have seen the highest inflation rates since 1982, based on the CPI (Consumer Price Index), which increased by 0.8 percent in February and 7.9 percent YoY.
Now, the Federal Reserve is about to raise interest rates.
The CPI measures the average change over time in the prices for urban consumers on typical consumer goods and services.
Although raising interest rates might seem harsh when prices are already high, it’s intended to eventually lead to a drop in inflation.
The primary reason the Federal Reserve (or the Fed) raises interest rates is to cause a slowdown in economic growth.
Interest rates determine how costly it is for consumers and businesses to borrow.
Economic growth is not the same as inflation. We can have fast economic growth without inflation, so slowing growth is not a cure for inflation.
Yet, the purpose of raising interest rates is to slow growth, and that is recessionary.
A recession is “a period of temporary economic decline during which trade and industrial activity are reduced, generally identified by a fall in GDP in two successive quarters.”
The Fed does not want to cause a recession, so its interest rate increases must slow economic growth (i.e., GDP growth) while not causing GDP to fall.
The Fed hopes that by raising interest rates, consumers and businesses will delay new investments, which will help lower demand and temper prices.
Although that is what the Fed claims to hope, delaying new investments does not lower demand.
It likely will lower supply by discouraging investment in Research & Development and production.
Let’s examine the logic. Inflation exists when the demand for critical goods and services exceeds the supply of those goods and services, creating shortages.
Shortages cause all inflations. ALL.
Because reducing demand leads to recessions, the non-recessionary prevention/cure for inflation is to increase the supply of scarce, critical goods and services.
Here are some of the critical goods and services for which supply must be increased:
Every industry and virtually every product and service uses oil in some way. Any increase in oil prices will cause a general rise in product/service prices (aka inflation).
Oil prices are determined by scarcity.
It is essential to reduce the oil shortage to fight inflation.
The oil shortage could be cured by reducing demand, but that would be recessionary.
The non-recessionary method for reducing the oil shortage involves federal funding for oil research, exploration, drilling, refining, and distribution, plus federal funding for oil substitutes like solar, wind, geothermal, electrical, nuclear, etc. power.
More federal funding, not less, could cure inflation. Interest rate manipulation does nothing to increase the supply of oil.
Higher interest rates could exacerbate the oil scarcity situation by negatively affecting the oil supply.
Interest rate manipulation can affect the oil demand only to the degree that it depresses the economy. Exchanging recession and depression for inflation is a bad tradeoff, yet that is the Fed’s solution.
II. Food. Second to oil, food is the next most crucial inflation-related product. Food shortages have caused many hyperinflations around the world.
The infamous Zimbabwe hyperinflation began when the government took farmland from experienced white farmers and gave it to inexperienced black farmers. The predictable result: A massive food shortage leading to an equally massive increase in food prices.
Raising interest rates will not help farmers grow more food.
All food prices now are predicted to increase between 7.5 and 8.5 percent.
An ongoing outbreak of highly pathogenic avian influenza (HPAI) reduced the U.S. egg-layer flock and drove a 5.0-percent increase in retail egg prices in May 2022 following a 10.3-percent increase in April.
Higher interest rates will not cure the meat and egg shortage.
The ongoing HPAI outbreak has also contributed to increasing poultry prices as over 40 million birds in 36 States have been affected.
The disease prevalence also impacts international demand for U.S. poultry. Price impacts of the outbreak will be monitored closely.
Poultry prices are now predicted to increase between 13.0 and 14.0 percent, and egg prices are predicted to increase between 19.5 and 20.5 percent in 2022.
Higher interest rates will not solve the poultry shortage.
Fish and seafood prices are now predicted to increase between 8.5 and 9.5 percent in 2022.
Higher interest rates will not cure the fish and seafood shortage.
Rapid increases in the consumption of dairy products have driven increases in retail prices in recent months.
This trend continued in May 2022 with a 2.6-percent increase in the prices for dairy products.
Dairy product prices are predicted to increase between 10.5 and 11.5 percent in 2022.
Higher interest rates will not cure the dairy shortage.
Following large price increases in January–May 2022, forecast ranges for fats and oils, processed fruits and vegetables, sugar and sweets, cereal and bakery products, and other foods have been adjusted upward.
