Washington Wednesday - Biden’s very painful experience

NICK EICHER, HOST: It’s Tuesday the 18th of May, 2022.

Glad to have you along for today’s edition of The World and Everything in It. Good morning, I’m Nick Eicher.

MARY REICHARD, HOST: And I’m Mary Reichard.

We told you about this yesterday, so a quick reminder right now about our new-donor drive. We have a generous donor who’s offered to match everything that new donors give, but this week only. A little competitive urgency.

EICHER: Right. It’s not a dollar-amount match. It’s a time-limited match. If you’ve never given before and you give today, tomorrow, or Friday, your gift is doubled at WNG.org/newdonor. Time is of the essence: today, tomorrow, Friday. It takes a team to support a team of journalists and we hope you’ll join that team today and make a gift—again, first-time donors only. WNG.org/newdonor.

REICHARD: Up first: inflation.

​​Costs continue to rise with no end in sight—everything from gas to rent to food.

President Biden says the pandemic, and more recently, Vladimir Putin, are to blame. Republicans say the White House is partly responsible.

EICHER: Of course we know that inflation is too much money chasing too few goods and services. Simple definition, difficult cure. The Federal Reserve is trying to fight inflation by raising interest rates in an effort to cool off the economy—and hoping that will tame rising costs.

So what are the real drivers of inflation? And when might we see some relief?

Joining us now to help tackle those questions is Desmond Lachman. He formerly served as managing director and a top economic strategist at the investment bank Salomon Smith Barney. He also served at the International Monetary Fund.

REICHARD: Desmond, good morning!

DESMOND LACHMAN, GUEST: Good morning!

REICHARD: In the simplest terms possible, how did we get here? Why do we have the highest inflation in four decades?

LACHMAN: Well, there are a number of reasons for it, as the administration and the Federal Reserve have been saying, part of the reason is the pandemic. So what that did is it disrupted supply chains. That meant that we couldn't get things like computer chips to go into our factories for automobiles and appliances and that sent up the prices of those goods. Now, more recently, what we've had is we've had Russia's war in Ukraine. And what that's doing is it’s sending oil prices through the roof. Oil prices are up something like 50%, food prices are up 50%. So those kind of factors that are external to the United States, certainly have played a role. But what has also played a very big role is the massive amount of fiscal stimulus that the economy received. So what President Biden did in March of 2021, is he introduced this American Rescue Plan. It was $1.9 trillion of spending. That's a huge amount. It's about 8% of the size of the economy. And that came on top of $3 trillion in the previous year that was the Trump bipartisan fiscal stimulus. So we were giving as much as $5 trillion in fiscal stimulus. That's a big boost to an economy and ran the risk of getting the economy overheated by the end of 2021, as Larry Summers warned and that's exactly what happened.

To make matters worse is the Federal Reserve was fast asleep at the wheel when all of this public spending was going on, when inflation was picking up, when we had all of these supply-side problems. The Federal Reserve kept its pedal to the metal. So they just kept expanding the money supply and money supply increased by something like 40% over the past two years. They kept interest rates at zero. They kept buying the pretty hundreds of billions of dollars of bonds, pumping up the market. So in the end, it's not very surprising that we now are having inflation running at around about eight and a half percent, something that we haven't seen since 1981. So we've certainly got an inflation problem on our hands. And it's not all due to factors that are beyond our control—pandemic or Russian invasion.. and what the Fed is now trying to do is it's trying to raise interest rates to cool the economy, in the hope that we can can bring inflation down without provoking a recession in the process.

REICHARD: Alright so that’s a lot to unpack there. Aside from politics though, what power does the president have to address it?

LACHMAN: The President has relatively limited power to deal with inflation. So what it can do and what he is doing is, for instance, he's releasing oil from the strategic reserve in the hope that increased supply will bring the oil prices down from where they are. That might be good. You might get lower prices at the pump, but you're not going to get much that way. You know, we've already seen even though he's released all of this oil, international oil prices are still around about $110 a barrel. We’re still paying close to $4.50 at the pump. So that didn't go too far. What they're toying with now is maybe reducing tariffs on China. That might provide a little bit of relief. But these measures are more political. He wants to be seen to be doing something about inflation. He's wanting to project the image that he feels people's pain. But the truth of the matter is that he doesn't have much control. Who does have control right now is the Federal Reserve, that by slamming on the monetary policy brakes, they can bring down inflation. But what they might be doing is when they bring down the inflation that way, they might be provoking a big recession. Part of the reason that one worries about a recession is that as the Fed raises interest rates, what we’re seeing is we seeing the stock market is now swooning. So we're getting the stock market swooning, we're getting credit markets swooning. That means that people feel a lot less wealthy than they did before, as they see their stock prices go down. That is another reason why they begin to restrain their spending. And that's part of the reason why I fear we could be headed into recession. And that would be part of the price that will pay for the big policy mistakes made both by the Federal Reserve and the administration last year when they overheated the economy.

REICHARD: I want to talk about you referenced earlier and that’s the supply chain problems. Both the White House and the Federal Reserve haver said for a while now that’s really what’s mostly driving inflation, saying inflation would be temporary, but the Fed’s changed its tune. It doesn’t look so temporary anymore. Why is that?

LACHMAN: Well, it’s very difficult to argue with the facts. So, the Fed at the beginning of last year, even though we had already had problems in the supply chain, the Fed was telling us, don't worry, we're gonna keep inflation below our 2% target. But as month after month went by, and inflation instead of coming down, kept going up, it's very difficult for them to remain in denial. So they've belatedly realized that this isn't a transitory problem. They probably know that they're partly to blame for this. So they've got no alternative but to raise interest rates, stop buying all of these bonds to try to bring inflation under control. Part of their problem, as I've mentioned, is that by keeping monetary policy so loose by pumping so much money into the economy last year, not only did they get an inflation problem, but they got an equity price bubble, a housing price bubble, fueled by these very low interest rates, now that they've got to slam on the monetary policy brakes, raise interest rates to curb the inflation, what they’re also likely to be doing is causing those bubbles to burst. And that is the reason that it's going to be very difficult for them to get the soft landing that they're hoping for.

REICHARD: You’re saying it’s not enough for the Fed to raise interest rates? That’s not going to fix the problem?

LACHMAN: No, I'm saying that by raising interest rates, the Fed is likely to succeed in getting inflation down. But they're gonna succeed in getting inflation down by getting the economy to go into recession by having unemployment rising by having all sorts of slack all over the place. So it's sort of like throwing the baby out with the bathwater. You'll solve the inflation problem, but you'll do it by creating an employment and output problem by creating a deep recession. So that's hardly a comforting thought that we might get inflation going back down next year, but we'll also get the economy in recession.

REICHARD: Desmond Lachman is a senior fellow at the American Enterprise Institute. Desmond, a pleasure to talk with you. Thank you.

LACHMAN: Well, it's good to talk to you, and it would be great if you sent us the podcast.

REICHARD: Certainly! Will do. Thanks again.

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