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No Radar, No Rudder: Fiscal & Monetary Destabilization

31 Wednesday May 2023

Posted by in Fiscal policy, Monetary Policy

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Policy activists have long maintained that manipulating government policy can stabilize the economy. In other words, big spending initiatives, tax cuts, and money growth can lift the economy out of recessions, or budget cuts and monetary contraction can prevent overheating and inflation. However, this activist mirage burned away under the light of experience. It’s not that fiscal and monetary policy are powerless. It’s a matter of practical limitations that often cause these tools to be either impotent or destabilizing to the economy, rather than smoothing fluctuations in the business cycle.

The macroeconomics classes seem like yesterday: Keynesian professors lauded the promise of wise government stabilization efforts: policymakers could, at least in principle, counter economic shocks, particularly on the demand side. That optimistic narrative didn’t end after my grad school days. I endured many client meetings sponsored by macro forecasters touting the fine-tuning of fiscal and monetary policy actions. Some of those economists were working with (and collecting revenue from) government policymakers, who are always eager to validate their pretensions as planners (and saviors). However, seldom if ever do forecasters conduct ex post reviews of their model-spun policy scenarios. In fairness, that might be hard to do because all sorts of things change from initial conditions, but it definitely would not be in their interests to emphasize the record.

In this post I attempt to explain why you should be skeptical of government stabilization efforts. It’s sort of a lengthy post, so I’ve listed section headings below in case readers wish to scroll to points of most interest. Pick and choose, if necessary, though some context might get lost in the process.

  • Expectations Change the World
  • Fiscal Extravagance
  • Multipliers In the Real World
  • Delays
  • Crowding Out
  • Other Peoples’ Money
  • Tax Policy
  • Monetary Policy
  • Boom and Bust
  • Inflation Targeting
  • Via Rate Targeting
  • Policy Coordination
  • Who Calls the Tune?
  • Stable Policy, Stable Economy

Expectations Change the World

There were always some realists in the economics community. In May we saw the passing of one such individual: Robert Lucas was a giant intellect within the economics community, and one from whom I had the pleasure of taking a class as a graduate student. He was awarded the Nobel Prize in Economic Science in 1995 for his applications of rational expectations theory and completely transforming macro research. As Tyler Cowen notes, Keynesians were often hostile to Lucas’ ideas. I remember a smug classmate, in class, telling the esteemed Lucas that an important assumption was “fatuous”. Lucas fired back, “You bastard!”, but proceeded to explain the underlying logic. Cowen uses the word “charming” to describe the way Lucas disarmed his critics, but he could react strongly to rude ignorance.

Lucas gained professional fame in the 1970s for identifying a significant vulnerability of activist macro policy. David Henderson explains the famous “Lucas Critique” in the Wall Street Journal:

“… because these models were from periods when people had one set of expectations, the models would be useless for later periods when expectations had changed. While this might sound disheartening for policy makers, there was a silver lining. It meant, as Lucas’s colleague Thomas Sargent pointed out, that if a government could credibly commit to cutting inflation, it could do so without a large increase in unemployment. Why? Because people would quickly adjust their expectations to match the promised lower inflation rate. To be sure, the key is government credibility, often in short supply.”

Non-credibility is a major pitfall of activist macro stabilization policies that renders them unreliable and frequently counterproductive. And there are a number of elements that go toward establishing non-credibility. We’ll distinguish here between fiscal and monetary policy, focusing on the fiscal side in the next several sections.

Fiscal Extravagance

We’ve seen federal spending and budget deficits balloon in recent years. Chronic and growing budget deficits make it difficult to deliver meaningful stimulus, both practically and politically.

The next chart is from the most recent Congressional Budget Office (CBO) report. It shows the growing contribution of interest payments to deficit spending. Ever-larger deficits mean ever-larger amounts of debt on which interest is owed, putting an ever-greater squeeze on government finances going forward. This is particularly onerous when interest rates rise, as they have over the past few years. Both new debt is issued and existing debt is rolled over at higher cost.

Relief payments made a large contribution to the deficits during the pandemic, but more recent legislation (like the deceitfully-named Inflation Reduction Act) piled-on billions of new subsidies for private investments of questionable value, not to mention outright handouts. These expenditures had nothing to do with economic stabilization and no prayer of reducing inflation. Pissing away money and resources only hastens the debt and interest-cost squeeze that is ultimately unsustainable without massive inflation.

Hardly anyone with future political ambitions wants to address the growing entitlements deficit … but it will catch up with them. Social Security and Medicare are projected to exhaust their respective trust funds in the early- to mid-2030s, which will lead to mandatory benefit cuts in the absence of reform.

If it still isn’t obvious, the real problem driving the budget imbalance is spending, not revenue, as the next CBO chart demonstrates. The “emergency” pandemic measures helped precipitate our current stabilization dilemma. David Beckworth tweets that the relief measures “spurred a rapid recovery”, though I’d hasten to add that a wave of private and public rejection of extreme precautions in some regions helped as well. And after all, the pandemic downturn was exaggerated by misdirected policies including closures and lockdowns that constrained both the demand and supply sides. Beckworth acknowledges the relief measures “propelled inflation”, but the pandemic also seemed to leave us on a permanently higher spending path. Again, see the first chart below.

The second chart below shows that non-discretionary spending (largely entitlements) and interest outlays are how we got on that path. The only avenue for countercyclical spending is discretionary expenditures, which constitute an ever-smaller share of the overall budget.

We’ve had chronic deficits for years, but we’ve shifted to a much larger and continuing imbalance. With more deficits come higher interest costs, especially when interest rates follow a typical upward cyclical pattern. This creates a potentially explosive situation that is best avoided via fiscal restraint.

Putting other doubts about fiscal efficacy aside, it’s all but impossible to stimulate real economic activity when you’ve already tapped yourself out and overshot in the midst of a post-pandemic economic expansion.

