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Handling Inflation

07/26/2022

The short answer on how to handle inflation is simple . . . create a recession and hope you don’t get stagflation.

The longer answer is that you have three tools to handle it.  First, one cause of inflation is a sustained period when demand exceeds supply.  If you cannot increase supply with targeted tax cuts or targeted regulatory relief, you can decrease demand by hiking interest rates and taking spending power out of the economy.  Demand destruction with higher interest costs is much quicker than increasing supply.  Demand destruction has already begun.  That destruction with higher rates can be handled by the Fed, but increasing supply requires a legislative solution.

Second, another cause of inflation is allowing the money supply to grow faster than the productivity growth.  Some economists (monetarists) like to say “inflation is everywhere and always a function of money supply.”  This is called monetary policy but sounds like “econo-speak.”  The current money supply growth is less now than before the pandemic, and the productivity growth is coming back to life . . . finally.  This tool is already being utilized but needs to be accelerated.

Third, the most onerous cause of inflation is inflationary expectations.  When people expect prices to rise, there is less resistance to it.  Maybe, it is memories with past bouts with inflation or maybe it is fueled by media hype, but most economists have been surprised by the sudden hysteria over inflation.  The Fed can do little to combat this.  The President and other leaders can attempt to “talk down inflation” but little else.  Consumer Confidence has already fallen three straight months.

Old timers are fond of saying “the cure for high prices is high prices”.  Prices can get so high that people will stop buying, and the economy will cool, but that takes too long.  We are fortunate to have the other tools, and it does appear that those tools are already being used . . . thankfully!   Help is on-the-way!

My worry is that political calculations will interfere and cause vacillation.  As the economy cools, unemployment is likely to rise somewhat, which is tragic personally but valuable politically.  Hang tough!

A big problem with killing inflation is the 8-14 month time lag with monetary policy.  Theoretically, raising interest costs today won’t be apparent in the economy for another year, but that’s excuse to stop.  Do it!  Do it now!!

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