In 2022 compared with 2021, fats and oils prices are predicted to increase between 14.0 and 15.0 percent, processed fruits and vegetables prices between 7.5 and 8.5 percent, sugar and sweets prices between 6.5 and 7.5 percent, cereal and bakery product prices between 10.0 and 11.0 percent, and other food prices between 10.0 and 11.0 percent.
Higher interest rates will not cure food shortages unless the plan is to force people to starve because of food scarcity and unaffordability.
A plan to solve inflation by forcing people to eat less food is repugnant to any but the most heartless demagogue. Yet that is exactly the Fed’s plan.
Interest rates are the Fed’s primary tool for impacting inflation. Borrowing is more expensive, but on the plus side, earnings on high yield savings accounts increase.
An increase in earnings on high-yield savings accounts cannot begin to offset the damage of inflation. It’s like using a sponge to offset the floods caused by global warming.
The food shortages can be moderated by additional federal deficit spending to support farming.
The government should pay farmers to grow rather than pay them not to grow, as was done when there were surpluses.
Additional federal funding for farmer education, the use of more efficient land use and crops, farm insurance, modern farm equipment, and shipping would reduce the shortage of farm products.
Strangely, the Fed focuses on “core inflation” which eliminates consideration of oil and food, the primary inflationary instigators. It’s like eliminating thoughts about hitting and pitching to arrive at “core” baseball wins.
III. Labor. COVID precipitated a labor shortage that has not abated. Federal deficit spending for the development and administration of vaccines and other healthcare helped moderate the shortage of labor.
Although the shortage, which manifested during COVID, and still continues, other factors were involved, notably compensation.
The salaries and benefits being offered were not tempting enough for many potential workers.
While the right-wing favors cutting benefits to force employees back to work, the more humanitarian approach is to increase remuneration.
First, FICA should be eliminated.
Despite myths to the contrary, FICA pays for nothing. FICA dollars are destroyed upon receipt by the Treasury. Because employers must pay half of FICA, this tax is an employment cost consideration.
Not only are employers forced to cut salaries to make room for FICA, but employer-provided healthcare insurance is an additional employment cost that must be considered when determining salaries.
These costs could be eliminated, salaries could be raised, and more people would come to work, if the federal government funded comprehensive, no-deductible Medicare for all, and took that burden from the salary consideration.
That reduction in labor scarcity would require additional federal deficit spending.
The Federal Reserve plans to raise interest rates several times in 2022.
The Fed’s main objectives are maximum employment, stable prices, and moderate long-term interest rates.
2 percent is the target interest rate, so 7.9 percent over the past year is nearly quadruple that rate.
Interest rate increases will do nothing to achieve maximum employment, nothing to stabilize prices, and of course, nothing to achieve 2% interest rates.
The Fed currently is doing nothing to achieve its three goals. Quite the opposite. The Fed is doing the exact opposite of its stated goals by hoping to “cool” the economy (Fedspeak for recessing the economy).
In short, the Fed is applying leeches to cure anemia.
To fight the economic impacts of the COVID-19 pandemic, the Fed dropped rates to zero.
The Fed has been talking about rate hikes for months. Increases were expected even before Russia invaded Ukraine and impacted oil and raw material costs.
Economists expect up to seven incremental rate increases, beginning with a likely quarter-point raise (25 basis points), according to CNBC. Some economists have suggested the Fed may add 50 basis points on some of these increases.
Why seven increases? How did the Fed arrive at that number? No one knows.
Consumers have already been hit with high prices on goods like groceries, furnishings, clothing, airline fares, and especially high fuel prices.
IV. Other shortages. Lumber, housing, computer chips, shipping, cars, clothing, airline seats, etc. all are in short supply, and each scarcity could be moderated by well-directed federal spending.
Think of any scarcity, and you will have no trouble imagining how the federal government could help cure that scarcity via additional federal spending.
The federal government’s greatest skill is to throw money at a problem. It costs taxpayers nothing; it stimulates the economy; and when properly planned, can help solve the problem.
The proposed interest rate hikes will not increase the supply of oil or food. Nor will they increase the supply of housing, lumber, computer chips, cars, clothing, airline fares, furnishings, shipping, or labor, all of which are in short supply.
Additional deficit spending, not reductions in deficit spending, can reduce the shortages of scarce goods and services. Inflations always are caused by shortages.
