Lawrence Summers, who served as Bill Clinton’s Treasury secretary, rocked the Democratic establishment last year by predicting that his party’s excessive spending would cause inflation. He was right. But he’s wrong now. On June 20 he told Bloomberg that “we need five years of unemployment above 5% to contain inflation”—or perhaps one year of 10% unemployment. That would throw millions of Americans out of work.
Mr. Summers echoed the advice of his uncle, the Nobel economics laureate Paul Samuelson, who famously wrote in 1980, a time of double-digit inflation, that “five to ten years of austerity, in which the unemployment rate rises to an eight or nine percent average and real output inches upward at barely one or two percent per year, might accomplish a gradual taming of U.S. inflation.”
Walter Heller, chairman of the Council of Economic Advisers under Presidents John F. Kennedy and Lyndon B. Johnson, similarly predicted that the 1981 Reagan tax cuts “would soon generate soaring deficits and roaring inflation.” He, too, was wrong. From Jan. 1, 1983, when the tax cuts took effect, to June 30, 1984, U.S. real gross domestic product grew at an average annual rate of 8%. Inflation collapsed.
Catalysts for inflation vary—excessive government spending, printing too much money, currency devaluations, specific and general shortages of goods and services. Once embedded in an economy they can create long-lasting inflation. The secret to curing inflation isn’t economic collapse and high unemployment but the opposite: pro-growth policies that create incentives for more goods, more employment, less government spending and sound money. As the economy produces more, prices go down.
Conversely, austerity means less goods produced and less employment. How does putting people out of work and reducing the supply of goods cause the prices of goods to fall?
History proves growth doesn’t cause inflation. In the 1920s, when the highest tax rate was cut from 73% to 25%, real GDP soared and the price level fell. In the 1960s, tax cuts and pro-growth policies led to an economic expansion, stable prices and budget surpluses.
The one mistake of the Reagan plan was to phase in tax cuts rather than implement them immediately. That contributed to the severe recession of 1982. Congress and President Trump avoided this pitfall in the Tax Cuts and Jobs Act of 2017, which avoided a downturn and kept inflation very low. Before COVID hit, we had the best of all worlds: the lowest unemployment rate in 50 years, 2% inflation and steady growth in real income for almost all Americans.
We don’t need austerity. An end to President Biden’s war on energy, permanent tax cuts, deregulation, less government spending and an immediate tightening of monetary policy by selling off some of the trillions of dollars of assets on the Federal Reserve balance sheet—that’s the formula for low inflation and low unemployment.
This piece originally appeared in The Wall Street Journal on 06/30/2022