Raise Taxes, Later
Inflation is a serious problem for the first time in decades. Starting in the late 1960s, the rate of inflation began increasing; 1965’s 1.6 percent rose to a peak of 14.8 percent in 1980. Paul Volcker, then chair of the Federal Reserve, reversed that trajectory in the early ’80s by driving interest rates into the high teens. He created what was then the deepest recession since the 1930s. Unemployment spiked, unions were busted, social spending was cut, and by 1986, inflation was back below 2 percent. The working class, restive throughout the ’70s, was rendered passive and scared. But inflation stayed low, averaging under 2.7 percent from 1983 through 2020 (when it was just 1.2 percent).
That changed earlier this year. In the latest reading for the 12 months ending in October 2021, the consumer price index (CPI) was up 6.2 percent. That’s not unprecedented in the post-Volcker era. There were similar inflation spikes in 1990 and 2008, but they burned off quickly. This one may also burn off, but it may not.
The Democrats’ reaction to this price scare has often been evasive, dismissing it as not real or as unimportant or “transitory.” That’s wrong on both facts and politics. It is real, it’s important for as long as it lasts, and only a soothsayer knows if it’s transient. More recently, they’ve blamed corporate greed, which has been with us forever, and high profits, which have been with us for decades. Many progressive economists argue that inflation is confined to a few product lines: goods (rather than services) and energy, led by gasoline—whose price has more than doubled over the year. A problem with this argument is that price indexes put out by the Federal Reserve Banks of Cleveland and New York that remove extreme price changes to isolate underlying trends are rising as well. The outliers are driving the headlines, but other prices are going up too.
The standard remedy—raising interest rates and provoking a recession—would be disastrous in an economy still recovering from the Covid shock. But we can’t deny that huge deficit spending and an infusion of trillions of dollars conjured out of nothing has something to do with the problem. The deficit spending financed a remarkably generous, though too temporary, aid package. It boosted household incomes despite sudden and massive job loss in the early months of the pandemic. That aid is still keeping millions of households afloat and has left many others with unusually large savings balances.
It would be a crime to take those benefits away, but an immense amount of purchasing power was introduced into an economy that was stretched to the limit, with workers in some areas hard to find, taut global supply chains vulnerable to interruption (a lesson for labor militants!), a preference for keeping only the thinnest possible stock of inventories, and a public infrastructure ragged from decades of underinvestment.
Since the beginning of 2020, the Fed has injected $4.5 trillion into the financial system, mainly by buying Treasury bonds with money created out of thin air. These infusions helped lubricate the financial system in the early days of the crisis, but did little or nothing to stimulate the real economy. Instead, they’ve fueled another kind of inflation: asset inflation. We’re living through one of the great bubbles of all time. Most earlier bubbles centered on one thing: in the 1920s and ’90s, stocks; in the early 2000s, houses. This one is operating on multiple fronts: stocks, start-ups (first “unicorns,” now “decacorns”), cryptocurrencies, NFTs, and collectibles, ranging from art to sneakers. Houses, one of life’s essentials, are being priced out of reach because of a speculative mania. These things never end well.
The stimulus spending is mostly gone; people are running down their bank accounts. That will reduce demand and probably make holdouts more willing to take a job. (Their numbers are greatly exaggerated, but they do exist.) That should ease inflationary pressures. The supply chain will eventually get its act together.
But the longer-term ambitions of the early Joe Biden era—really building back better—come with economic risks. The support payments in the Covid relief bills are models for some of the redistributionist social spending that we’d like to see made permanent, but unless the spending is paid for by taxes on people who have money to spare rather than by borrowing, it will have strong inflationary potential. There’s a belief on the left that you can fund a social democratic program just by taxing the rich, but there’s simply not enough money up there to do it. Plus we want to tax the billionaire class out of existence, which means they can’t serve as ATMs in perpetuity. Greening the energy supply could be inflationary as well. If the production of fossil fuels is limited, prices will rise until new sources come online in serious quantity. It’s going to take some deft politicking to work through all this, and it’s not clear that Biden has the skills, or the will, to do it.
Most of the recent increase in the inflation rate—both in the United States and abroad—is not due to an overheating economy or too much stimulus; it’s the result of supply and demand factors that are linked to the pandemic. With people understandably hesitant to return to many in-person services, consumers have shifted their spending toward goods—like cars, home furniture, TVs, and camping gear—at the same time that many industries are experiencing supply constraints and bottlenecks.
Covid-19 has played a role in nearly every dramatic price increase in the past year. I believe that this inflation will subside once people and our public infrastructure have adapted to the changes brought about by the pandemic. We must, of course, keep working toward vaccinating as many people as possible and implementing other public health measures so that people will want to return to services. As of November, consumer spending on services remains well below pre-pandemic levels, while spending on goods is well above them. These dynamics are taking place in an economy whose GDP is still significantly lower than we’d expect without a pandemic. Therefore, as people shift their spending back to more services, spending on goods will decrease and relieve the stress on supply chains, which will stabilize prices. The United States must also be a leader of and a major contributor to the international pandemic response, so that the global economy can operate with less disruption.
But while public health initiatives and infrastructure investments are critical, Democrats should also experiment with new policy responses—especially in categories that account for a large portion of the average household budget, like housing, energy, food, and medical costs.
Over the past 40 years, our government has primarily used one policy tool to combat inflation: raising interest rates to slow down the economy. But given the current supply chain disruptions and the ongoing public health crisis, that response would only make the situation worse. What we are experiencing is the result not of too much overall demand but of supply-side issues coupled with a shift in demand. For example, a semiconductor shortage has led to the production of fewer cars just as more Americans are looking to buy. Raising interest rates would raise the cost of borrowing and discourage investment by automobile manufacturers—investment that is necessary to expand the production of and access to semiconductor chips. Rather than compare the headline inflation rate with the Federal Reserve’s target rate of 2 percent, we need to consider the sector-specific factors. If Democrats do that, they will find that there are many solutions to rising prices.
Democrats in Congress are working to pass the Build Back Better Act, which would combat inflation in some of these sectors over the long term—from public investment in affordable housing to transitioning our energy supply to more diverse and renewable sources. And if inflation weren’t being weaponized by Republicans and cited as a cause of President Biden’s dwindling approval ratings, Democrats wouldn’t need to do much about it in the short term. Still, at the local, state, and federal levels, there are ways governments can immediately address inflation that are also just good policy. For example, housing is one of the largest components of the average household budget. While passage of the Build Back Better Act would unleash a historic public investment in new housing, this policy solution would take some time to affect prices. But municipalities, states, and the federal government can implement rent stabilization policies right now to bring down housing costs. In 2019, Oregon and California were the first states to adopt policies that regulate the amount by which rent can increase each year. More than 180 municipalities already have some form of rent stabilization policy. Democratic officeholders throughout the country could implement similar measures and launch public education campaigns to help their constituents take advantage of them.
Energy costs have also been one of the largest contributors to inflation over the past five months. While the recent price increases in this sector are largely related to pandemic disruptions, controlling energy prices is challenging because they are inherently volatile and influenced by geopolitics and the financial sector. Transitioning away from fossil fuels will offer some long-term solutions to this price variability. But in the short term, Democrats can demand more transparency and oversight. They can also expand the eligibility for and the coverage of programs like the Low Income Home Energy Assistance Program (LIHEAP) and invest more in the campaigns that inform the public about these lesser-known programs.
Being proactive about addressing the major expenses households face every month, and continuing to address the pandemic that has caused or exacerbated rises in those costs, can be a unifying policy agenda for Democrats—one that uses every level of government to demonstrate that Democrats are committed to improving the quality of life for all.