The Federal Reserve’s deflationary focus conflicts with Biden’s inflationary policies

In July, price levels actually dropped from June. Nevertheless, Federal Reserve Chairman Jerome Powell announced his efforts to curb inflation were not about to subside. Powell’s remarks supported expectations for a further increase in interest rates when the Fed next adjusts short-term rates on September 21.

The only remaining question appears whether the next rate increase will be 0.75%, like the increase in July, or 0.50%, for which more political observers are hoping. Indeed, the political pressure would be for no further increase in rates at all—since higher interest rates will hurt everyone carrying an adjustable-rate mortgage, credit card debt, or looking to buy a home.

One month and two weeks before the midterm elections, the administration would prefer to avoid a jolt of economic pain.

This is the most recent manifestation of growing divergence between the Federal Reserve and the Biden administration. Powell said curbing inflation was so important that America might have to endure a recession to do so. The Biden administration continues to deny that two sequential quarters of falling growth constitutes a recession. “There is no recession” from the White House contrasts with the “Bring it on” messaging from the Fed.

Spending more money than the government takes in through taxes is another disconnect. That practice, in which the U.S. has engaged in every one of the last 21 years, sends the Treasury out to borrow the difference. Its principal lender is the Federal Reserve, which prints the money to buy Treasury IOU’s.

It seemed for a (short) while that the White House and the Fed were in synchrony when the Inflation Reduction Act (“IRA”) was passed. The supporters of the massive spending in that bill claimed it would reduce inflation because it raised tax collections even more than its increase in spending. The act’s purported deficit reduction of $300 billion over ten years meant the Federal Reserve would have to print $300 billion less than otherwise.

Why printing less money lowers inflation was explained sixty years ago by Nobel-prize winning economist Milton Friedman, “Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.”

Now, however, the White House has announced a student-loan forgiveness program that will require the Treasury to find at least $600 billion over the next ten years to make up for the loss in student loan payments, eating up the deficit reductions from IRA.

Further, the former students receiving this windfall will have more money to spend, at just the time the Federal Reserve is trying to slow the economy by higher interest rates.

The two policies are economically irreconcilable.

The Fed wants higher interest rates, less government spending, and higher taxes. The White House wants to postpone further interest rate hikes, increase government spending, and impose higher taxes on corporations, whose ability to pass the tax increases along to consumers will further add to inflation.

The Fed could refuse to buy at least some of the new IOU’s the Treasury will have to sell. That would send the Treasury to the private bond market instead, where interest rates would soar. The slow-down of the economy the Fed seeks would certainly be achieved, and so would a recession whose definition would not be open to quibble. Paul Volcker was willing to do that, and President Jimmy Carter, who appointed him, lost his re-election bid overwhelmingly.

It is thus most instructive that Powell praised Volcker in his remarks.

“The successful Volcker disinflation in the early 1980s followed multiple failed attempts at lower inflation over the previous 15 year,”  Powell concluded, “Our responsibility to deliver price stability is unconditional.” That means no conditions to keep unemployment from rising (although the Fed’s own statute makes achieving maximum employment equally important as price stability), and no conditions to help the White House politically.

Tom Campbell is a professor of economics and a professor of law at Chapman University. He served five terms in Congress, including serving on the Joint Economic Committee. He was finance director of California, and a member of Gov. Arnold Schwarzenegger’s Council of Economic Advisors. 

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