Reduce Inflation in Three Big Steps

Inflation has reached ghastly proportions, as a new report shows. Its oxygen supply must be cut. 

The official Consumer Price Index numbers released Thursday were like a nightmare from the 1970s. Prices rose 7.9% in the last 12 months, and they rose at an annualized 9.6% rate in February. And as my colleague Tiana Lowe noted, the particular nature of this inflationary spiral makes the price hikes an even heavier burden than usual for people with lower incomes

Half-measures won’t work to fix this problem. Bold action is needed in three areas. 

The first is monetary policy. The great economist Milton Friedman once noted that, even if other causes contribute to price hikes, in the final analysis, “inflation is always and everywhere a monetary phenomenon.” If the quantity of money increases faster than the production of goods and services, then price inflation is inevitable. To slow that increase, the first arrow in the Federal Reserve Board’s quiver is its control over the “federal funds” interest rate. It must be raised. 

Earlier this month, Federal Reserve Chairman Jerome Powell predicted the Fed soon would raise the funds rate, which has stood at essentially zero for several years, by a quarter of 1% (25 basis points). That’s not enough. Markets will see such a puny move and immediately discount it, expecting that it will be followed by another quarter percent later, and then another, in a series of ratchets. With such assumptions “baked into the cake,” as it were. Big-money-manager behaviors won’t change, and the rate hikes essentially will be “priced in” to expectations for an inflationary spiral. 

What’s needed is a shock to the system — and better to do it now, when rates remain at such historically low levels and markets can handle the pain. An immediate hike of at least 150 basis points could help suffocate monetary inflation while avoiding the need for further hikes down the road. Interest rates would rise sharply, but they would remain lower than they were for the vast bulk of the 50-year period ending in 2010. 

The second imperative is for lawmakers to turn off the fiscal spigot. Between 2000 and the onset of the pandemic, annual domestic discretionary spending alone rose by a huge, utterly irresponsible 33% after inflation and population growth. That doesn’t include entitlement spending, and that’s also before the $5.7 trillion in “emergency” COVID-related spending, plus another $1 trillion-plus for a porked-up “infrastructure” bill. And Congress just this week passed another annual $1.5 trillion spending bill to cover both domestic and defense accounts. That’s not even including entitlement spending, which needs reform but is unlikely to be fixed any time soon. 

To tackle inflation, Congress must impose a hard freeze, for at least two years, on domestic discretionary spending. Congress will soon begin working on the 2022-23 fiscal-year budget. It should first adopt something modeled on the Budget Control Act of 2011, which put hard caps on appropriations. The agreement would allow funding levels to be adjusted between federal departments but with no overall increases, even for inflation, for two years. The government will be spending far more in real terms than it did less than 25 years ago, but the slowdown would help rein in inflation. As Democratic former Treasury Secretary Larry Summers warned a full year ago, rapid increases in federal spending can “overstimulat[e] the economy” and induce central bankers to expand the money supply to cover the debt. 

One more fiscal measure: Congress should impose a one-time diminution on the annual “indexing” for cost-of-living and tax-bracket calculations. Economists long ago estimated that the official inflation rate has slightly overstated price hikes for at least two decades. To make up for that overstatement, Congress should provide that next year’s inflation index be set at a half-percent below the official rate. This would help keep deficits in check without incentivizing detrimental long-term changes in free-market economic behavior. 

Third, and this is more in the vein of looking to the longer term, Congress should seriously consider and start studying whether it is time to end the fiat money era. 

Some continue to argue that a return to the “gold standard” for U.S. dollars would work wonders. Others argue for a modified version of that, using a gold-centered “basket of commodities” that would be somewhat more flexible than the pure gold standard but stable. Friedman himself supported a modified approach to the current system, creating a fixed formula for Fed interest rate changes, rather than leaving the question to human governors. It’s all very complicated, with all sorts of pros and cons. But the idea of a fixed or semi-fixed standard for the dollar ought to be on the table for review. Congress should appoint a commission to study all such alternatives. 

Something must be done long-term so that today’s inflation, which is corroding the U.S. standard of living, does not become a permanent fixture of our economy.