Interest rate hikes will exacerbate those shortages, thus exacerbating inflation. The only possible “benefit” of rate increases (if one can call it a “benefit”) is that it will cut Gross Domestic Product and recess the economy.
A recession isn’t expected due to promising labor markets, but low-income workers will likely suffer.
And there we have it. The usual government response to any emergency is to punish the poor and middle-income classes. When deficits (wrongly) are deemed too high, the first instinct is to cut Social Security, cut medicare, and cut all poverty aids.
So far, it appears that a recession is unlikely in 2022, largely due to the fact that the labor market is strong.
Diane Swonk, the chief economist at Grant Thornton, told CNBC the employment market continues to improve.
However, the Fed must be cautious to avoid raising rates too quickly, which could slow down the economic recovery and lead to higher unemployment.
The labor market is “strong” (i.e., low unemployment) because people must work to pay their high bills. But the labor market is “weak” because there is a shortage of labor.
Raising interest rates will not reduce the shortages that cause inflation. Cutting federal spending only will recess an economy already weakened by scarcity and previous interest rate increases.
The government could end the inflation with more, not less, government spending to eliminate shortages and with lower, not higher, interest rates.
But the government, ruled by the rich, prefers to pretend that inflation must be cured at the expense of the poor and middle classes.
By beating down the “not-rich,” the rich widen the income/wealth/power Gap between them and the rest of us.
The Gap makes them rich, and the wider the Gap, the richer they are. Everything the Fed does is in service of a wider Gap.
At the start of this post, we told you that Congress and the President could prevent and cure inflations. But they pretend federal spending causes inflation.
For many in Congress, this is sheer ignorance. For others it is politics. Neither side wants the other side to succeed, and because Congress now is evenly divided, no one can overcome the minority rule system.
America’s founders created the minority rule system to entice the low-population states to join the union, so between the two-Senators-per-state voting system and the filibuster, a minority can prevent any progress unless one party has a super majority.
Add in House gerrymandering and the Presidential electoral college, and you have a creaky, arthritic government designed for obstruction, not for progress.
If all that were not bad enough, we are burdened with a Supreme Court that claims money is free speech and should not be limited, so money in politics has reached outrageous levels.
Finally, we also have a Supreme Court that now does not want agencies making decisions that offend the right wing, when in reality, agencies are the only ones capable of making decisions, thus tossing so many wrenches into the gears of progress, we are frozen.
In short, the Fed doesn’t have the tools, Congress doesn’t have the will, and the President doesn’t have the Congress or agencies.
Inflation will charge along with no one solving the scarcity problem until the private sector does it.
Capitalism, with its focus on profits and competition, eventually will reduce scarcities, at which time the Fed, Congress, the President, and both political parties will claim credit for “getting us out of this mess.”
The rich will prosper and the rest will suffer, and life will return to its normal domination by the rich.
Rodger Malcolm Mitchell
Twitter: @rodgermitchell Search #monetarysovereignty
Facebook: Rodger Malcolm Mitchell
THE SOLE PURPOSE OF GOVERNMENT IS TO IMPROVE AND PROTECT THE LIVES OF THE PEOPLE.
The most important problems in economics involve:
- Monetary Sovereignty describes money creation and destruction.
- Gap Psychology describes the common desire to distance oneself from those “below” in any socio-economic ranking, and to come nearer those “above.” The socio-economic distance is referred to as “The Gap.”
Wide Gaps negatively affect poverty, health and longevity, education, housing, law and crime, war, leadership, ownership, bigotry, supply and demand, taxation, GDP, international relations, scientific advancement, the environment, human motivation and well-being, and virtually every other issue in economics. Implementation of Monetary Sovereignty and The Ten Steps To Prosperity can grow the economy and narrow the Gaps: Ten Steps To Prosperity:
- Eliminate FICA
- Federally funded Medicare — parts A, B & D, plus long-term care — for everyone
- Social Security for all
- Free education (including post-grad) for everyone
- Salary for attending school
- Eliminate federal taxes on business
- Increase the standard income tax deduction, annually.
- Tax the very rich (the “.1%”) more, with higher progressive tax rates on all forms of income.
- Federal ownership of all banks
- Increase federal spending on the myriad initiatives that benefit America’s 99.9%
The Ten Steps will grow the economy and narrow the income/wealth/power Gap between the rich and the rest.