Beware the Inflationary Bogeyman

The headline chosen for Harvard economist Jason Furman's November 15 commentary in the Wall Street Journal was both apt and sad. It was apt, because it repurposed then-President Gerald Ford's "Whip Inflation Now" slogan from 1974, and sad because Furman's advice comes straight from that era--and because his prescriptions could reprise the economic and political disasters of those years.

Furman, formerly the chair of President Barack Obama's Council of Economic Advisers, writes that "ultimately inflation is a macroeconomic problem," meaning it is an issue that afflicts the economy as a whole. In exploring the causes of the problem, Furman writes of "rapid recovery," "tight labor markets," excessive fiscal stimulus, and too-easy money. The US economy, in his telling, has too much spending pressing on its capacity to produce. It is too big.

"Democrats should remember that Volcker's shock led to 12 long years of Republican rule, under Ronald Reagan and George H.W. Bush."

Except that it's not. According to the latest GDP report, the actual size of the US economy--measured in inflation-adjusted dollars--is still smaller than it was in the last quarter of 2019. Americans are spending and producing in real terms less now than we did then. For all the hot air about high growth rates, low interest rates, and big deficits, America is not even back to the starting gate. That means there is no way that our current inflation rate is "macroeconomic."

Furman goes on to insist that "it's the Fed's job to keep [inflation] under control." That also is not true. The US Federal Reserve operates under the Full Employment and Balanced Growth Act of 1978, which stipulates that full employment and reasonably stable prices are goals for the US government as a whole.

The drafters of that law--I was among them--did not buy the dogma that inflation "is always and everywhere a monetary phenomenon," as Milton Friedman had argued. Rather, we believed, and the law states, that all of the economic objectives had to be pursued with all of the available tools, and by all of the agencies.

Now as then, oil is the most obvious price problem. Back then, the culprit was OPEC; today, other forces have driven up prices of gasoline, fuel oil, and natural gas by 50% or more since last year's trough. Some of the increase reflects the rebound from the pandemic lows, and some of it is the result of supply constraints, owing to cuts to shale-energy production.

Commodity speculation may also be a factor, as it was just before the 2008 global financial crisis. If so, this activity can be curtailed by raising margin requirements--over which the Fed has authority. Energy prices can be stabilized by selling from the Strategic Petroleum Reserve, as US President Joe Biden's administration may be about to do, in cooperation with China. Production will soon pick up, as is already happening in the Permian Basin.

The other common factor between inflation 50 years ago and now is military spending. Economists in the 1960s and 1970s knew that the Vietnam War was inflationary; war always is. Somehow, this fact has been forgotten as we spend more than $700 billion per year on weapons and defense--creating bottlenecks, burning fuel, cutting into civilian output, and diverting new technologies and talented people from things we could use toward things we cannot use. All of that activity is inflationary.

The other issues Furman raises are peripheral. There is no sign yet that higher wages are a source of higher prices for consumer goods or even for services. The Chinese did not raise their prices by anything close to the amount of the increase caused by Donald Trump's tariffs (if they had, they would have lost market share).

By contrast, the supply-chain problem is real, particularly in semiconductors, where the downstream effects on automobile production have resulted in higher used-car prices; but this issue will work itself out. The ports are indeed clogged, and that is adding to costs; but, again, it's not a macroeconomic issue.

More to the point, none of America's price problems would be helped by higher interest rates. Tighter credit would get in the way of the business investment that the US economy needs to expand capacity and keep costs down. Interest is a cost, and therefore will get passed on to consumers.

With less capacity and higher costs, inflation would get worse until the Fed tightened so much that the economy cracked. That is what happened--and what finally squelched inflation--after Paul Volcker became Fed chair in 1979. Democrats should remember that Volcker's shock led to 12 long years of Republican rule, under Ronald Reagan and George H.W. Bush.

Furman is right that Biden's next big policy package--the Build Back Better Act--isn't inflationary. And to be fair, Furman is not demanding higher interest rates immediately. He wants the Fed to announce that the benchmark federal funds rate will rise soon, but not if growth slows or inflation recedes. Well, growth was just 2% in the latest quarter, and the annual inflation rate will start to fall as soon as last spring's gas-price hikes fall out of the 12-month window.

So, while Furman's formula could lead to disaster, the most likely scenario, if it were adopted, is that nothing would be done. In that case, the Biden administration and Congress would have a new macroeconomic problem, because they would have done too little, not too much.

Back in the 1970s, the leading voice on economics in Congress was my boss, the chairman of the House Banking Committee, Henry Reuss of Wisconsin. He liked to say that we need a "rifle-shot" anti-inflation policy, not a "blunderbuss." The focus should be on stabilizing energy prices, cracking down on speculators, cutting the Pentagon budget, unclogging the ports, and ensuring that sorely needed wage increases go mainly to the lowest-paid workers.

What most certainly should not be done is to turn a manageable problem into a big crisis by handing it off to the Fed.