ViewPoint | A case for a mixed-method fix to the US economy
Anyone entering the labor market or buying cars or property this year or next will be highly affected by inflation policies.
Throughout history, sometimes the Federal Reserve, or "Fed," has altered the federal funds rate in the same direction, up or down, over lengthy eras. The Fed has also often left interest rates constant.
An example of the first was raising them from approximately 1977-1980, or cutting them from 1968-1971. An example of the second was over the Great Recession (2010-2015) - which held near 0%. Predictability gives firms expectations, causing smoother shifts in supply and demand without smaller iterations.
However, keeping rates lengthily at the same level can lead to financial instability, from: "chasing higher yield;" savings and investments imbalances; or, from larger policy changes once “shocks” arise. With the pandemic “shock,” political-economic turbulence might still be ahead, and more inflation. The 1920’s economist Irving Fisher described inflation as butter (money) spreading too far over bread (goods).
Inflation today has several culprits: monetary policies of central banks; international conflict; fiscal policies of spending bountiful government money, much of it deficit-financed; labor shortages from workers fearing the virus; and online-bought goods causing trouble coordinating ships or truck entries into ports.
The Fed, while independent, must still align itself with President Biden’s policies, which called for two infrastructure bills. With the larger bill, even moderates have to compromise, and the newly-convoluted idea that lawmakers do not have to reveal their stances makes politics more dyspeptic.
The wealth tax (on unrealized capital gains) to pay for the bill may have been unconstitutional or could have shifted investments overseas. But, raising the top income bracket was rejected, and raising the payroll tax on upper-earners was not even considered. Spending proposals, such as “free” community college, or even scholarships, or my own proposed idea for an ice-breaker vessel for the Arctic’s infrastructure, were rejected ad-hoc in behind-the-scenes negotiations. Hyper-politicized parliamentary rules took precedent over actually voting on amendments.
Undernoted in this debate, and absent from modern economic texts, is the 1960’s "balanced budget theorem," promulgated by economist Paul Samuelson. Increasing taxes and spending by similar amounts can theoretically increase short-term growth, though never attempted, but permitting an inflation focus. Yet, bills sometimes die, and Mr. Biden has not even addressed healthcare yet.
Fortunately, last year’s annual end-of-year budget crises were averted. Perhaps the Republicans saw no need to add “insult to injury,” since inflation hit. As Fisher described, perhaps butter melts faster than bread expands, in our analogy, because money is more liquid than goods, which take time to produce.
Henceforth, Mr. Powell may have lowered rates too slowly before, too quickly during, and to be seen too delayed after the pandemic. Some economists have said these were the Fed’s worst historical mistakes.
With both inflation and held-back pandemic growth presenting challenges, it might benefit the Fed to follow a third course, of short-term changing rates incrementally, from meeting-to-meeting, or quarter-to-quarter, based on changing conditions "on the ground," as military leaders say. In essence, mix the ingredients differently. The Fed did so in the mid-1980s and mid-1990s. Instead of dubiously committing to raising rates indefinitely, it might be wise to keep an eye on growth, especially with the conflict overseas, as rate hikes could lead to recession- worse than the current climate.
The economy is now Mr. Biden’s, having re-nominated Mr. Powell for Chair, while nominating Lael Brainard for Vice-Chair, both now before the Senate amidst questions over Fed "insider trading," and whether the Fed should own environmentally-unfriendly assets.
Dr. Brainard could steer Mr. Powell within his newfound fixation on rate-raising. Once set, though, a mixed-method approach, as described here-to-fore, might prove most stabilizing, along with mixing policies between different tools. Also helpful for Fed policy, and for keeping rates low, would be if President Biden’s larger bill were to be revisited once growth slows, even if voted on in pieces. Parts, even those aimed at climate change, could stimulate the economy, especially if some revenues paid down debt.
A combination of all such approaches would ensure that the government gets the upcoming climate right and that the kids get their holiday baked goods just under a year from now, without a recession, but certainly with butter for everyone.
Dr. Todd J. Barry holds a PhD from the University of Southern Mississippi, and teaches economics, currently with Hudson County Community College in New Jersey, USA.