Multipliers In the Real World

So-called spending multipliers are deeply beloved by Keynesians and pork-barrel spenders. These multipliers tell us that every dollar of extra spending ultimately raises income by some multiple of that dollar. This assumes that a portion of every dollar spent by government is re-spent by the recipient, and a portion of that is re-spent again by another recipient. But spending multipliers are never what they’re cracked up to be for a variety of reasons. (I covered these in “Multipliers Are For Politicians”, and also see this post.) There are leakages out of the re-spending process (income taxes, saving, imports), which trim the ultimate impact of new spending on income. When supply constraints bind on economic activity, fiscal stimulus will be of limited power in real terms.

If stimulus is truly expected to be counter-cyclical and transitory, as is generally claimed, then much of each dollar of extra government spending will be saved rather than spent. This is the lesson of the permanent income hypothesis. It means greater leakages from the re-spending stream and a lower multiplier. We saw this with the bulge in personal savings in the aftermath of pandemic relief payments.

Another side of this coin, however, is that cutting checks might be the government’s single-most efficient activity in execution, but it can create massive incentive problems. Some recipients are happy to forego labor market participation as long as the government keeps sending them checks, but at least they spend some of the income.

Delays

Another unappreciated and destabilizing downside of fiscal stimulus is that it often comes too late, just when the economy doesn’t need stimulus. That’s because a variety of delays are inherent in many spending initiatives: legislative, regulatory, legal challenges, planning and design, distribution to various spending authorities, and final disbursement. As I noted here:

“Even government infrastructure projects, heralded as great enhancers of American productivity, are often subject to lengthy delays and cost overruns due to regulatory and environmental rules. Is there any such thing as a federal ‘shovel-ready’ infrastructure project?”

Crowding Out

The supply of savings is limited, but when government borrows to fund deficits, it directly competes with private industry for those savings. Thus, funds that might otherwise pay for new plant, equipment, and even R&D are diverted to uses that should qualify as government consumption rather than long-term investment. Government competition for funds “crowds-out” private activity and impedes growth in the economy’s productive capacity. Thus, the effort to stimulate economic activity is self-defeating in some respects.

Other Peoples’ Money

Government doesn’t respond to price signals the way self-interested private actors do. This indifference leads to mis-allocated resources and waste. It extends to the creation of opportunities for graft and corruption, typically involving diversion of resources into uses that are of questionable productivity (corn ethanol, solar and wind subsidies).

Consider one other type of policy action perceived as counter-cyclical: federal bailouts of failing financial institutions or other troubled businesses. These rescues prop up unproductive enterprises rather than allowing waste to be flushed from the system, which should be viewed as a beneficial aspect of recession. The upshot is that too many efforts at economic stabilization are misdirected, wasteful, ill-timed, and pro-cyclical in impact.

Tax Policy

Like stabilization efforts on the spending side, tax changes may be badly timed. Tax legislation is often complex and can take time for consumers and businesses to adjust. In terms of traditional multiplier analysis, the initial impact of a tax change on spending is smaller than for expenditures, so tax multipliers are smaller. And to the extent that a tax change is perceived as temporary, it is made less effective. Thus, while changes in tax policy can have powerful real effects, they suffer from some of the same practical shortcomings for stabilization as changes in spending.

However, stimulative tax cuts, if well crafted, can boost disposable incomes and improve investment and work incentives. As temporary measures, that might mean an acceleration of certain kinds of activity. Tax increases reduce disposable incomes and may blunt incentives, or prompt delays in planned activities. Thus, tax policy may bear on the demand side as well as the timing of shifts in the economy’s productive potential or supply side.

Monetary Policy

Monetary policy is subject to problems of its own. Again, I refer to practical issues that are seemingly impossible for policy activists to overcome. Monetary policy is conducted by the nation’s central bank, the Federal Reserve (aka, the Fed). It is theoretically independent of the federal government, but the Fed operates under a dual mandate established by Congress to maintain price stability and full employment. Therein lies a basic problem: trying to achieve two goals that are often in conflict with a single policy tool.

Make no mistake: variations in money supply growth can have powerful effects. Nevertheless, they are difficult to calibrate due to “long and variable lags” as well as changes in money “velocity” (or turnover) often prompted by interest rate movements. Excessively loose money can lead to economic excesses and an overshooting of capacity constraints, malinvestment, and inflation. Swinging to a tight policy stance in order to correct excesses often leads to “hard landings”, or recession.

Boom and Bust

The Fed fumbled its way into engineering the Great Depression via excessively tight monetary policy. “Stop and go” policies in the 1970s led to recurring economic instability. Loose policy contributed to the housing bubble in the 2000s, and subsequent maladjustments led to a mortgage crisis (also see here). Don’t look now, but the inflationary consequences of the Fed’s profligacy during the pandemic prompted it to raise short-term interest rates in the spring of 2022. It then acted with unprecedented speed in raising rates over the past year. While raising rates is not always synonymous with tightening monetary conditions, money growth has slowed sharply. These changes might well lead to recession. Thus, the Fed seems given to a pathology of policy shifts that lead to unintentional booms and busts.

Inflation Targeting

The Fed claims to follow a so-called flexible inflation targeting policy. In reality, it has reacted asymmetrically to departures from its inflation targets. It took way too long for the Fed to react to the post-pandemic surge in inflation, dithering for months over whether the surge was “transitory”. It wasn’t, but the Fed was reluctant to raise its target rates in response to supply disruptions. At the same time, the Fed’s own policy actions contributed massively to demand-side price pressures. Also neglected is the reality that higher inflation expectations propel inflation on the demand side, even when it originates on the supply side.

Via Rate Targeting

At a more nuts and bolts level, today the Fed’s operating approach is to control money growth by setting target levels for several key short-term interest rates (eschewing a more direct approach to the problem). This relies on price controls (short-term interest rates being the price of liquidity) rather than allowing market participants to determine the rates at which available liquidity is allocated. Thus, in the short run, the Fed puts itself into the position of supplying whatever liquidity is demanded at the rates it targets. The Fed makes periodic adjustments to these rate targets in an effort to loosen or tighten money, but it can be misdirected in a world of high debt ratios in which rates themselves drive the growth of government borrowing. For example, if higher rates are intended to reduce money growth and inflation, but also force greater debt issuance by the Treasury, the approach might backfire.

Policy Coordination

While nominally independent, the Fed knows that a particular monetary policy stance is more likely to achieve its objectives if fiscal policy is not working at cross purposes. For example, tight monetary policy is more likely to succeed in slowing inflation if the federal government avoids adding to budget deficits. Bond investors know that explosive increases in federal debt are unlikely to be repaid out of future surpluses, so some other mechanism must come into play to achieve real long-term balance in the valuation of debt with debt payments. Only inflation can bring the real value of outstanding Treasury debt into line. Continuing to pile on new debt simply makes the Fed’s mandate for price stability harder to achieve.

Who Calls the Tune?

The Fed has often succumbed to pressure to monetize federal deficits in order to keep interest rates from rising. This obviously undermines perceptions of Fed independence. A willingness to purchase large amounts of Treasury bills and bonds from the public while fiscal deficits run rampant gives every appearance that the Fed simply serves as the Treasury’s printing press, monetizing government deficits. A central bank that is a slave to the spending proclivities of politicians cannot make credible inflation commitments, and cannot effectively conduct counter-cyclical policy.

Stable Policy, Stable Economy

Activist policies for economic stabilization are often perversely destabilizing for a variety of reasons. Good timing requires good forecasts, but economic forecasting is notoriously difficult. The magnitude and timing of fiscal initiatives are usually wrong, and this is compounded by wasteful planning, allocative dysfunction, and a general absence of restraint among political leaders as well as the federal bureaucracy..

Predicting the effects of monetary policy is equally difficult and, more often than not, leads to episodes of over- and under-adjustment. In addition, the wrong targets, the wrong operating approach, and occasional displays of subservience to fiscal pressure undermine successful stabilization. All of these issues lead to doubts about the credibility of policy commitments. Stated intentions are looked upon with doubt, increasing uncertainty and setting in motion behaviors that lead to undesirable economic consequences.

The best policies are those that can be relied upon by private actors, both as a matter of fulfilling expectations and avoiding destabilization. Federal budget policy should promote stability, but that’s not achievable institutions unable to constrain growth in spending and deficits. Budget balance would promote stability and should be the norm over business cycles, or perhaps over periods as long as typical 10-year budget horizons. Stimulus and restraint on the fiscal side should be limited to the effects of so-called automatic stabilizers, such as tax rates and unemployment compensation. On the monetary side, the Fed would do more to stabilize the economy by adopting formal rules, whether a constant rate of money growth or symmetric targeting of nominal GDP.

Oh To Squeeze Fiscal Discipline From a Debt Limit Turnip

01 Wednesday Feb 2023

Posted by in Fiscal policy, Monetary Policy

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It’s as if people view the debt limit controversy as a political nuisance rather than the stopgap enforcement mechanism for fiscal sanity that it’s intended to be. That’s a lesson in how far we’ve gone toward an unhealthy acceptance of permanent federal deficits. Oh, most people seem to realize the the government’s spending is prodigious and beyond our capacity to collect taxes, but many don’t grasp the recklessness of the ongoing blowout. Federal deficits are expected to average $1.6 trillion per year over the next decade, versus less than $0.9 trillion and $1.25 trillion over the two previous decades, respectively. That $1.25 trillion includes the massive (and excessive) transfers that took place during the pandemic, which is why we’ve bumped up against the debt limit earlier than had been expected. The trend isn’t abating, despite the fact that the pandemic is behind us. And keep in mind that the Congressional Budget Office has been too optimistic for the past 20 years or so. Take a look at federal debt relative to GDP:

Unpleasant Arithmetic

With federal debt growing faster than GDP, the burden of servicing the debt mounts. This creates a strain in the coordination of fiscal and monetary policy, as described by David Andolfatto, who last year reviewed the implications of “Some Unpleasant Monetarist Arithmetic” for current policy. His title was taken from a seminal paper written by Thomas Sargent and Neil Wallace in 1981. Andolfatto says that:

“… attempting to monetize a smaller fraction of outstanding Treasury securities has the effect of increasing the rate of inflation. A tighter monetary policy ends up increasing the interest expense of debt issuance. And if the fiscal authority is unwilling to curtail the rate of debt issuance, the added interest expense must be monetized—at least if outright default is to be avoided.

Andolfatto wrote that last spring, before the Federal Reserve began its ongoing campaign to tighten monetary policy by raising short-term interest rates. But he went on to say:

“Deficit and debt levels are elevated relative to their historical norms, and the current administration seems poised to embark on an ambitious public spending program. … In the event that inflation rises and then remains intolerably above target, the Federal Reserve is expected to raise its policy rate. … if the fiscal authority is determined to pursue its deficit policy into the indefinite future, raising the policy rate may only keep a lid on inflation temporarily and possibly only at the expense of a recession. In the longer run, an aggressive interest rate policy may contribute to inflationary pressure—at least until the fiscal regime changes.”

So it is with a spendthrift government: escalating debt and interest expense must ultimately be dealt with via higher taxes or inflation, despite the best intentions of a monetary authority.

