The Fed Should Cool It: The Only Alternative To Stop Inflation is to Tackle the Supply Shocks with Supply Side Reform
A Modest Proposal
I see that the tide of inflation has finally started to ebb recently. As a despiser of inflation more concerned with overregulation and unhinged spending, I am slightly dismayed. I have been hoping that perhaps if we stared at these high prices for long enough, then perhaps it might give us pause to reflect, and maybe relearn some of the lessons we were supposed to have learned in the 1970s. The current crisis, I would argue is similar.
In the 70s two Arab oil price shocks combined with government overregulation of private sector industry, and Keynesian demand management produced dismal inflation for years. Today the war in Ukraine has once again shook oil prices all over the world, overregulation and protectionist policies have made economies uncompetitive, and Keynesian loose fiscal policy during the pandemic have all conspired to lock the global economy into a new death spiral of high prices and virtually no growth.
One night a couple months ago on PBS News Hour, to discuss inflation they had a young woman on from a progressive think tank. A comparison was struck between the possible causes and solutions to inflation from her perspective, and the viewpoint of the Federal Reserve. While Fed chair Jerome Powell, attributes the overheated economy to an excessively tight labor market, the woman from the think tank blames profiteering oil corporations making windfall profits, the war in Ukraine, and supply chain disruptions.
From my perspective, I thought it was interesting how both the fed chair and the progressive seemed to be partially correct about one thing, the cause, while demonstrating perfect ignorance regarding the method for addressing it, another thing. I concede the Fed is partially correct to argue the labor market is having a highly disadvantageous effect on prices. Employment is too high. Wages are rising too much. People are spending too much money. Loose fiscal policy at the end of the pandemic lockdowns combined with money stored in savings for the duration of the emergency, elderly workers retiring, also loose monetary policy employed by the same Federal Reserve waging this critique—have converged to give working age people excess money to splurge, causing businesses to raise prices, then for workers to have higher wages, so they will continue to spend more money as consumers—in a cycle. It is a cycle the Fed thinks they can only break by raising interest rates until they force the heat to cool, whether that entails bringing inflation down to a certain number in relation to GDP—their declared target is 2%— or it involves causing a recession.
The Fed is authorized to use interest rates as a cruel instrument to deliberately provoke unemployment in order to quash the excess demand, choking supply. Or short of causing unemployment, they are permitted to raise interest rates against anyone who might want a loan from the bank, home buyers, home builders like construction companies, automakers—in the Fed’s efforts to control the money supply from the top down, whoever might get hurt by these rate hikes are treated as collateral damage. I am in partial agreement that a tight labor market is causing inflation. But I entirely disagree with the Fed’s blunt, cruel methods. To me it’s not worth it, because it’s not necessary, that so many people suffer, of select groups of individuals as well (who are the same people who get hit every time the Fed has to tighten), strictly to bring down prices. Because I don’t believe government should have the discretionary authority to pick winners and losers, rate hikes are an injustice to home buyers or automakers in my perception, nor is it fair to anyone whom it might become the Fed’s goal intentionally to make unemployed.
It can also be counterproductive economically. In attempting to slow inflation by controlling the money supply, the Fed confuses investors, destabilizes investment on Wall Street and risks distorting the market. And considering how it can cause a recession, then I wonder what’s the point? If we’re attempting to correct economic problems, why should we substitute one inflation, for another, recession? Although I shall save the topic for another day, I do not approve of the Fed as an institution. I think it causes more trouble than it’s worth, and it has a highly unsettling, increasing tendency to behave like a central planner, and its failures, and collateral destruction, are a signal example, in a Hayekian sense, of how attempts from above to intervene in and unilaterally direct economic activity are liable just to exacerbate dysfunction.
As regards the progressive from the think tank, her alternative solution is to punitively tax profiteering corporations, to punish them for making windfall profits and cornering the oil market, while exploiting the rest of us at the gas pump in these times of need. While I can agree with her that it’s unpleasant that certain business have been doing exceptionally well right now seemingly at our expense, although I don’t blame corporate greed but our uncompetitive economy which allows a couple oil companies to monopolize oil markets, I can only partially agree that some companies could be exacerbating inflation with their opportunity to set prices. There are other factors. As she acknowledges, the war in Ukraine is a big driver behind oil prices.
