More to this than Putin’s price hike

Is an expression of optimism about the current economy, “peak inflation” has had a far shorter shelf life than “transitory.” May’s headline inflation number of 8.6 percent put an end to hopes that surging prices had peaked with March’s 8.5 percent (in April, the year-on-year increase had declined to 8.3 percent). There is little in the immediate future to suggest that things will cool down any time soon. 

There is more to this than Putin’s price hike. The price of oil and of various foodstuffs, such as wheat, was increasing long before the war was on the horizon. To be sure, even these increases had only a limited connection to U.S. policy (thus unfavorable weather conditions made a significant contribution to the run-up in the wheat price). While those price increases are problems in their own right, they are still only relative prices and do not on their own represent a general increase in the price level. Much of our current inflation is homemade — by the Fed and, to a lesser extent, by reckless fiscal policy — and is now showing worrying signs of becoming entrenched. Thus shelter, which makes up about one-third of the CPI and is a lagging indicator, is now reflecting soaring rents and house prices.

Meanwhile, expectations of inflation are on a firm upward trajectory. In the markers, earlier hesitation about crossing the 3 percent barrier for ten-year Treasury Notes has now been consigned to the past. The public, not oblivious to the assault on its pocketbook, is also paying attention. The University of Michigan’s consumer sentiment survey showed a jump in inflation expectations for five years hence from 3 percent to 3.3 percent. Nominal wage rates are rising sharply (in real terms, it’s a different matter).

So, what should be done? The Fed, rightly criticized for having been too complacent for too long, is widely forecast to bump up rates by 50 basis points this week. A 75-basis-points hike, a move that some in the markets are beginning to price in, would be better and should be reinforced by a clear message that wait and see is not going to be an option any time soon. The Fed’s credibility is a critical element in the fight against inflation, and, when it comes to that, Chairman Powell has some work to do. Taking a tough (or, more accurately, less accommodative: rates would still be negative in real terms) line might dent already battered markets, but it ought to take some of the heat out of the economy. At this point, the Fed’s concern for the markets’ welfare should be focused exclusively on ensuring that they continue to function smoothly.

So far as the administration and legislators are concerned, our best advice for now is, as so often, not to make matters any worse than they already are. Raising tax rates on “the rich” will do nothing to put out the inflationary fire. Hiking corporate taxes would discourage investment in new productive capacity, a perverse move at a time of mismatched supply and demand. Witch hunts in pursuit of alleged price gouging are as destructive as they are absurd. And now is the worst possible time (there is no good time) to switch the focus of antitrust enforcement away from the goal of consumer welfare and towards an ideological crusade against some of America’s most efficient companies. Yet another assault on the supply side — the increase in the regulatory burden imposed on corporations since Joe Biden took office — should be halted (and, ideally, put into reverse).

The president is neither responsible for the Ukraine war’s effect on the oil price nor for the decision by many oil and gas companies to cut back on investment in new production after the shale glut earlier last decade. Nevertheless, the hostility that the Biden administration has shown towards fossil fuels won’t encourage investment in that sector. Increased oil and gas production here in the U.S. will benefit national security and the American consumer. Persuading fossil-fuel companies that this administration is one that they can trust will be an uphill struggle, but there will be no better way to ensure that such efforts will fail than a windfall tax.

Finally, the administration should demonstrate that it is determined to set this country back on the course of living within its means and that its intent is that this should be achieved by discipline on the spending side rather than higher taxation. This is a course correction that will take time, even in the unlikely event that the Democrats wish to make it. However, in the spirit of not making things even worse than they already are, plans to revive Build Back Better or, for that matter, to embark on an expanded student-loan-forgiveness program should be scrapped. Pressing forward with either will only reinforce Americans’ perception that Washington is not serious about inflation, further increasing the risk that this bout of inflation will feed upon itself.

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