A favorite argument of those who support fair trade—as opposed to free trade—is that Americans won’t mind paying higher consumer prices due to tariffs because it will help create more jobs.
It’s an open question whether this trade-off is even possible, let alone worth it. But for those who insist that it is, the recent Consumer Price Index (CPI) surge provides a stark lesson: Americans do not like paying higher prices.
Hopefully, the Fed will not let this fact force them into making a major policy blunder.
The recent CPI increases basically bring the overall inflation rate back to the pre-pandemic trend. The surges follow comparable decreases during the earliest months of the pandemic. But even after they pay lower prices for a few months, Americans do not like to pay higher prices.
It also hasn’t mattered much that the recent jump in the CPI follows major supply-chain disruptions caused by the COVID-19 pandemic. Those paying more for gasoline and food seem more interested in finding bargains than listening to detailed explanations of why the CPI rose so much during the last few months.
That attitude is perfectly understandable, but the fact remains that price increases in just a handful of consumer goods categories—mainly due to pandemic-related shortages and disruptions—explain most of the recent CPI surge.
Still, Americans really don’t like paying higher prices, which is why Fed Chair Jerome Powell is under heavy fire for overseeing higher-than-expected inflation. (The inflation surprise looks even worse, of course, because it closely follows the Fed’s decision to implement a new “flexible average inflation targeting” framework.)
According to The Wall Street Journal, some Fed officials now worry “that high inflation will persist, requiring the central bank to consider raising interest rates sooner or more aggressively than they had anticipated.” Such a step would, most likely, be particularly harmful.
As this recent Backgrounder points out, the Fed is in a predicament common to inflation-targeting central banks: When an economy is hit with damaging supply shocks, sticking to an inflation target requires the central bank to intervene in a counterproductive way.
In the current situation, pandemic-related supply shocks have led to higher prices with fewer goods and services in the economy. If the Fed were to respond by shrinking the money supply (tightening), it would starve the economy even further.
In other words, the Fed would provide even less money to purchase even scarcer items, thus making it more difficult for people to buy the goods and services they need. All for the sake of hitting an inflation target.
The Fed should not tighten its policy stance for the sake of hitting an inflation target until the economy has recovered—the Fed should only shrink the money supply to correspond to a decrease in the demand for money. One way to accomplish this goal would be to target total nominal spending, but it is highly unlikely that the Fed could—or would—switch to such a framework in time to get out of its current pickle.
None of these arguments should be taken as an endorsement of higher inflation.
To the contrary, as this Backgrounder argues, Congress should refrain from passing more deficit-financed spending bills. The unexpectedly high inflation from the last few months is on the heels of several large deficit spending bills, only adding to Americans’ inflation fears.
Even Larry Summers, an advisor to both the Clinton and Obama Administrations, believes that the last relief package ($1.9 trillion) was too large relative to the economic shortfall. He warned that a spending plan so large could “set off inflationary pressures of a kind we have not seen in a generation, with consequences for the value of the dollar and financial stability.”
Now Congress is contemplating another $4.5 trillion in deficit spending, with $1 trillion disguised as infrastructure and $3.5 trillion as a more generic spending package. There is no lack of consumer demand or job opportunities, so additional deficit spending—even if marketed as an infrastructure bill—will most likely lead to even more upward pressure on prices.
Countless government regulations—only a fraction of which are listed here—already drive up consumer prices, including those for food and energy. These artificially higher prices hurt consumers even during normal times, when people are not struggling to deal with a pandemic.
If Congress wants to help Americans, now is the time to start eliminating these government-imposed economic roadblocks. They put upward pressure on prices—and if it isn’t clear already, Americans really don’t like paying higher prices.
This piece originally appeared in Forbes https://www.forbes.com/sites/norbertmichel/2021/08/26/a-blunder-by-the-fed--or-congress--could-drive-consumer-prices-still-higher/?sh=46912eee68da