However, I think a big but underrated reason oil companies now are producing less oil but setting higher prices, comes from lax antitrust enforcement, leading to the over-consolidation of the oil industry. In an article in The American Prospect, “The Hidden Driver of High Gas Prices,” by David Dayen, “Nearly 20 years ago,” he writes, “the Government Accountability Office found that petroleum industry mergers led to something called ‘networking,’ where refiners establish relationships with large retailers, rather than operating as independents. In some cases refineries make handshake deals to produce certain supplies for one another, which looks suspiciously like cooperative agreements with rivals. This vertical control means that the same companies engage in oil exploration, refining, and in some cases retail sales. Indeed one of the largest global refinery owners is Saudi Armco, the state owned oil company, which also owns the biggest refinery in North America. As these consolidations occurred, not a single major new refinery was built between 1977 and 2020. Nor did the Federal Trade Commission, which had jurisdiction over refinery mergers act to stop many of them.” Mergers cause consolidation of a market by a couple companies who are permitted to set high prices, because they have no competitors who would give companies an incentive to lower prices to sell goods. Antitrust law is supposed to stop this. In an open competitive market, prices are reliably low or high depending on actual scarcity.
But to punitively tax oil companies, as the progressive suggested on PBS, seems to me a very bad idea. First because it would constrain and limit supply by raising production costs, making oil scarcer, and when cheaper gas is what we want, then it makes no logical sense, to incentivize further limiting the production of oil. Second although she claims her progressive suggestion would help workers—I’m not sure how and she doesn’t explain, because we would redistribute the expropriated money around?—directly giving more money to workers is the opposite of what the overheated economy needs. That’s virtually half the problem, that workers are doing too well. I thought we want to stop inflation, not line the pockets of people whose wages are rapidly rising, and also came out of a pandemic with historic savings, but this just demonstrates the extent of the blame she lays at the feet of corporations, that she denies the tight labor market reality.
I liked on the show, how they struck a comparison between the mission of the hawkish Fed, and the pleas of the vindictive progressive, because they wanted the audience to decide for themselves whose ideas they thought were better. However while I agreed with both Powell and the progressive partially about causal factors, I emphatically disagree regarding their proposed cures. Here’s how I would fix inflation.
If I could, I would open up the supply side of the economy. In my studies of economic issues, I have come to two conclusions about what causes inflation, the money supply, meaning literally the amount of money quantitatively circulating in the economy, and also excess demand stimulated by fiscal policy, which obstructs the ability for supply to meet surging demand. The Fed agrees with my first contention; I only disagree with their method for limiting the money supply. For me, it is fiscal not monetary policy which should bear the brunt of the responsibility for stabilizing the money supply. While the Fed is destructive already, their monetary policy might not even work either, not unless the government cuts back, too. Indeed, if the government neglects to cut spending—the government can delegate the inflation problem to the Fed while it pursues a high spending agenda, causing the Fed to have to hit the brakes over and over.
To stave off inflation, fiscal policy warrants what I call prudence but what others call austerity measures, the antithesis of which would be Biden’s pandemic relief stimulus checks, which played no minor role in starting this. So a commitment to reduce government spending and incorporate spending cuts should be a top priority. The government takes up a huge share of spending output in the economy at any given moment. To reduce that output as much as possible in times of overheating, is commonsense.
As for my second contention, we can tamp down demand by making supply more abundant and accessible by pursuing a deregulatory agenda, which preferably is as comprehensive as possible, not least as briefly outlined in Discourse Magazine in this great article, “Winning the Battle Against Inflation Also Requires Supply Side Reforms.” Veronique de Rugy and Jack Salmon recommend increasing legal immigration; changing trade policy by abolishing punitive tariffs, quotas, and duties, and repealing the Jones Act which necessitates that trade overseas is limited to US made ships; they suggest overhauling land use regulations and zoning restrictions; and they make suggestions to expand the supply of oil, not that anyone on the left would be open to this, but it’s worth quoting Rugy and Salmon’s analysis. They note that, “on his first day in office, Biden revoked the cross border permit for the Keystone XL pipeline—a long term investment that would have brought over 800,000 barrels of oil into the US every day.” They say, “to make matters worse a week later, the president halted all new leases for oil and gas drilling on federal lands and has since refused to renew the federally mandated five year offshore drilling plan. Now, 21 months after Biden was sworn in, crude oil production remains 8% below 2020 levels and Americans continue to pay a hefty premium at the gas pump.” They conclude, “a good place to start would be to reverse these two self-defeating gestures and allow the pipeline to be completed and drilling on federal land to resume. This would not only increase the country’s supply of oil and gas in the next few years, but would send a message to the energy industry that the government is no longer interested in slowly suffocating it.”
But besides Rugy’s and Salmon’s suggestions on trade policy or oil manufacture which rather than dealing with inflation immediately, mainly provide the road for growing the economy in the long term, the solutions to inflation which would have immediate effect that struck me were their suggestions to liberalize immigration and deregulate zoning and land use restrictions. Since the cause has so much to do with excess aggregate demand, (and since expanding the supply of oil at this point might be a waste of time, where it’s probably smarter to accelerate the transition to clean energy), in my opinion the best way to stop it would be to lift the barriers limiting the free movement of people, constraining opportunity, and contributing immensely to the overly tight labor market. Let’s start with immigration.
