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It’s the Spending, Stupid!

 

By S.T. Karnick, Heartland Institute

The latest reports on jobs and inflation send at best a mixed message about the state of the economy.

Inflation is starting to accelerate again. The Bureau of Labor Statistics (BLS) reported on Thursday that although inflation has slowed from its torrid pace of last year, prices remain high and the past few months’ trend toward lower inflation reversed in December:

The Consumer Price Index for All Urban Consumers (CPI-U) increased 0.3 percent in December on a seasonally adjusted basis, after rising 0.1 percent in November, the U.S. Bureau of Labor Statistics reported today. Over the last 12 months, the all items index increased 3.4 percent before seasonal adjustment.

Translated to full-year numbers, price inflation in December was nearly one and a half percentage points above the Fed’s target of 2 percent and headed in the wrong direction, the BLS reports:

The all items index rose 3.4 percent for the 12 months ending December, a larger increase than the 3.1-percent increase for the 12 months ending November. The all items less food and energy index rose 3.9 percent over the last 12 months, after rising 4.0 percent over the 12 months ending November. The energy index decreased 2.0 percent for the 12 months ending December, while the food index increased 2.7 percent over the last year.

Shelter and energy led the price increases, whereas food price inflation remained stable, per the BLS:

The index for shelter continued to rise in December, contributing over half of the monthly all items increase. The energy index rose 0.4 percent over the month as increases in the electricity index and the gasoline index more than offset a decrease in the natural gas index. The food index increased 0.2 percent in December, as it did in November. The index for food at home increased 0.1 percent over the month and the index for food away from home rose 0.3 percent.

Removing food and energy, which are characterized by price volatility and hence can make longer-term comparisons less accurate, inflation stayed stable in December:

The index for all items less food and energy rose 0.3 percent in December, the same monthly increase as in November. Indexes which increased in December include shelter, motor vehicle insurance, and medical care. The index for household furnishings and operations and the index for personal care were among those that decreased over the month.

What all of this means is that the Federal Reserve (Fed) has some tough choices ahead. Fed Chair Jerome Powell and the central bank’s governors clearly want to start bringing interest rates back down, to avert a recession that would provide a very big incentive for voters to reject President Joe Biden’s reelection bid (if Biden ends up being the Democrats’ nominee, which still seems likely). Lowering interest rates, however, could bring on another bout of inflation, the Fed’s governors fear.

The reality is that no one knows what the optimal interest rate is and hence what the Fed’s target should be. In addition, the most powerful influence on inflation—federal government spending—has continued to rise, which makes anything the Fed does even more dangerous: raising interest rates or keeping them at the present mark will reduce private sector investment and output, and thus bring on a recession, whereas lowering interest rates will fuel an acceleration of inflation as happened in 2021 and 2022.

The one thing that has kept the U.S. economy from collapsing into the deepening ravine between the Scylla and Charybdis of inflation and recession has been the House Republicans.

The GOP’s inability to agree on a budget deal with Biden and the Senate Democrats has slowed the increase in federal spending—slowed it, mind you, not stopped it by any means—and thus taken some of the inflationary pressure off the economy.

Unfortunately, what the economy needs from the federal government is not a stabilization of the massive ongoing budget deficits—currently at a brutal $2 trillion per year—but a rapid lowering of the deficit. The latter cannot be achieved by any means other than major spending reductions.

Spending cuts accompanied by tax rate cuts and a massive reduction of federal regulation of private-sector economic activity would be even better.

This combination of policies would reduce inflationary pressure in two ways. One, the spending cuts would directly reduce the effective demand for goods and services (that is to say, what people want and think they can afford). Two, the tax rate cuts and reductions of meddlesome federal regulation would increase the total output of goods and services—and rather rapidly, as history shows. With more goods and services being produced, inflationary pressure declines ceteris paribus  (meaning no new funny business on the fiscal or monetary side).

In addition, the increase in private output of goods and services increases federal tax revenues, thus easing inflationary pressures even more.

The spending deal that House Speaker Mike Johnson and the congressional Democrats are conspiring to inflict currently working on will do nothing of the sort. It basically locks in the current spending level, which is far too high for the economy to sustain. Yes, as The Wall Street Journal  notes, the proposed deal means “House Republicans have a chance to show they can actually govern.” Unfortunately, what that really means is that House Republicans will show that they can actually govern like Democrats.

Here’s my simple and indisputable message to Speaker Johnson and the House Republicans:

It’s the spending, stupid!

 


S. T. Karnick is a senior fellow and director of publications for The Heartland Institute, where he edits Heartland Daily News.