Washington Wednesday: Getting inflation under control

NICK EICHER, HOST: It’s Wednesday, September 7th, 2022.

We’re so glad you’ve joined us 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. It’s Washington Wednesday.

First up, inflation. The number one buzz word in Washington these days.

The rate at which prices are rising has slowed a bit, but it remains painfully elevated. For the 12 months ending in July, the annual US inflation rate stood at 8.5 percent.

EICHER: President Biden recently signed into law a slimmed-down version of his Build Back Better bill, which Democrats dubbed the “Inflation Reduction Act.”

But the nonpartisan Congressional Budget Office and other independent sources say one thing the Inflation Reduction Act won’t do is reduce inflation — at least in the short term, if ever.

And some economists are concerned that the president’s student loan forgiveness plan will further fuel inflation.

So what impact will these measures have on rising costs? And what will it take to finally bring inflation under control?

Joining us now to help answer those questions is Jeff Haymond with Cedarville University in Ohio. He is the Dean of the School of Business Administration and Professor of Economics.

REICHARD: Professor, good morning!

JEFF HAYMOND, GUEST: Good morning!

REICHARD: Well, let’s start with the “Inflation Reduction Act.” The White House says this will help to bring costs down. But Republicans and others say it will do the opposite. What’s your take?

HAYMOND: Well, first of all, to understand what's going to happen to inflation, you have to know what causes inflation. And in reality, the cause of inflation is what the Nobel Laureate Milton Friedman once said, “Inflation is always and everywhere a monetary phenomenon.” So what it means is when we print too much money in the economy and there's just too few goods that results in rising prices. And it's important to realize that because it's not simply that we're paying more for some goods and services. That's not necessarily inflation. We could have shortages in an area. For instance, we're all struggling with the energy prices, the food prices, that in itself is not necessarily inflation. However, when the Federal Reserve prints $5 trillion in the aftermath of the COVID crisis, and the federal government extended its debt by $7 trillion, you know we've had too much money printed in the economy. And that's the underlying root cause. So when we start thinking about, Okay, what's the Inflation Reduction Act going to do? If anything, it's going to be inflationary, because they wanted to spend some resources in the near term and they promised some cuts and tax increases over the longer term. Well, if anything, that brings more purchasing power online today, that will tend to cause additional pressure as once again there's more aggregate demand in the face of a certain limited amount of aggregate supply. Heretofore, the Federal Reserve had been monetizing that expanded debt and now the Fed isn't. So there's going to be tension, and we're going to see some continuing problems. But I don't I certainly agree with the other economists, the Inflation Reduction Act is not going to lower inflation, because it's really not designed to do that.

REICHARD: Beyond inflation, what effect do you think the law will have on the economy as a whole, positive or negative?

HAYMOND: Every bill that the Congress passes has some effect or they wouldn’t do it, right? And there are winners, and there are losers. In this particular case, I don't think it's good, necessarily, for the general population. But there will be interest groups that will benefit from some of that spending. I mean, clearly, if you're in the green energy business, you're gonna be particularly happy about this. But here's what we do know: absent the government intervention, the market had not wanted to steer resources towards those areas. Now, we're going to steer resources towards those areas because of the government push, which by definition was a less efficient use of those resources as the market itself would have determined. So I think that's a net negative. I believe markets choose more wisely than governments do. But that is not the political course we took.

REICHARD: Let’s talk about the president’s announcement regarding student loan forgiveness. Some worry that will further drive inflation. Do you agree with that?

HAYMOND: I do, but there’s a couple ways to think about that. First of all, the inflationary effects of the student loan bill are less than they otherwise might be because it's not as if we were going to have if he would have resumed the payment this past month, and then just all of a sudden this, all the loans were going to be paid off this quarter for say. But all that would have done was there would have been some people that are going to have their loans forgiven, that would have otherwise started making a small amount of payments. So yes, it's additional purchasing power and to the extent that he's forgiven that, that will be inflationary, so to speak, or put cost pressures. But it's not as if the whole $300 billion to $1 trillion, depending on which estimate you're looking at, would have been spent in the economy right now, that would have been over several years. But I would argue that the inflationary aspect is not the reason to criticize that bill, and that's—as you probably know, and your listeners know—the real issues with respect to that are all the longer second order effects, the unintended consequences, as well as the equity issues. I mean, what do you say to the people that paid off loans? What do you say to the people who never went to college or couldn't afford a college, so they didn't and went to trade school or what have you, they got no relief and now they're going to have to pay somebody else's loans. So that's a real equity issue that we should all be concerned about. And then the second order effects are okay, what do you think's going to happen now to future borrowers of student loans, right? They're going to be willing, on the margins, to take on a little bit more debt because there's at least now going to be the slight possibility, if this is upheld, that future borrowers, likewise, could have some of their debt forgiven. And then we have to ask, well, what do you think colleges are going to do with respect to that? They're gonna say, well, hey, if there's additional demand, and people are willing to take on more debt, we can raise tuition rates. And so this isn't necessarily a good move at all for reasons beyond the inflation. So those are my bigger concerns.

