Inflation and High Interest Rates Have a Root Cause
Many of our citizens are suffering from inflation and high interest rates, which are high in order to try to tame inflation. High interest rates accomplish this by slowing the economy and reducing aggregate demand, which in turn lowers inflationary pressures. And high interest rates are not directly a part of the CPI calculation. But most consumers will be impacted by the high interest rates if you buy a house or car or use consumer credit on your charge cards and do not pay your account in full each month. The impact of inflation and its corollary high interest rates is worse for many than it seems.
How did we get here?
It isn’t magic, the explanation is in basic economics. Bad fiscal policy, compounded by bad monetary policy is the answer. Let me explain.
Bad fiscal policy results in losses the U S government runs every year, called deficits in government lingo. It spends more than it takes in. Ever since the last profit (surplus) we ran under President Clinton in 2001, it has gotten progressively worse. Deficits alone are not necessarily inflationary, but they harm the economy in other ways, especially by slowing growth. But when you finance the deficits by printing money, which is bad monetary policy, you get inflation. In 2020 and 2021 we had big deficits and high growth in the money supply, 26% in 2020 and 11.3% in 2021 (see No Spin #39, Do Federal Deficits Cause Inflation).
When the money supply grows faster than output, the result is inflation.
When the deficits are financed by the private sector, and not the Federal Reserve (which means printing money), the money supply is not grown excessively, and inflation is subdued. The reason is selling the debt to the private sector takes capital away from it equal to what the deficits are putting in through deficits. Hence there is no growth to the money supply. If we sell the debt to the Fed, we are printing new money.
The results were very high inflation after a lag period, reaching over 9%. In 2022, the Fed reversed course and stopped growing the money supply and raised interest rates to slow the economy down to reduce demand. Voila, inflation is subsiding, but we have not worked through all the excesses yet. To get to the target 2% inflation, the economy needs to slow further, possibly a recession, and the Fed needs to avoid excessive growth in the money supply. When that occurs, both inflation and interest rates will come down.
BOTTOM LINE
The way to get to the promised land - solid growth, low inflation and lower interest rates - starts with good fiscal policy. Reduce the deficits, hopefully balancing the budget someday. This takes the pressure off the Department of the Treasury and the Federal Reserve in that we do not have large deficits to finance. And, and, and - this will help our country achieve fiscal stability and avoid the fiscal cliff that I have been warning about. If we continue the outrageous spending and deficits, that will lead to our destruction.
Don't let that happen on our watch!
LEARN ECONOMICS, THEN VOTE SMART
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