Fiscal Wrasslin’

Some people think the debt limit debate is all a big fake. Maybe … there are spendthrifts on both sides of the aisle. Still, the current debt limit impasse could serve a useful purpose if fiscal conservatives succeed in efforts to restrain spending. There is, however, an exaggerated uproar over the possibility of default, meaning a failure to make scheduled payments on Treasury securities. The capital markets aren’t especially worried because an outright default is very unlikely. Establishment Republicans may well resort to their usual cowardice and accept compromise without holding out for better controls on spending. Already, in a politically defensive gesture, House Speaker Kevin McCarthy has said the GOP wishes to strengthen certain entitlement programs. Let’s hope he really means restoring solvency to the Social Security and Medicare Trust Funds via fundamental reforms. And if the GOP rules out cuts to any program, let’s hope they don’t rule out cuts in the growth of these programs, or privatization. For their part, of course, Democrats would like to eliminate the debt ceiling entirely.

One of the demands made by Republicans is a transformation of the federal tax system. They would like to eliminate the income tax and substitute a tax on consumption. Economists have long favored the latter because it would eliminate incentives that penalize saving, which undermine economic growth. Unfortunately, this is almost dead in the water as a political matter, but the GOP further sabotaged their own proposal in their zeal to abolish the IRS. Their consumption tax would be implemented as a national sales tax applied at the point of sale, complete with a new Treasury agency to administer the tax. They’d have done better to propose a value added tax (VAT) or a tax on a simple base of income less saving (and other allowances).

Gimmicks and Measures

We’ve seen proposals for various accounting tricks to allow the government to avoid a technical default and buy time for an agreement to be reached on the debt limit. Treasury Secretary Janet Yellen already has implemented “extraordinary measures” to stay under the debt limit until June, she estimates. The Treasury is drawing down cash, skipping additional investments in government retirement accounts (which can be made up later without any postponement of benefits), plus a few other creative accounting maneuvers.

Payment prioritization, whereby the Treasury makes payments on debt and critical programs such as Social Security and Medicare, but defers a variety of other payments, has also been considered. Those deferrals could include amounts owed to contractors or even government salaries. However, a deferral of payments owed to anyone represents a de facto default. Thus, payment prioritization is not a popular idea, but if push comes to shove, it might be viewed as the lesser of two evils. Missing payments on government bonds could precipitate a financial crisis, but no one believes it will come to that.

Two other ideas for avoiding a breach of the debt ceiling are rather audacious. One involves raising new cash via the sale of premium bonds by the Treasury, as described here by Josh Barro (and here by Matt Levine). The other idea is to mint a large denomination ($1 trillion) platinum, “commemorative” coin, which the Treasury would deposit at the Federal Reserve, enabling it to conduct business as usual until the debt limit impasse is resolved. I’ll briefly describe each of these ideas in more detail below.

Premium Bonds

Premium bonds would offer a solution to the debt limit controversy because the debt ceiling is defined in terms of the par value of Treasury debt outstanding, as opposed to the amount actually raised from selling bonds at auction. For example, a note that promises to pay $100 in one year has a par value of $100. If it also promises to pay $100 in interest, it will sell at a steep premium. Thus, the Treasury collects, say, $185 at auction, and it could use the proceeds to pay off $100 of maturing debt and fund $85 of federal spending. That would almost certainly require a “market test” by the Treasury on a limited scale, and the very idea might reveal any distaste the market might have for obviating the debt limit in this fashion. But distaste is probably too mild a word.

An extreme example of this idea is for the Treasury to sell perpetuities, which have a zero par value but pay interest forever, or at least until redeemed beyond some minimum (but lengthy) term. John Cochrane has made this suggestion, though mainly just “for fun”. The British government sold perpetuities called consols for many years. Such bonds would completely circumvent the debt limit, at least without legislation to redefine the limit, which really is long overdue.

The $1 Trillion Coin

Minting a trillion dollar coin is another thing entirely. Barro has a separate discussion of this option, as does Cochrane. The idea was originally proposed and rejected during an earlier debt-limit controversy in 2011. Keep in mind, in what follows, that the Fed does not follow Generally Accepted Accounting Principles (GAAP).

Skeptics might be tempted to conclude that the “coin trick” is a ploy to engineer a huge increase the money supply to fund government expansion, but that’s not really the gist of this proposal. Instead, the Treasury would deposit the coin in its account at the Fed. The Fed would hold the coin and give the Treasury access to a like amount of cash. To raise that cash, the Fed would sell to the public $1 trillion out of its massive holdings of government securities. The Treasury would use that cash to meet its obligations without exceeding the debt ceiling. As Barro says, the Fed would essentially substitute sales of government bonds from its portfolio for bonds the Treasury is prohibited from selling under the debt limit. The effect on the supply of money is basically zero, and it is non-inflationary unless the approach has an unsettling impact on markets and inflation expectations (which of course is a distinct possibility).

When the debt ceiling is finally increased by Congress, the process is reversed. The Treasury can borrow again and redeem its coin from the Fed for $1 trillion, then “melt it down”, as Barro says. The Fed would repurchase from the public the government securities it had sold, adding them back to its portfolio (if that is consistent with its objectives at that time). Everything is a wash with respect to the “coin trick”, as long as the Treasury ultimately gets a higher debt limit.

Lust For the Coin

In fairness to skeptics, it’s easy to understand why the “coin trick” described above might be confused with another coin minting idea that arose from the collectivist vanguard during the pandemic. Representative Rashida Tlaib (D-MI) proposed minting coins to fund monthly relief payments of $1,000 – $2,000 for every American via electronic benefit cards. She was assisted in crafting this proposal by Rohan Grey, a prominent advocate of Modern Monetary Theory (MMT), the misguided idea that government can simply print money to pay for the resources it demands without inflationary consequences.

Tlaib’s plan would have required the Federal Reserve to accept the minted coins as deposits into the Treasury’s checking account. But then, rather than neutralizing the impact on the money supply by selling government bonds, the coin itself would be treated as base money. Cash balances would simply be made available in the Treasury’s checking account with the Fed. That’s money printing, pure and simple, but it’s not at all the mechanism under discussion with respect to short-term circumvention of the debt limit.

Fed Independence

The “coin trick” as a debt limit work-around is probably an impossibility, as Barro and others point out. First, the Fed would have to accept the coin as a deposit, and it is under no legal obligation to do so. Second, it obligates the Fed to closely coordinate monetary policy with the Treasury, effectively undermining its independence and its ability to pursue its legal mandates of high employment and low inflation. Depending on how badly markets react, it might even present the Fed with conflicting objectives.

Believe me, you might not like the Fed, but we certainly don’t want a Fed that is subservient to the Treasury… maintaining financial and economic stability in the presence of an irresponsible fiscal authority is bad enough without seating that authority at the table. As Barro says of the “coin trick”:

“These actions would politicize the Fed and undermine its independence. In order to stabilize expectations about inflation, the Fed would have to communicate very clearly about its intentions to coordinate its fiscal actions with Treasury — that is, it would have to tell the world that it’s going to act as Treasury’s surrogate in selling bonds when Treasury can’t. …

These actions would interfere with the Fed’s normal monetary operations. … the Fed is currently already reducing its holdings of bonds as part of its strategy to fight inflation. If economic conditions change (fairly likely, in the event of a near-default situation) that might change the Fed’s desired balance sheet strategy.”

On With The Show

Discussions about the debt limit continue between the White House and both parties in Congress. Kevin McCarthy met with President Biden today (2/1), but apparently nothing significant came it. Fiscal conservatives wonder whether McCarthy and other members of the GOP lack seriousness when it comes to fiscal restraint. But spending growth must slow to achieve deficit reduction, non-inflationary growth, and financial stability.

Meanwhile, even conservative media pundits seem to focus only on the negative politics of deficit reduction, ceding the advantage to Democrats and other fiscal expansionists. For those pundits, the economic reality pales in significance. That is a mistake. Market participants are increasingly skeptical that the federal government will ever pay down its debts out of future surpluses. This will undermine the real value of government debt, other nominal assets, incomes and buying power. That’s the inflation tax in action.

Unbridled growth of the government’s claims on resources at the expense of the private sector destroys the economy’s productive potential, to say nothing of growth. The same goes for government’s insatiable urge to regulate private activities and to direct patterns of private resource use. Unfortunately, so many policy areas are in need of reform that imposition of top-down controls on spending seems attractive as a stopgap. Concessions on the debt limit should only be granted in exchange for meaningful change: limits on spending growth, regulatory reforms, and tax simplification (perhaps replacing the income tax with a consumption tax) should all be priorities.

In the meantime, let’s avoid trillion dollar coins. As a debt limit work-around, premium bonds are more practical without requiring any compromise to the Fed’s independence. Other accounting gimmicks will be used to avoid missing payments, of course, but the fact that premium bonds and platinum coins are under discussion highlights the need to redefine the debt limit. When the eventual time of default draws near, fiscal conservatives must be prepared to stand up to their opponents’ convenient accusations of “brinksmanship”. The allegation is insincere and merely a cover for government expansionism.

Price Stability: Are We There Yet?

22 Thursday Dec 2022

Posted by in Inflation, Liberty, Monetary Policy

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The answer to that question, kids, is a resounding no! The Federal Reserve created far too much liquidity during and after the pandemic and waited too long to reverse that policy. That’s a common view among the “monetarazzi”, but far too many analysts, in the next breath, assert that the Fed is going too far in tightening policy. Sorry, but you can’t have it both ways! Thus far, the reductions we’ve seen in the monetary aggregates (M1, M2, M3) represent barely a trickle out of the ocean of liquidity released during the previous two years. The recent slight moderation in the rate of inflation is unlikely to gain momentum without persistence by the Fed.

This Could Be Easier

I humbly concede, however, that a different approach by the Fed might have been less disruptive. A better alternative would have involved more aggressive reductions in the gigantic portfolio of securities it acquired via “quantitative easing” (QE) during the pandemic while avoiding direct intervention to raise short-term interest rates. In fact, allowing interest rates to be determined by the market, rather than via central bank intervention, is more sensible in terms of pricing debt of any duration. It also suggests a more direct and sensible approach to managing the growth of the money supply. Of course, had the Fed unwound QE more aggressively, short-term rates would surely have risen anyway, but to levels appropriate to rationing liquidity more efficiently. Furthermore, those rates could have served as a useful indicator of the market’s ability to digest a particular volume of sales from the Fed’s portfolio.

Getting Tight

The chart below shows the level of the monetary base (bank reserves plus currency) over the past five years from the Trading Economics site. The monetary base is the narrow monetary aggregate supporting growth of the money stock and is under fairly direct control of the Fed.

The base has declined substantially during 2022 largely as a consequence of the Fed’s restrictive policies. However, it has retraced only about a third of the massive expansion engineered by the Fed over the two prior years. Here is the corresponding plot of the M1 money stock (currency plus checking deposits):

So the reductions in the base have yet to translate into much of a reduction in the money stock, though growth in all of the aggregates has certainly declined. No one thinks this will be a walk in the park. Withdrawing liquid capital from markets accustomed to swilling in excesses will have consequences, particularly for investors who’ve grown undisciplined in their approach to evaluating prospective assets. Investors and society at large inevitably pay the price for the malinvestment encouraged by unbridled money growth (not to mention misdirected industrial policies … that’s a different can of worms).

But the squeamish resist! I got a kick out of this tweet by Noah Smith in which he pokes fun at those who insist that the surge in inflation was a mere transitory phenomenon:

“Team Transitory: OMG inflation is just going to go away, you don’t need to raise interest rates.

Fed: *raises interest rates*

Inflation: *goes down a bit*

Team Transitory: SEE, I told you inflation was going away and that you didn’t need to raise interest rates!!”

Well, in fairness, “Team Transitory” has been fixated on supply disruptions that very well should resolve with private efforts over time. Some have resolved already. And again, we’ve yet to feel much impact from the Fed’s tighter policy, but I’m amused by the tweet nevertheless.

In fact, the surge in inflation has been driven by both supply and demand factors, and it’s true the Fed can do very little about the former. But stalling the effort to purge excess liquidity and demand-side inflation risks allowing expectations of inflation to edge higher, creating an environment in which price pressures are more resistant to policy actions.

Inflation And Its Proximate Sources

It is indeed good news that inflation has tapered slightly over the past few months, or at least the “headline” inflation numbers have tapered. Weaker energy prices helped a great deal, though releases from the Strategic Petroleum Reserve aren’t sustainable. Measures of “core” inflation that exclude food and energy prices, and more central measures of inflation within the spectrum of goods and services, have moved sideways or perhaps shown signs of a slight moderation.

Here’s a plot of several measures of CPI inflation taken from the Cleveland Fed’s web site. Note that the median component of the CPI has finally hit a plateau, and a “trimmed” measure that excludes CPI components with extreme changes has dipped slightly. The Core CPI has fluctuated in a range just above 6% for most of the year.

The deflator for personal consumption expenditures (PCE) gets more emphasis from the Fed in its policy deliberations. The latest release at the start of December showed patterns similar to the CPI:

With respect to the PCE deflator, the slight dampening of price pressure we’ve seen recently came primarily from the supply side, with some progress on the demand side as well. Energy was one factor on the supply side, but even the core PCE deflator shows less supply pressure. Adam Shapiro has a decomposition of the PCE deflator into supply-driven and demand-driven components (but the chart only goes through October):

First, without endorsing Shapiro’s construction of this dichotomy, I note that the impact of monetary policy is primarily through the demand side of the economy. Of course, monetary instability isn’t good for producers, and excessive money growth and inflation create uncertainty that inhibits supply. But what we’ve seen recently has more to do with the curing of supply chain bottlenecks that cropped up during the pandemic (or in its wake), and Shapiro attempts to capture that kind of phenomenon here.

Still, many would argue that the November CPI showed sufficient progress for the Fed to pause its tightening campaign. The reductions in the monthly price increases were fairly widespread, as shown by this table from the CPI report:

The next chart from Joe Wiesenthal (via Bloomberg) displays trends in broad CPI categories, but it shows vividly that the reductions were concentrated in energy components and goods prices, while services and food inflation did not really abate. (The legend is so hard to read that I took the liberty of blowing it up a bit below the chart itself):

Playing Catch-Up

While the Fed’s effort to restrain inflation began in earnest in the spring of this year, it lifted the federal funds rate target rapidly. Here’s another chart from Adam Shapiro, via the Wall Street Journal: the Fed’s current tightening cycle is the fastest in 40 years in terms of those rate hikes:

Fast, yes, but they got a late start in the face of a rapid acceleration of inflation, and for what it’s worth, the Fed’s rate target remains below the rate of inflation. Yes, I’m forced to acknowledge here that the Fed’s preference for rate intervention and targeting is just what they do, for now. In any case, top-line inflation and strictly demand-side inflation are still above the Fed’s 2% target.

Fabian Fiscal Expansionists

One “fix” recommended in some circles suggests that the Fed’s inflation target is too low, as if price stability had nothing to do with its mandate! The idea that low-grade inflation is a healthy thing has never been convincingly demonstrated. In fact, the monetary literature leans strongly in the direction of price stability and an optimal rate of inflation of zero! That the Fed should aim for higher inflation seems like a cop-out intended to appease those who still subscribe to the discredited notion that there exists a reliable long-run tradeoff between inflation and unemployment.

In fact, proposals to increase the central bank’s inflation target would enable more deficit spending financed with the “printing press”, which is at the root of the demand-side inflation problem we now face. A major justifications for ballooning levels of federal spending has been so-called Modern Monetary Theory (MMM), which has gained adherents among statists in the years since the Great Recession. MMM holds that “important” initiatives can simply be paid for with new money creation, rather than interest bearing debt, or God forbid, taxes! “Partisan” is probably a better description than “theorist” for any fan of MMM, and they have convinced themselves that money financed deficits are without inflationary consequences. Of course, this represents a complete suspension of the law of resource scarcity, not to mention years of monetary history. Raising the Fed’s inflation target plays well with the same free-lunch advocates who rally behind MMM.

The Fed’s Unfaithful Fiscal Partner

Federal budget control is likely to take another hit this week with passage of the $1.7 omnibus spending bill. It includes spending increases with no immediate offsets as required under the pay-as-you-go budget law. It delays those offsets to 2025 and increases deficits in the interim by hundreds of billions of dollars. It also sets a new, higher baseline for discretionary appropriations in future years. The federal deficit has already risen dramatically compared to a year ago under the fiscal profligacy of Congress and the Administration. Another contributing factor, however, is that the interest cost of servicing the national debt has spiked as interest rates have risen. Needless to say, none this makes the Fed’s job any easier, especially as it seeks to reverse QE.

Say Uncle!?

When will the Fed begin to take its foot off the brake? It “only” raised the Fed funds target by 50 basis points at its meeting last week (after four 75 bps moves in a row. It is expected to raise the target another 50 bps in early February and perhaps another 25 in March. Strong signals of imminent recession would be needed for the Fed to call it off any sooner, and we’re definitely seeing more hints of a weakening economy in the data (and see here, here, here, and here). More definitive declines in inflation would obviously help settle things. Otherwise, the Fed may pause after March in order to gauge progress toward its goal of 2% inflation.

