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Two Shades of Gray

08/09/2022

The poorly-named “Inflation Reduction Act” was just passed by Congress.  Democrats rave that it will reduce inflation.  Republicans crow it will not!  They’re both right . . . a little!

Think of it this way:  If you own a $1,000 CD, you get paid interest.  The money spent buying the CD is called principal.  The interest paid by the bank is called income.  Now, remember that accounting for principal is different than accounting for income.  (Income is taxable, but return of principal is not.)

In very round terms, this new bill will extract $900 billion from the income of Americans, which reduces their demand for goods & services.  Then, the government will spend $600 billion on goods & services, leaving $300 billion to “reduce the national debt,” which is likely to be reinvested as principal and not spent as income.  Savers/investors normally rollover their CDs or bonds when repaid, without spending it on goods & services.

So, the Democrats are correct in saying inflation will weaken – a tiny bit – because $300 billion will not be spent on goods and service and will be reinvested.  But, the Republicans are correct in saying, to the extent any money escapes from principal and doesn’t get reinvested, it will increase inflation – a tiny bit.

Talking points for true believers?

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