The Federal Reserve has raised interest rates five times this year, essentially doubling them. His rationale is that higher rates will dampen inflation by reducing demand, especially in interest-rate-sensitive sectors like home and car purchases. The newly elected Republican House majority will try to further reduce demand by pushing hard to “cut spending.” A recession caused by these policies will serve Republican political goals, and they know it.
The Fed and the economists and pundits in favor of these policies, if we take their economic rationale at face value, are looking through the wrong end of the telescope. The causes of the current inflation are not public and private spending. These are supply shocks in crucial sectors, mainly energy. These post-Covid disruptions are caused by the OPEC oil cartel, the war in Ukraine, and Russia’s efforts to use energy to force members of the European Union to stay on the sidelines of this war.
Global energy supply cuts and the world’s vulnerability to OPEC decisions will not be solved by higher rates or spending cuts. They will not return energy products – gasoline for cars and trucks, natural gas for home heating, power generation and industry, diesel for trucks and heavy equipment, fertilizers, fuel oil, propane – more available at lower prices. Worse still, high energy prices are increasing the cost of almost every good and service Americans buy.
Energy price-driven inflation is not new. The OPEC cartel cut oil production in the 1970s and was a major cause of the very high inflation of that decade. Are Federal Reserve members and deficit hawks really serious when they say the way to fix these energy supply problems is to raise interest rates and reduce demand for energy commodities?
Supply problems are also leading to price increases for non-energy products. Raising interest rates and cutting spending will not reduce inflation for dairy, milk, cheese, butter and ice cream. The price increases for these products are the result of a reduction in dairy herds during the pandemic that will take time to reverse. The prices of wheat products and animal feed have been affected by drought and floods on several continents, and of course by the oil cartel and the war in Ukraine. How will higher rates and spending cuts encourage farmers to replenish egg, chicken and turkey production reduced by bird flu this year?
Shortages of certain types of computer chips and other high-tech parts for our rapidly changing economy raise the same question. Will higher rates and spending cuts increase or decrease investment in high-tech areas? What about our antiquated transportation infrastructure, power generation facilities, and power grid? President Biden is channeling government money into efforts to increase production and investment in these sectors. A recession orchestrated by the Fed and Republicans in Congress will reduce private sector investment in these sectors, especially by smaller, credit-dependent players. It will not increase the supply.
There are other areas where domestic pricing is causing inflation. Solutions in these areas will require tough political decisions, not higher interest rates and spending cuts. Health care costs in the United States are rising every year and cost at least a third more than in Europe and Canada. Health care is dominated by local provider monopolies, expensive and medically unnecessary insurance and payment arrangements. Everyone knows that health care in the United States is a nightmare of costly red tape, but the politics of attacking these comfortable price-fixing deals is daunting.
Executive compensation is another area where the solution lies. Again, everyone knows that. Executives are stacking their boards and increasing their own pay and benefits while complaining about high labor costs. The Fed’s broad monetarist approach serves to deflect public attention from the outrageous abuses of these price setters on corporate boards.
The solution would be corporate governance reforms to stamp out inflationary personal dealings, but Republicans don’t want the government to force corporations to play cards. This is why they focus on interest rates and government spending as the causes of inflation. It distracts the public from pointing the finger at well-heeled, well-sworn culprits. Suffice it to say that early in our history, corporations were given extraordinary powers by government to achieve public goals, not just to enrich their boards and shareholders.
College tuition is another area where inflation is skyrocketing due to gold plating of facilities and huge paydays. College executives get million-dollar contracts. Higher interest rates and spending cuts will do little to reduce these ever-increasing costs. This will require political action.
President Gerald Ford held the Whip Inflation Now (WIN) conference in November 1974. The professors and business titans Ford assembled all told him that he should risk a recession by raising interest rates and by cutting public spending, exactly what conventional wisdom says today. A notable exception was Professor Otto Eckstein of Harvard, who had served on President Lyndon Johnson’s Council of Economic Advisers (1964-1966) and founded Data Resource Inc., a famous economic consulting firm. Eckstein told the conference that the government should fight inflation by opening up industries where government-sanctioned price-fixing deals drove up prices. By the mid-1980s, Presidents Ford, Carter and Reagan had opened many of these sectors to increased competition – oil, natural gas and electricity, automotive and related manufacturing, trucking, railroads, airlines, telecommunications, finance and same retail. As a result, inflation was not a serious problem for the next 35 years, until the OPEC cartel regained power.
The United States should follow Eckstein’s approach to dealing with inflation today by tackling price fixing and investing in alternative energy that will gradually free us from OPEC’s dominance. More private and public investment is needed in specific areas where inflation is a persistent problem and better public oversight of price-fixing agreements that have driven prices up. This is essentially what President Biden’s anti-inflationary infrastructure and policies are aimed at, but the Fed’s monetarist policies undermine sensible thinking about ways to increase supply.
We need to look through the right end of the telescope and focus on ways to increase supply, not pretend that inflation is a problem of overconsumption that can be solved by causing a recession.
Paul A. London, Ph.D., was senior policy adviser and assistant assistant secretary of commerce for economics and statistics in the 1990s, deputy assistant administrator at the Federal Energy Administration and Energy Department, and visiting scholar at the American Enterprise Institute. . Legislative aide to Sen. Walter Mondale (D-Minn.) in the 1970s, he served as a foreign service officer in Paris and Vietnam and is the author of two books, including “The Competition Solution: The Bipartisan Secret Behind American Prosperity ” (2005).
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