The causes of inflation can be hard to isolate, but in the U.S. at least, one culprit is clear: President Biden and congressional Democrats spent too much in the last two years, and even now refuse to take steps that would ease the problem.
Chaired by Jerome Powell, the Federal Reserve has moved decisively with large increases in interest rates and expressed a determination to keep raising them until inflation is contained. As a result, there has been a run-up in mortgage rates, which has put a damper on the U.S. housing market. Mark Makela/Getty Images via TNS
Economists usually think of inflation as coming in one of two ways: from the supply side or from the demand side. The former is when an important input – such as microchips for automobiles – is in short supply. That drives up prices, usually but not always temporarily. The latter is when a combination of excessive government spending and low interest rates creates more demand for goods and services than the private market can produce. This type of inflation is self-sustaining unless the government cuts spending or the central bank raises interest rates.
Over the last two years the U.S. has seen both types of inflation. In fairness, the government can do little about supply-side inflation. Demand-side inflation, however, is a different story – and prominent economists such as Larry Summers issued prescient warnings about congressional Democrats and the White House were adding to it with their oversized stimulus bill in 2021.
Then came the war in Ukraine, which only added to inflationary pressures. One might have hoped that month after month of record price growth would have spurred government officials to adjust their strategies.
Federal Reserve Chair Jerome Powell, at least, did just that. The central bank has moved decisively with large increases in interest rates and expressed a determination to keep raising them until inflation is contained.
There are drawbacks. First, there has been a run-up in mortgage rates, which has put a damper on the U.S. housing market. As new homebuyers face higher payments and existing homeowners see their equity decline, consumer spending will slow.
The rise in rates has also sent the dollar sharply higher as savers from around the world look to exchange their currency for higher-yielding dollar deposits. This makes imported products cheaper for Americans – but it raises the price foreigners pay for U.S. exports. And expensive exports are bad for the U.S. manufacturing sector.
Meanwhile, you might ask, what have the president and Congress done? The so-called Inflation Reduction Act included hundreds of billions in credits for green energy. That could have been a genuine effort to increase the U.S. supply of energy if it had been paired with permitting reform to speed those projects along.
Unfortunately, Sen. Joe Manchin, D-W.Va., was forced to remove his amendment on permitting reform last week after opposition from both Republicans (who want more drastic deregulation) and many Democrats (who want more stringent regulation). The result will be billions of dollars thrown at clean energy – adding to demand-side inflation – with little to any relief in the delays that are contributing to supply-side inflation. That means more of the work to reduce inflation will fall to the Fed, which in turn means higher interest rates.
It gets worse. The White House has a student debt-relief plan that will cost at least $400 billion over the next decade, according to the Congressional Budget Office (the nonpartisan Committee for a Responsible Federal Budget puts the cost even higher, at about $500 billion). That’s even more inflation the Fed will have to fight.
What this all adds up to is a rough future for housing and manufacturing, two sectors that only recently had begun to show signs of health. For the average American, it means that inflation may indeed be coming down – but that higher interest payments will take up more and more of their paychecks.
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