Reviews | Inflation remains a problem for Democrats


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On Wednesday, President Biden rightly celebrated the news that July’s inflation rate had fallen from previous months. But the underlying data suggests it could just be the calm before the next economic storm.

July’s rate was so encouraging largely because of energy prices, which fell 4.6%. That included a 7.7% drop in gasoline prices, which have continued to fall since July. That means there could be more good news in next month’s report.

But that masks the underlying problem. The average price of gasoline has fallen nearly a dollar a gallon since its peak in mid-June, but is now only at March levels. At just over $4 a gallon, gas is still almost 30% more expensive than it was in June 2021. The sudden and massive price rise, not the recent drop, is more likely to weigh on people’s minds as they assess how things are going.

More importantly, prices continued to rise in virtually every other major economic sector. Food prices are a particularly problematic area for Biden. They rose 1.1% last month, 11% more than a year ago. Inflation was even higher for dairy products (up 1.7% last month) and grain products (up 1.8%). In other words, groceries become more expensive each time Americans visit the grocery store. This ubiquitous fact highlights the importance of inflation for every consumer.

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House prices are the most worrisome indicator of stubbornly high future inflation. They rose 0.5% in July, almost unchanged from the previous month. This puts house prices 5.7% higher than last year and shows that demand continues to outstrip supply for this essential sector. Housing makes up one third of the entire consumer price index. If housing continues to rise at an annual rate of nearly 6%, the rest of the index is unlikely to fall below this level for long periods.

All of this means that the Federal Reserve will continue to be hawkish on inflation for the foreseeable future. Its discount rate is still only 2.5%, well below inflation. And with the latest unemployment report still showing a strong job market, there is no indication that recent Fed tightening has slowed the economy. It is therefore likely that the Fed will continue its trend of increasing the discount rate by jumps of 0.75%.

Biden is surely hoping that the Fed can engineer a so-called soft landing, a reduction in inflation without triggering a significant recession. But that’s increasingly unlikely. Americans are spending their record pandemic-era savings, but there are still trillions of dollars in the bank. This allows them to continue spending even though they complain about rising prices, which keeps economic activity high.

It will take them a few more months to dip into their bank balances before they have to start cutting spending. This could coincide with high interest rates, producing a double whammy for the economy. The likely outcome: an end to the booming labor market in early 2023 and further declines in gross domestic product.

No desire will make these facts disappear. Our current inflation is a direct consequence of our response to the pandemic. We have flooded the economy with money through multiple aid programs and reduced the supply of services that constitute the bulk of our economic activity. This created an accumulation of savings, and when supply constraints were lifted as the pandemic subsided, the money had to go somewhere. We will not return to pre-pandemic inflation and growth rates until the balance between the supply of money and the supply of goods and services is restored.

This will likely translate to much higher interest rates than we’ve had for over a decade. The historical relationship between the Fed’s discount rate and inflation was clear before the financial crash of 2008. The Fed typically held its rate above the rate of inflation before, providing savers with a low real rate of return but positive. The Fed chose to break away from that to fight the crash, pushing its discount rate below inflation and keeping it there until 2019. Truly fighting inflation means going back to the old practice. Interest rates need to be high enough to keep a significant chunk of those pandemic-era savings in the bank.

The best solution for Biden would be to get on the level of the American people and tell them the truth: we will fight the effects of the pandemic on the economy for years to come. But his penchant for quick fixes and calming harmony means he probably won’t. Instead, it will promise quick and relatively painless returns to normal that won’t happen. The last American president who tried this approach in an economic crisis was Herbert Hoover.

Inflation does not disappear until its underlying causes disappear. It’s not going to happen quickly, no matter what happy conversations are coming out of the Oval Office.

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