Immigration
Since Donald Trump took office and curtailed illegal and legal immigration right away, and the Covid 19 pandemic gave him an excuse to further restrict immigration, and Joe Biden has done nothing to alter or reverse Trump’s policies, the US has slowly been drained of the talent of foreign workers, immigration formerly a major source of America’s economic dynamism. In the Washington Post article, “Trump, covid slowed down immigration. Now employees can’t find workers,” they observe, “the number of new immigrants entering the country, legally, each year, which peaked in 2016, fell by 6% in 2017 and another 9% the following year, according to data from the US Department of Homeland Security. But the pandemic dealt the biggest blow: New arrivals plunged 50 percent between 2019 and 2021.” This has had no negligible impact regarding inflation. While taking a chunk out of the available labor force, contributing to a labor shortage, and causing the labor market to become excessively tight, it has also caused businesses to raise worker’s wages just to hold onto the labor that is still available, leading to more inflation. A lack of immigration also directly leads to higher grocery prices, as the agricultural sector is missing the low-skilled foreign labor it depends on for harvesting crops.
Declining immigration constitutes an understated supply shock to the economy, which our government has caused through capping the number of work visas we issue. In a great Foreign Affairs article, “America Needs More Immigration to Defeat Inflation,” Gordon H. Hanson and Matthew J Slaughter observe, “right now, the United States caps the number of new private sector visas at 85,000—65,000 for workers who possess a bachelor’s degree or higher and 20,000 for workers with at least a master’s degree. For decades, demand for H1-B visas has far exceeded supply. In the 2022 fiscal year, 308,613 people sought H1-B visas before the US government stopped accepting applications.” And while observing our self- imposed drain of foreign talent, Slaughter and Hanson point to the corresponding severe productivity loss we are causing ourselves, “The low cap on H-1B visas constrains not just the US labor supply but also US productivity growth. Highly skilled immigrants boost innovation in several ways. They generate more patentable ideas and technologies than do US born workers, and they are more likely to found companies. Companies that scale up their hiring of skilled immigrants also tend to scale up their hiring of native born workers, underscoring once again that the two categories of workers complement each other. Moreover skilled immigrants tends to boost the wages not just of skilled native-born workers but also of less-skilled native born workers.” The decline of immigration over the decades is a tragedy to me. We’re supposed to be the land of opportunity, yet we willfully turn away those who are seeking it; and we certify our economic stagnation in the process; and we complain about declining birth rates while we foreclose the economic boon literally sitting outside our gates with Title 42. I was hoping the Supreme Court would strike it down, but I see they have extended the policy temporarily. I think the policy is illegal now that we have the pandemic under control. You should check out Justice Gorsuch’s dissent from the majority. He says awesomely, “… the current border crisis is not a covid crisis. And courts should not be in the business of perpetuating administrative edicts designed for one emergency only because elected officials have failed to address a different emergency. We are a court of law, not policymakers of last resort.”
Zoning Regulations
In addition to the lower and lower levels of immigration, land use regulations deter labor from migrating to cities where labor is the most abundant and the most needed. They are also regressive and redistribute the benefits of inflated property values upward to the affluent. In a terrific book I read, which is an indispensable guide for understanding how overregulated the American economy has become over the last couple decades, The Captured Economy, How the Powerful Enrich Themselves, Slow Down Growth and Increase Inequality Brink Lindsey and Steven Teles devote a chapter to discussing the way zoning restrictions cause inequality and prevent economic growth. They say that in the last thirty years, “incumbents in the most expensive housing markets in the country, such as San Francisco, Los Angeles, New York, and Boston, have become increasingly successful at stopping the creation of new housing. By preventing supply from responding to rising demand, they have artificially boosted housing prices in those markets, creating a windfall for existing homeowners. In the process, they have also made it harder for newcomers to move into cities with surging incomes, pushing them into parts of the country with less opportunity” (110, Teles, Lindsey). Right now I would argue, we are feeling the effects of the tight labor market worse in cities than anywhere else in the country. That’s because there are more economic opportunities in cities, and yet we have fewer people to fill them. Zoning regulations exacerbate the decline of available labor massively, by pushing millions and millions out of the cities which have become too expensive for people to settle there and start their careers. Teles and Lindsey relate how these constraints on geographic mobility affect the supply side of the economy. “It turns out that most of our country is empty for a very good reason: people derive great value from concentrating together in urban areas. First, proximity reduces transportation costs, so producers benefit from being close to their suppliers and customers. Second, more people living in one place means deeper and more diverse markets for both products and labor. With a large enough urban population, niche markets that appeal to only a small fraction of consumers become profitable to serve. Employers have a better pool of potential workers to draw from, while workers have greater choice in prospective employers. Third people living and working close to one another, can take advantage of information spillovers in which cities expand opportunities for exchanging ideas and information, thereby facilitating both innovation and the accumulation of human capital” (114, Teles, Lindsey).
