Inflation Ignites: Best-Case, Worse-Case Scenarios and Policy

By SBE Council at 12 May, 2021, 9:40 am

by RAYMOND J. KEATING –

One of the deeply troubling aspects of inflation is that once ignited, it is not something that is easy to get back under control.

As the old saying goes, once the inflation genie is let out of the bottle, it’s not easy to get back in. That’s one reason why policymakers need to be constantly vigilant to stomp out early indicators that inflation might be heating up.

All of this, and more, must be kept in mind when looking at the latest Consumer Price Index report from the U.S. Bureau of Labor Statistics.

The Consumer Price Index leaped by 0.8 percent in April, and that came after a 0.6 percent increase in March and 0.4 percent in February. So, if we annualize these last three months, inflation is running at better than 7 percent.

Source: Federal Reserve Bank of St. Louis

The best case scenario on this recent trend is that inflation is temporary, as the recovering economy struggles to get production, operations, supply chains and employees back to something close to normal after the dramatic fall off in output and employment due to the pandemic and related shutdowns. The market will adjust, responding to price signals, and growth will advance while inflation calms down.

However, policymakers should not be working under best-case, all-will-be-well assumptions. Instead, they need to be thinking in worst-case-scenario terms.

And it must be understood that fighting inflation does not mean fighting economic growth. Quite the contrary, economic growth works against inflation. After all, if inflation is about “too much money chasing too few goods,” then producing more goods is anti-inflationary.

In fact, the reality about the dramatic decline in inflation in the 1980s was that it was just as much about pro-growth tax, regulatory and trade policies established under the leadership of President Reagan as it was about then-Federal Reserve Chairman Paul Volker tightening monetary policy.

Unfortunately, on the fiscal and monetary fronts, policymakers are pushing policies in the exact wrong direction.

First, as noted in the following chart tracking the monetary base (currency in circulation plus bank reserves), the Federal Reserve has been running historically loose monetary policy since the late summer of 2008 – that is, for nearly 13 years now – and that serves as high-octane fertilizer for inflation to spread wildly.

Source: Federal Reserve Bank of St. Louis

Second, the Biden administration is aggressively pushing an anti-economic-growth agenda of hefty tax increases, increased regulation, radical increases in government spending, and failing to get the U.S. back to advancing free trade.

This combination is a recipe for an economic mess – for an eventual stagflation scenario.

Let’s be perfectly clear. The Fed should be working to rein in loose money, as it had started to do from roughly November 2017 to September 2019. And Congress and the White House should be working together to move tax, regulatory and trade policies in a pro-growth direction.

That means substantive and permanent tax and regulatory relief, and working to reduce governmental barriers to trade. This growth agenda will support and advance economic recovery and expansion, while working against inflation.

Let’s hope that the current inflation fires are temporary. But hoping for the best is not serious policymaking. Being serious about policies affecting our economy means jettisoning foolish assumptions and politics, and getting focused on establishing the best policy foundation upon which entrepreneurship and private investment can flourish.

Raymond J. Keating is chief economist for the Small Business & Entrepreneurship Council.