REICHARD: When inflation really began to take off last year, both the White House and the Federal Reserve predicted that the cost surge would be short-lived. They turned out to be wrong about that. What did they miss?

HAYMOND: Well, from a theoretical basis, the Federal Reserve just really rejected at least 40 years of collective wisdom when they went on a policy of saying they were going to do what's called average inflation targeting. And I know this is a little bit wonkish, but what they did was they changed their regime to say, hey, if we have undershot inflation for a while, like we did, say, the previous decade, they were shooting for 2% and it was a little bit below that. That means we need to go over that 2% for an extended period of time, well, that rejects the wisdom of what we learned in the 1970s that if you allow inflation to go above what your expectations are, first of all, how would you control it? As we found out they couldn't, and it went much higher than they expected. And then if you ever let the inflationary expectations get running wild, you get that 1970s experience, and we don't want to go there. So at a theoretical level, the Federal Reserve just blew it. And they rejected the monetary wisdom that Paul Volcker and the rest of us Americans learned painfully. From the political perspective, the White House, of course, they want more spending. They were elected in their minds to do and accomplish great things and they wanted to be able to have accomplishments to tell to the people that were supportive of them, all of whom, basically like a lot bigger government. So yeah, it wasn't that they missed it. And the interesting thing is, especially at the Biden administration, Mr. Biden himself says there's no economist that’s predicting it. And yet, Larry Summers—former Democratic Secretary of the Treasury in the Clinton Administration—has told us that you're gonna get a lot of inflation if you do this. And, shock, Mr. Summers was right and Mr. Biden was wrong, not surprisingly.

REICHARD: The Fed is of course now raising interest rates rather rapidly to beat back inflation. Will that be enough?

HAYMOND: It will be to beat back inflation. There's no doubt about that. Here's the question, though, at what cost? The Federal Reserve just a week or so ago at their monetary conference that they had at Jackson Hole, suggested they're prepared to go a lot higher and the markets were not pricing in. They the markets were thinking they were going to back off. And now we're starting to see the stock markets, the bond markets react negatively, accordingly. And there is the possibility of a more significant downturn in the economy as the Fed raises interest rates. My personal expectations, I expect them to to keep aggressively raising interest rates till we get somewhere between the 3% and 4% rate and then kind of pause a little bit to see what actually happens in the real economy because we've already seen a significant slowing. And we'll see what's going to happen to prices because monetary policy operates with a lag. Milton Friedman's famous line was six to 18 months. And so it's going to take a while for all this to get baked into the economy, but we're already starting to see signs of slowing in the upstream of costs. Commodity prices, for instance, have fallen quite a bit and I would expect that to continue if they keep raising interest rates.

REICHARD: You’ve touched on this. What everyone wants to know. Do you think we’ll have to endure a lengthy recession before prices come back down to earth?

HAYMOND: I hope not. My hope is if the Fed does what I think they're going to do, which is raise, again, 3-4% and then pause, we may see enough curtailing of this. I don't think there have been widespread inflationary expectations that are built in such that a mild kind of slowdown and recessionary force might curtail that. The problem, why I'm concerned, of course, is the way we finally beat the inflation in the 1970s and when we started doing in the 1980s, the early 1980s, it was the combination of tight monetary policy coupled with a real focus on increasing aggregate supply—ie the production of goods and services in the economy. Reagan and really Carter even preceding him had started a deregulatory agenda that Mr. Reagan accelerated. And obviously, Reagan cut taxes and so forth. So there was a lot of stimulus to the production side. I don't see any possibilities of that under the Biden administration. They continue to want to emphasize more regulation, not less. Higher taxes, not lower. So that's the concern I have is even if we get the tight monetary policy, we won't necessarily have the support we could have on the supply side of the equation.

REICHARD: Professor Jeff Haymond with Cedarville University. Professor, thanks so much!

HAYMOND: You’re welcome. Glad to be with you.

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