The Employment Situation: Where’s the Recession?

14 Wednesday Dec 2022

Posted by in Economic Outlook

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It’s always hard to foresee dramatic turns in the economy and their timing. One day, way back in grad school, a professor of mine went on about how the Great Depression seemed to surprise people at the time. He felt they should have known it was coming, and he emphasized that housing had been in a downturn starting around 1926. Well, hindsight’s 20/20, and I’m not sure how timely and accurate economic reporting was at the time, but today it’s not any easier to call recessions in advance.

An Array of Weak Signals

We’ve seen a downturn in housing this year, and for that and several other reasons many forecasters are predicting a recession in 2023. Consumers are depleting their savings and running up debt, and in November consumer confidence dropped for a fourth month in a row. In October, the Index of Leading Economic Indicators declined for an eighth straight month. A slump in business confidence has been underway for 12 months. Businesses are accumulating debt at much higher interest rates, and the earnings outlook (excluding energy) is bleak.

Buttressing that negative outlook is the inverted yield curve, which has been reliable (though not infallible) as a recession signal in the past. We now have a gap between the one-year Treasury yield and the 10-year Treasury yield of well over 100 basis points, which is as high as it’s been since 1981. That looks rather ominous.

The Fed’s Mission

Perhaps most importantly, the Federal Reserve has succeeded in reducing the money supply. That shift to tightening policy really only began in the late spring, however, and as Milton Friedman emphasized, the impact of money supply growth on the real economy is subject to “long and variable lags”. That could mean an economic slowdown or recession any time from now into 2024, but many analysts believe it will begin in the first half of 2023.

Denialists

Yet a few observers claim things are rosy, not least of all those within the Biden Administration. They insist the economy is in fine shape, pointing to the continuing strength in some of the employment numbers. Those gains have also been a preoccupation of the media, but employment statistics aren’t especially good predictors of changes in economic growth. Job growth and unemployment are lagging indicators, so we shouldn’t expect to see obvious signals of recession from employment data, at least until a downturn is underway. Even the Fed’s official economic forecast still calls for something of a “soft landing”, but Chairman Jerome Powell is wary of placing much confidence in particular outcomes, and with good reason.

The Employment Situation

There are unusual patterns in recent employment data that might portend a weaker economy, but first, the statistics most widely followed are changes in non-farm employment (from the Bureau of Labor Statistics’ Survey of Business Establishments) and the unemployment rate (from the BLS Household Survey). The chart below shows monthly changes in nonfarm payrolls over the past year. There was a still-healthy gain in payrolls in November, but the pace of job growth slowed over the last twelve months as we came off the post-pandemic rebound.

One factor partly offsetting recent gains in non-farm employment is a decrease in the average workweek. Average weekly hours declined slightly in November and it was down 0.4 hours from a year earlier.

There are sectors of the economy that have shown recent weakness in payroll jobs. There was a decline in goods-producing employment in November, and layoffs are underway in the tech sector, a first for some of the big tech firms. Job reductions have also been announced at a few prominent financial firms.

The next chart shows that the unemployment rate has remained near post-pandemic lows since early this year. An ongoing factor helping to keep it low, however, is that labor force participation is still running below pre-pandemic levels (despite rebounding well off pandemic lows during 2021). You aren’t counted as unemployed if you don’t participate in the labor force by seeking work.

One negative sign here is an uptick over the past two months in the share of job losers among the unemployed (as opposed to quitters or new entrants). That’s a pattern that would become more pronounced when and if a recession takes hold.

Keep in mind that these statistics are derived from surveys and extrapolated to the universe of households or non-farm employees. The Household Survey samples 60,000 households, whereas the Establishment Survey samples 131,000 employers, accounting for 670,000 employees. So the Household Survey is much smaller. Nevertheless, sample sizes of these magnitudes should be highly reliable, even for most subcategories.

Contradictory BLS Surveys

There are a few other possible signs of a weakening labor market in recent employment data. One such development is a gap between new job numbers from the Establishment Survey (non-farm payrolls) and the Household Survey (total employment). The following table (taken from the December 2nd BLS Report for households) is from a series of tweets by Elise Gould:

Total employment from the Household Survey has actually declined by almost 470,000 the past two months, while non-farm payrolls have increased by a total of over 500,000. Turning points in employment from the Household Survey tend to lead non-farm payrolls, so this could foretell a softening. While the Household Survey is smaller than the Establishment Survey, it is broader in some respects, covering several categories of workers who aren’t counted on non-farm payrolls, including agricultural workers and the self-employed. The latter are a more significant part of the employed population given the rise in the so-called gig economy. Self-employed workers (unincorporated) have declined by more than 170,000 over the past two months. However, it’s not clear that these workers would be affected earlier than others around turning points.

A separate employment report by ADP Research noted a sharp slowdown in private sector hiring in November, with the most weakness in construction and interest rate sensitive industries. The report also noted that fewer workers are leaving jobs voluntarily.

Is the Labor Market Tight Or Loose?

Nominal wages are rising at an accelerating pace, which might make it more difficult for the Fed to rein-in inflation. However, wages are still rising less than prices — as of October, real hourly earnings had declined 1.9% over the past year. November will mark 20 straight months of declines in the real wage. The drop in real weekly earnings is even steeper, given a slight decline in the average workweek. If we’re looking for a silver lining, inflation and declines in real earnings mean that employers have gained additional incentive to hire. Perhaps that can be offered as one reason for persistent strength in the payroll numbers.

