A Note on Inflation

You’d think it would hardly need restating that inflation is chiefly caused by monetary profligacy by the government (especially the Federal Reserve and other central banks that think they can “create” money out of thin air), but the Biden Administration began on an ominous note with Slow Joe proclaiming that “Milton Friedman isn’t in charge any more.” Well, the CPI seems to have something to say about that.

Economist and former Fed Board member Kevin Warsh (whom I’ve met and think is the bee’s knees on these subjects) writes in today’s Wall Street Journal that the Fed is the main culprit, and worse, that the Fed may actually be running behind Joe Biden’s learning curve right now, which is amazing to contemplate:

Inflation is a choice. It’s a choice for which the Fed is chiefly responsible. The risk of an inflationary spiral arises when policy makers first dismiss the problem and then cast blame elsewhere. Inflation becomes embedded in the price-formation process when the central bank acts belatedly or with insufficient conviction. To date, the Fed has acted as an enabler.

The sure sign of a problem: when a president gives voice to the scourge of inflation—and takes executive action—well before the central bank acknowledges the severity of the situation. . .

One interesting part of Warsh’s argument is that the surging stock market is actually a bad sign:

Extraordinarily aggressive monetary policy, namely quantitative easing, discourages investments in real assets like capital equipment relative to financial assets such as stocks. That’s why nonresidential capital investment in the real economy—things like port modernization—is running 7% below the pre-pandemic trend and 25% below trend since the advent of QE. A more exuberant stock market and a less resilient real economy are both consequences of the Fed’s extant policy regime. . .

Stopping QE altogether—even a few quarters ago—would have kept a lid on inflation and allowed a more measured path of rate increases. The Fed now has fewer degrees of freedom to keep the economy out of harm’s way. If the Fed doesn’t act with due speed and skill, inflation—the most regressive tax of all—will do further harm, particularly to the least well-off. If the central bank lurches into a significant, unexpected rate-rising cycle, the same hardworking Americans will bear the brunt of an economic slowdown.

Meanwhile, my old AEI colleague Desmond Lachman writes today in Barron’s:

The way to squeeze out inflation without abruptly bursting asset price bubbles would be for the Biden administration to relieve the Fed of at least some of the burden of having to reduce inflation through interest-rate hikes. To do so, the administration would at a minimum need to back off from the Build Back Better Act, which has passed the House but not the Senate. According to the Congressional Budget Office, the bill would add some $750 billion to the deficit over the next five years. Better yet, the administration would be well-advised to make a significant budget U-turn by some combination of public-spending cuts and tax increases to bring down the budget deficit.

While in principle there would seem to be a way out of our twin inflation problem, the political chances of that happening are negligible.

A few charts to end our look at this subject, starting with the fact that our inflation is running ahead of everyone else: