Fight Inflation — Cut the Deficit

I said it after last month’s inflation report, and I’ll say it again: We’re stuck.

March’s 3.5 percent annual inflation rate means the consumer-price index has continued its streak of year-over-year inflation between 3 and 3.8 percent that has held since June 2023. That’s obviously better than the peak of 9 percent inflation from June 2022, but it’s still well above the Fed’s target of 2 percent annual inflation.

A big part of the reason for that decline was the drop in energy prices from the summer 2022 peak. That process is now complete, and energy is currently doing very little to influence the overall price index in either direction.

It remains true, as it has since March 2023, that core inflation — inflation of everything except food and energy — is higher than overall inflation. That means the parts of the economy that are supposed to be less volatile are seeing prices rise faster than if you include the more volatile categories of food and energy in the average.

As economist Marc Goldwein points out, “even if monthly inflation matches the Fed’s target for the rest of the year, CPI inflation will total 3% in 2024. At our current pace, we’ll have 4%-4.5% inflation.” That’s way too high, and the Fed knows that. Any talk of interest-rate cuts will have to wait if restoring 2 percent inflation is the goal.

Jerome Powell has repeatedly insisted that 2 percent remains the goal, and he is right to do so. The difference between 2 percent and 4 percent doesn’t sound like a lot, unless you consider that 4 percent is twice as high as 2 percent. Nobody should want inflation to be twice as high as its target.

The problem is the federal government ran a $2 trillion deficit last year, is set to run a similarly large deficit this year, and if Biden gets what he wants, it will run a $1.8 trillion deficit next year. These deficits are due to ever-increasing entitlement spending, spiraling interest costs, and a complete lack of fiscal responsibility from Washington. And never mind the fiscal cliff that’s coming in 2025. Inflating away the debt will become an increasingly attractive option to politicians who don’t want to make hard decisions to get spending under control.

As the Economist pointed out yesterday, the U.S. is hardly alone in running a large deficit, as many rich countries are spending more than they are taking in. (Somewhat amusingly, given their fiscal histories, Greece and Portugal are two of the only European countries with nearly balanced budgets.) But the magnitude of the U.S. deficit — about 7 percent of GDP — is “a level unheard of outside recession and wartime.” Imagine what the deficit would look like if (when) a recession or war (or both) happens.

Both major-party candidates are essentially promising to do nothing to reverse the bulging deficits. (And Biden wants to pile at least half a trillion dollars of student-loan “forgiveness” on top of the current deficit.) So the Federal Reserve will increasingly find itself under pressure from politicians to lower interest rates while simultaneously needing to keep interest rates higher because those same politicians keep deficit-spending and contributing to inflation.

In month-to-month reports, that inflation will likely show up in seemingly random places. This month, for example, prices related to cars are pulling up the average. In a few months, it could be energy again. Or maybe food. Any sector-specific efforts to fight inflation will be like a game of economic Whack-a-Mole. The problem is too much money chasing too few goods, and if you scare some of the money away from one category of goods, it will scurry to another category.

It would also be unusual for inflation to only spike once and then return all the way back to the long-run target. That seems to be the Fed’s goal, and it would be great if it happened, but in the past when inflation spiked, it spiked multiple times over several years or was followed by stagflation. The nearly 40 years of moderate, stable inflation from the 1980s through the 2010s seems to have erased the memory of how inflation usually behaves, or, more accurately, misbehaves.

Powell has staked his career, and the Fed’s reputation, on returning to the 2 percent long-run target. He has demonstrated admirable independence from politicians so far in his tenure. The most recent example was in standing up at an international conference of central bankers against the fashionable left-wing idea that central banks should fight climate change.

But the pressure on the Fed is going to increase as politicians look for scapegoats for their own fiscal irresponsibility. Unelected central bankers make pretty good scapegoats, from a politician’s perspective. And Powell’s term expires in 2026. Assuming he does not wish to continue (which is likely considering that he will be 73 years old, will have already served two terms as chairman, and isn’t likely to become friendlier with Biden or Trump in the next two years), the next president will appoint his replacement. That replacement might not be as committed to 2 percent inflation as Powell has been.

And Powell could cave between now and then, too. I wouldn’t consider it likely given his track record, but it’s not just politicians who want rate cuts. Wall Street does as well. The stock market enjoyed the near-zero interest rates of the 2010s and would love to have them back. Powell will have fewer and fewer friends in the fight to lower inflation if things keep going the way they are.

One really big thing that could help prevent these ugly situations is for the federal government to stop spending so much money that it doesn’t have. Powell finally started to warn about runaway spending in February, and the Economist story notes that other countries such as the U.K. and France have realized they need to make cuts. The U.S. needs to as well, unless it wants to make inflation even harder to eliminate than it has already proved to be.