What Will it Take to Finally Reduce Inflation?

The GOP has regained control of the House of Representatives and has promised to reduce inflation. So far, they are a little short on specifics, rather saying they will push for pro-growth tax and regulatory policies. They say they will also control government spending and increase energy production. Can the GOP reduce inflation?

The short answer is yes, but not by much.

We should first look at the reasons we have inflation. There are four causes for the current inflation and two more that are popularly believed but not really significant. Of the four primary causes, the GOP can only impact one or two.

Energy inflation can be significantly reduced simply by producing more energy. At its peak, the U.S. produced 12.5 million barrels of oil daily. Today that number is 11.3 million. Through executive action, the Biden administration has canceled the Keystone pipeline, withdrew permits to drill on federal land, canceled the leases to drill in ANWR, made the permitting process more difficult, especially for refiners and discouraged banks from making loans to the petroleum industry.

Congress can’t reverse that and, even if a bill was passed by both the House and the Senate, President Biden would veto it. Not much the GOP can do to increase energy production.

The U.S. also has a wage inflation problem mostly caused by a decline in the labor force participation rate. That means fewer adults are working or actively seeking work. To lure workers back, companies have offered higher wages. That also puts upward pressure on wages for the existing workers, resulting in wage inflation.

The cure would be to simply stop paying people not to work and stop handing out free money to all American households. The Biden administration continues to seek ways to give people free money like passing the American Rescue Plan, expanding the childcare tax credits and forgiving student loan debt.

A GOP House can stop much of the Biden administration’s free money giveaway.

The most significant reason for the current inflation is excess demand. The excess demand is caused by huge government spending deficits and the loose monetary policy in 2021 and early 2022.

The Biden administration has deficit spent $4.5 trillion in its first two years. That two-year deficit spending total is greater than any previous president. When Biden entered office, the prior administration deficit spent $3 trillion in 2020 to end the brief but deep recession caused by the COVID lockdowns. As a result, the economy grew rapidly in the last half of 2020 and was growing at better than a 6% rate in 2021.

No additional stimulus was needed. But Biden insisted on deficit spending another $3 trillion in 2021 and an additional $1.5 trillion in 2022 which overstimulated the economy. The resulting excess demand contributed significantly to the current inflation.

And the “Inflation Reduction Act” actually made inflation worse. The GOP can stop any further deficit spending increases.

The largest factor causing today’s inflation was the shockingly irresponsible monetary policy in 2021 and early 2022. With inflation poised to reach a 40-year high, the Fed kept interest rates near zero and continued the bond-buying program through the entire 2021. Finally, in March 2022, they reversed course. The tight money policy will be necessary well into 2023 and possibly beyond. The GOP Congress has no impact on monetary policy.

The supply chain issues did not add significantly to today’s inflation. That’s because, by the summer of 2021, the economy was producing at the same level as before the shutdown, meaning aggregate supply was adequate to meet normal demand. But because of the excess demand, inflation resulted. While there were some supply chain disruptions in some markets, lack of supply was not a major cause of inflation.

Similarly, the Russian invasion of Ukraine had minimal effects on inflation, although that may change soon because of food supply disruptions. In the energy market, Russia is producing more energy today than before the invasion. While Western countries have stopped buying Russian energy, China and India are buying as much as they can from Russia.

The Fed has reversed its easy money policy and is committed to removing excess demand from the economy. The GOP will not allow government spending to continue to increase. The GOP will also not pass any more spending bills that give Americans free money. That should help to bring some workers back into the labor force and reduce inflation.

The Fed’s aggressive action is already reducing demand. The Fed will continue its restrictive monetary policy until inflation comes way down. Unfortunately, that will lead to a recession in the US. Since current Fed policy strengthens the dollar, a global recession will follow.

By the middle of next year, all these actions will finally start to bring the inflation rate down to an acceptable level.

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