Conclusion
In making my case for supply side reforms, rather than the Federal Reserve continually raising interest rates to try and force inflation down, I only chose to discuss the specific ways a lack of immigration and tight zoning regulations detrimentally impact the economy, because to me these constraints on the free movement of people are having the biggest effect on inflation. Since I would argue, while it was stirred by recklessly loose fiscal and monetary policy, and now I would say the main cause of inflation has been supply shocks combined with a staggering labor shortage, I would argue the least we could do is fix the labor shortage. And how hard would that be to fix? Remove Title 42, liberalize legal immigration and raise the caps on work visas, and lift zoning restrictions in the coastal cities. I think that not just would these very basic supply side reforms kill inflation, allowing the new amounts of free labor to meet prospective employers, but it would also lead to much, much needed economic growth in the long term.
Now I could list more changes that could be made for the purposes of economic growth, welfare reform (putting the shrinking amount of employable working age men back to work), healthcare reform (fixing our half socialized healthcare system which raises healthcare prices and insurance premiums, and limits people to have to negotiate with government programs, aligned with insurance companies, for treatment for their own private conditions), tax reform (get rid of illiberal capital gains taxes, inheritance taxes, estate taxes), social security privatization (so we’re not all paying people to retire, a system which we can’t even afford anymore), overhaul occupational licensing (which by shielding specialized labor from competition, inflates the incomes of doctors, lawyers, teachers and even hairdressers), financial deregulation (get rid of Dodd Frank), lift all self-flagellating tariffs and quotas, repeal the pointless Jones Act. There are a lot of options for limiting inflationary government spending and cutting down the growth of the regulatory state, which, while capping innovation, constraining opportunity, concentrating wealth, and lowering the bar on growth—are also regressive and upwardly redistributive, and expensive for taxpayers and consumers.
In this post, it was my intention only to list a couple of reforms which would defeat inflation by going right at the tight labor market, which the government has practically subsidized and created with senseless regulations on the free movement of labor and people. I listed just a couple of reforms which we could make, which would be the least we could do, while doing the most of any of those other reforms, to fight inflation in particular.
I’m inclined to believe that the US government is hiding behind and delegating its responsibilities to the draconian and only marginally effective Federal Reserve, which should give up and cool it on the rates. Our congressmen and our president should rather do their damn jobs and take responsibility for the bloated administrative government they have duped the complacent masses into paying for to secure their votes. I remember that early in his presidency when this inflation started, Biden said publicly that he had no power to stop inflation. That is absolutely wrong! Government has a ton of power to stop inflation. Hell the government starts it! Biden should at least admit that the executive can help inflation by not dumping more money on it, because he has done, and he has attempted to do, everything under the sun to multiply it.
From the pandemic relief aid that started it, to the Rooseveltian pretensions of the attempted Build Back Better Bill whose disastrous inflationary effects the maverick Joe Manchin honorably stepped in to save the country from, to Student loans, and I’m afraid to contemplate whatever comes next. Only government can keep supply from meeting demand with excessive regulation. Only government can increase overheated demand through profligate spending. Government needs to make the hard choices it made in the early eighties, where Ron and Maggie successfully defeated inflation with sweeping deregulatory policies, which expanded the supply side, put everyone to work, and led to and even served to institutionalize the significant growth and prosperity that we would enjoy for decades.
In the December 3rd-9th issue of The Economist, they wrote a column waxing nostalgic for the rigor of the 80s, whose example they suggest we have important lessons to learn from, one being that inflation cannot be fought with monetary policy by itself—while also expressing doubt that governments have the guts for the requisite fiscal adjustments. “Do policymakers today have the stomach for the fight? Coming so soon after the fiscally austere 2010s, many are reluctant to tighten the tax and spending screws once again. Indeed many politicians have gone the other way and now seem uncomfortable with the notion that anyone should lose out from anything, ever. They are offering hundreds of billions of dollars of deficit-financed fiscal support that will fuel inflation, whether by subsidizing energy bills (in Europe), offering cost of living payments in (Australia and New Zealand), or forgiving student debt (in America).”
In the beginning of this article, I was dismayed inflation appears to be dying down, because we would be missing an opportunity to start making some massively important reforms. But inflation is not going away, and it might get worse. Indeed Niall Ferguson, in an NBC interview you can see on Youtube, thinks that with the war in Ukraine, and depending on China, the 2020s could become economically worse than the 70s.
So with the prospect of more supply shocks, and probably more rate hikes, and looming recession, it stands to reason that sooner rather than later, we need to reform, by expanding, the supply side of the economy, strengthening ourselves against future shocks, while taming inflation, and even spurring growth.
— Jay