Why do the smartest people in the world (at least in their own minds) keep getting surprised? This past week, the most common measure of inflation rose, even though official Washington (the Fed, Biden Treasury, White House) told us it would fall. Inflation is often defined in the press as too much money chasing too few goods. So, the solution seems simple — reduce the supply of money, increase the supply of goods and services, or both.

The Federal Reserve (the U.S. central bank), in theory, controls the supply of money — and thus, it gets blamed for inflation. Those who run the Fed, however, have several problems, including the definition of money they are trying to manage (usually M2, which includes cash, checking deposits, and noncash assets that can easily be converted into cash). Changes in the supply of M2 can take a long and variable time to show up as a change in the inflation rate — and even then, they are not perfectly correlated. There are exogenous shocks to the economic system that can cause quick shifts in relative prices that are often confused with inflation (a general rise in the price level), which is not the same as a rise in particular prices.

In 2019, the U.S. economy was humming with reasonable growth, full employment, rising real incomes, and inflation under 2%. When the pandemic hit in 2020, the U.S. and most other countries shut down their economies to a greater or lesser degree. Policymakers realized incomes would fall. Their solution was for the government to give individuals and businesses “free money” — unrelated to producing anything. So, again, the supply of money was increased without a corresponding increase in production, causing much higher inflation. Note: The U.S. Treasury sent out the checks it funded by selling bonds — primarily to the Fed — and the Fed “printed” the money to pay for the bonds. (The previous sentence was a shorthand for a complex process.) The Biden administration and the Fed were surprised when inflation soared to 9%, but rather than reduce government spending, they increased it (adding fuel to the inflation fire). The result of the wrongheaded policy is that inflation is now running at rates above the increase in wages — meaning that many people are suffering a real fall in their standard of living despite having a job.

One of the most rapidly growing areas of employment is in government jobs. For the most part, these jobs do not produce more and better real goods and services, but in fact, are of negative value. First responders and schoolteachers who teach basic skills are some of the most important and productive people in society. But the legions of government bureaucrats who impede productive activity through counterproductive paperwork and regulation are a true cancer on the economy.

At the moment, sanctuary cities such as New York are providing housing, health care, education, crime protection, food, and other benefits to large numbers of illegal aliens who are not producing needed or desired goods and services. These payments are being funded by productive taxpayers and by government bond issues. Again, the government is indirectly increasing the money supply to cover the costs of people who are not adding to national wealth but are a drain on it — which shows up in the form of inflation.

Next to reducing government spending, perhaps nothing can reduce real economic costs for society; hence, pressure on the Fed to create excess money instead of making energy production less costly — given that energy is a component of almost everything.

Green energy is all the rage with the Biden administration, but it often makes no economic sense. Proponents of wind and solar energy often argue that those sources are cheaper than fossil fuels. Typically, they leave out the amount of downtime when the sun is not shining, or the wind is not blowing at useful speeds — not too fast or too slow. They often also leave out the capital and maintenance costs of wind and solar power.

Rational people who are truly interested in minimizing energy costs are looking at new technology, nuclear units and geothermal, which are not dependent on the weather and can run for decades, with extremely low marginal costs. Natural gas also has a low carbon imprint, coupled with low capital costs and proven non-weather-dependent technology. The administration should allow markets rather than government bureaucrats — driven by often irrational ideologies — to determine the most cost-effective sources of energy.

At this point, the administration has little choice if it wants to reduce inflation. It should greatly reduce government spending and size by applying a serious cost-benefit analysis to every government activity. But Washington seems unable to gather the political will to do what should be easy things, like stopping transfer payments to those who are not U.S. citizens or legal residents.

• Richard W. Rahn is chairman of the Institute for Global Economic Growth and MCon LLC.


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