There is absolutely no doubt anymore. Inflation is deeply embedded in the economy. The recent report of inflation at 8.6% in May is the highest since 1981. The only question is what can be done about this punishing tax that hits hardest at low-income families and seniors on fixed incomes.
What will it take — and how long will it take? And how much pain must the economy endure in the process? Those are the questions that economists and the American public are asking. And they are asking ahead of a significant congressional election less than six months away.
Make no mistake. While inflation is an economic problem, it is also a political issue. And the prescribed treatment for inflation can have devastating political side effects and consequences.
Why inflation exists
There is a lot of finger-pointing as to the cause of inflation. Stripping away the politics, the basic definition of inflation is “too much money chasing too few goods.” That causes prices to rise, which is the visible effect of inflation.
Then wages are pushed higher in an effort to catch up. But wages tend to lag price increases, causing widespread pain. Even Social Security COLAs (now projected to be around 8.5% in 2023) won’t keep up with rising Medicare premiums and other costs.
This time around, inflation is particularly difficult to deal with. Let’s start with the “too much money” side of the equation. The government spent (borrowed) more than $6 trillion dollars since the start of the pandemic to save the economy. Yes, some of it was handed out in stimulus checks to individuals — and even more was handed out in corporate subsidies.
Where did the government get the money to do this? They borrowed it, issuing IOUs — Treasury bills, notes and bonds. Much of that debt was purchased by the Federal Reserve — paid for with newly created “money” — liquidity that flowed into the system. And the Fed also bought mortgage-backed securities in the open market, again paying with newly created money.
The Fed “accommodated” the government’s excess spending by literally creating (“printing”) the money! Yes, it can do that! And now it has to undo this mess it made.
It won’t be easy because if you look at the other part of the definition — “too few goods” — you can see that everything from the supply chain problems of the pandemic to the Russian invasion of Ukraine has constricted supplies of products that are essential to the global economy.
Oil continues to be in short supply around the world, spiking prices higher. But higher food prices are also a huge problem — with even more increases on the way. Disruptions in the growing season in Ukraine and the inability to get grain out of its ports will impact food prices worldwide.
Scarcities drive prices higher. And the cost of fuel impacts the price we pay for everything from airline tickets to fresh avocados and strawberries at the supermarket. Your groceries are trucked in from somewhere!
What can the Fed do?
The Fed blew its chance for an easy fix by waiting too long to increase interest rates, and then perhaps by planning such small incremental increases. Remember, until last month it was still adding new liquidity to the market by purchasing mortgages, even as it was announcing higher rates.
Now, the Fed must act dramatically to make an impact. The most visible impact will be higher interest rates. If it can’t increase supply, it must decrease demand by slowing the economy. That will be painful. But not as painful as runaway inflation.
The stock market doesn’t like that slowdown solution — as evidenced by today’s huge decline. An economic slowdown is sure to mean lower earnings and potential layoffs, leading to slower consumer spending. All are big negatives for stocks, which have been fearing this prospect for months.
What can the president do?
This administration is in a tough situation, one not faced since Jimmy Carter was president. (And he lost his bid for re-election.) Asking oil companies to produce more oil now is not just a case of turning on the spigot. It will take time for oil companies to reinvest in production and refineries and pipelines.
And the increase in fossil fuels will negatively impact the administration’s clean energy agenda. The only alternative is to plead with Saudi Arabia to increase production in the OPEC cartel. That’s equally unpalatable.
Inflation will not be the only issue in the fall elections. Everything from student loans to gun control and other social issues will hang in the balance of congressional control, which is at stake in the next election. But inflation is the one factor that impacts all voters.
And there are no painless solutions.