Politics & Perspective
Taming Inflation:
What Policymakers Can – and Should – Do by DOUGLAS HOLTZ-EAKIN The shocking acceleration of inflation is the economic percentage point each quarter and ended 2021 at 4 percent. signature of 2021. In January, year-over-year Consumer Part of the U.S. experience is driven by supply chain issues, Price Index (CPI) inflation was 1.4 percent; by December it as well. had shot to 7.0 percent. Even more striking, prices for food, But the U.S. government added fuel to the fire, passing energy, and shelter – which constitutes over 50 percent of the $1.9 trillion, deficit-financed American Rescue Plan the typical family budget – had stimulus in March 2021. At the skyrocketed by 8.2 percent. time of its signing, the U.S. The 5.7 percentage point economy was growing at a red-hot 12-month jump in CPI inflation 6.5 percent; additional stimulus has been exceeded only twice in was neither needed nor desirable. the postwar era: In 1951, it jumped Inflation responded immediately as much as 10.6 percentage to the policy error, jumping from points, and in 1974, it rose 6.1 1.9 percent in the first quarter to percentage points. Both episodes 4.8 percent in the second quarter – are instructive. nearly three times the increase of The 1951 episode is Europe’s supply-driven inflation. a cautionary tale about The fiscal stimulus was reinforced overstimulating the economy. In by an aggressively accommodative this case, year-over-year growth monetary policy that featured zeroin gross domestic product entered percent interest rates and large, the year in double-digit territory continuous monetary infusions. and Korean War-related defense Inflation continued to rise as the production layered on yearyear went on. over-year growth in government Inflation is clearly a problem Douglas Holtz-Eakin spending that peaked at 49 percent in the present. Will it continue? in the third quarter. Lesson: To be durable, price inflation must Perhaps the best we can Excessive government spending be accompanied by wage inflation in a hot economy can quickly fuel hope from policymakers is and higher inflation expectations. inflation. that they stop adding to the Wage inflation has already arrived, In contrast, the 1974 episode as average hourly earnings rose 5 problem with massive new percent from December 2020 to demonstrates the exact opposite of demand stimulus. Instead, it December 2021. To compound spending bills, such as the features a huge supply cost shock matters, consumers’ expectations Build Back Better Act. – the quadrupling of oil prices due for inflation over the next year rose to the OPEC oil embargo. Lesson: from 3 percent to 6 percent during Cost increases borne by supply 2021. This raises the specter of problems can quickly be passed along to consumers, even if workers bargaining for higher wages as a hedge against the economy is moving toward recession. expected inflation. When those labor cost increases get The inflation of 2021 reflects a combination of these passed on to consumers, the expected inflation becomes a forces. The COVID-19 pandemic has wreaked havoc on self-fulfilling prophecy. labor markets worldwide, and the resulting disruptions What should policymakers do? in supply chains and goods production have been wellTo diagnose the roots of this inflation is to identify documented. These supply constraints increased costs the appropriate policy response. Ultimately, the supply and generated higher inflation across the globe. European chain issues boil down to the impact of the coronavirus. consumer price inflation, for example, increased about one This is best offset with a more effective public health 4
RIPON FORUM February 2022
