The Race to Tame Inflation
Government spending won’t calm inflation – curing supply chain imbalances with employment growth to expand domestic capacity will.
The pandemic recession produced a steep economic decline. Enter John Maynard Keynes, who advocated fiscal stimulus during periods of economic contraction to lessen its severity and duration. The 2020 fiscal stimulus worked. A sharp V-shaped recovery resulted, with the U.S. economy experiencing unprecedented, Asian Pacific Rim GDP growth.
The U.S. economy then growing at two to three times its natural rate was unprepared to support such rapid expansion. The W. Edwards Deming logistics philosophy of just-in-time inventory management was not ready to serve this post-pandemic demand. Moreover, stimulating an economy during this period of expansion produced inflationary pressure. Thus, the early 2021 $2.8 trillion stimuli ushered in this new era of inflation with too many dollars chasing too few goods. Irresponsible congressional action now requires remedy.
The Federal Reserve has a dual mandate to grow the economy but not too fast. Capacity utilization is the one innocuous statistic that captures both. Prior to the Great Recession, capacity utilization and the prime rate tracked in unison. Monetary policy, however, remained accommodative following the Great Recession, lagging changes in capacity utilization. Housing and stock market asset appreciation followed the Federal Reserve’s accommodative monetary policy and the current goods inflation now being experienced are a result of the early 2021 congressional fiscal stimuli. The Fed is trying to recapture time lost. As Milton Freedman recognized, changing interest rates changes demand.
Inflation has a rippling effect. It’s devastating impact on real wages cascades upon the entire economy. Real wages, when adjusted for inflation, are in decline and this reduction in purchasing power is historic. To sustain hefty cost-of-living increases, consumers are required to dip into savings to supplement the effect of real wage declines, depleting savings. These pressing economic circumstances have erased a decade and a half of accumulated savings when examining the personal savings rate. In response to both declining real wages and drawn down savings, consumers have become credit dependent to finance spending.
The economic hardship of inflation is illustrated by its components, with necessity spending on housing, food and transportation responsible for nearly three quarters of the consumer price index market basket. While discretionary spending has yet to be crowded out, the economy weighs in its balance as 68% of GDP is sourced from a consumer’s appetite to spend. The uneasy effect of taming inflation requires consumers to withstand this inflation price shock.
Consumers have been resilient to date, and the resulting disparity among supply and demand has had a telling effect on GDP. The draw down in inventory has shaped the decline in GDP, as production cannot keep up with demand.
Creating comparative wealth by adding an additional wage earner to a household is an economic necessity to insulate the impact of inflation. Confronted by less buying power, inflation has encouraged the workforce idled by the pandemic to seek employment opportunities. The result was an employment surge in July with continued strength exhibited in the August report. More government spending will not have a calming effect on inflation. Curing supply chain imbalances with employment growth to expand domestic capacity will.
Credit unions plays a consequential role in creating commerce by providing the capital support allowing businesses to expand and create jobs, and by delivering loans to consumers to improve their quality of life. Communities prosper when individuals do and individuals prosper when local businesses have the confidence to invest in expansion.
Tom Long is the principal at The Long Group LLC in Merrimack, N.H.