There are still more than 10 million job openings across the country, but only 6 million workers are unemployed. Again, many would-be job candidates are sitting things out. (Perhaps they are mostly terrible candidates, given their apparent disinterest in work.) Some observers assume this means that the labor market is extremely tight, yet real wages are declining, as if there were an excess supply of workers! The answer to this “puzzle” is that many vacancies are ultimately filled by candidates who were already employed. Also, there is a large number of underemployed workers. Thus, the available pool of candidates is much larger than the number available due to unemployment. It’s not outlandish to think that there is actually an excess supply of labor at the moment, rather than excess demand, but that doesn’t bode well for real wage gains going forward.

Conclusion

Despite an ostensibly strong labor market, there are reasons to think that strength is waning, even without appeal to other economic and financial indicators. The BLS household survey showed recent declines in employment, as did the ADP survey, and we’ve seen an increase in the share of job losers among the unemployed. High-profile layoff announcements should also give pause. The recessionary outlook is reinforced by a number of other indicators, but most of all, the Federal Reserve’s tightening of the money supply is bound to have a stronger impact on the economy in 2023, and the Fed is not finished tightening yet.

Harms Dismissed In “Standing Dead Zone” of Executive Action

26 Friday Aug 2022

Posted by in Checks and Balances, Executive Authority, Student Loans

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I hate to contribute to the deluge of ink spilled over Joe Biden’s latest executive action, which forgives massive amounts of federal student loan debt, but there’s an angle that hasn’t received adequate treatment. Of course, Biden’s action is an abridgment of taxpayer rights, a violation of the separation of powers, and an affront to borrowers who already paid off their student loans, but it will be nearly impossible for any challenger(s) to show that they have standing in court. Writing in the Virginia Law Review earlier this year, Jack V. Hoover says this kind of action lies within what he calls a “standing dead zone” created by the courts.

I’ll start with a few preliminaries. Note that student loan forgiveness was NOT legislated, unlike the Paycheck Protection Program, which the Administration keeps referencing in defense of the action. And I’d be remiss if I failed to mention that Biden’s action looks like a pathetic attempt to salvage votes ahead of what some democrats fear could be a disastrous midterm election. In addition, the action is regressive, with benefits weighted heavily toward high-income debtors with graduate degrees. The cost (write down, loss) to the federal government was originally said to be near $300 billion, depending on uptake, but independent estimates now put the full cost at $600 billion. This wipes out the hoped-for deficit reduction in the ridiculous but much ballyhooed “Inflation Reduction Act”, and yes, student loan forgiveness may well be inflationary. At a minimum, it makes the Fed’s job of restraining inflation by tamping down demand that much harder. Loan forgiveness will not solve the underlying problem of runaway cost escalation in higher education. In fact, it will exacerbate the problem by encouraging non-payment and additional borrowing, while tuition to colleges and universities will escalate all the more. So this is really bad policy all the way around!

Biden’s action is clearly a huge stretch on statutory grounds. In particular, the Administration invoked the HEROES Act, which authorizes the Secretary of Education to waive loan requirements during periods of national emergency. In this case, the Administration appeals to hardships caused by the pandemic for individuals with student debt. Of course, just two weeks ago, the CDC rolled back their emergency pandemic guidelines on social distancing and quarantines, so the “emergency” seems to be over, officially. Also, the Administration recently ended the “return to Mexico” policy at the border on the pretext that it had only been necessary because of the pandemic! Pardon my incredulity, but playing the “pandemic card” at this point is both dishonest and hypocritical.

“Standing” in the legal sense can’t be found in the text of the Constitution. It was itself created by the courts. Even so, why do taxpayers, Congress, or past borrowers lack standing to challenge the action on student loans through the judicial system? How can that be when the harms are so obvious? Well, courts tend to avoid interfering with the executive branch, and they’d rather leave such disputes up to the political system to hash out. That doesn’t seem like a terribly effective way to practice the game of “checks and balances”. Nevertheless, for many years the courts have relied on a strict test for establishing plaintiff standing promulgated in the Supreme Court decision in Lujan v. Defenders of Wildlife. In that majority opinion, Justice Antonin Scalia laid out a three-part test, which Hoover describes thusly:

“… (1) injury in fact that is actual, concrete, and particularized; (2) a causal connection between the injury and the conduct complained of; and (3) a likelihood that exercise of judicial power will redress the injury.28 The Court furthermore differentiated between cases in which government regulation targets the plaintiff and cases where the plaintiff complains about ‘unlawful regulation (or lack of regulation) of someone else,’ in which case “much more is needed” for standing to exist.29 The Court has regularly reaffirmed this formulation of its standing requirements.3”

Hoover discusses the executive’s authority to cancel debt under the Higher Education Act (HEA) of 1965. In terms of the impregnability of Biden’s action to legal challenge, Hoover implies that the president might just as well have fallen back on HEA as HEROES. However, the Department of Education (DOE) opined last year that it lacked the power to forgive debt. Here’s what the DOE said in 2021:

“… the Secretary does not have statutory authority to provide blanket or mass cancellation, compromise, discharge, or forgiveness of student loan principal balances, and/or materially modify the repayment amounts or terms thereof, whether due to the COVID-19 pandemic or for any other reason.”

Hoover seems to be saying that it is all but impossible to challenge Biden’s bald assertion of extra-legal power in forgiving student loans. Hoover goes on to discuss all classes of potential litigants who might challenge student loan forgiveness: taxpayers, former borrowers, Congress, state governments, and loan servicers. He is skeptical of all those, citing various reasons for their lack of standing, but I’ll focus on only the first three classes.

Taxpayers: The logic of denying taxpayers standing is at least two-fold. First, taxpayers cannot show direct harm from the action, though they are likely to pay a higher inflation tax over time as a consequence. Second, Congress appropriated funds for student loans, but it did so as an entitlement, and it did not restrict loan amounts nor the executive’s ability to waive “the government’s claim that borrowers must return the funds to the Treasury”. Hoover believes that the courts would defer to the political branches of government in settling such issues. The whole thing sounds rather thin to my ears, but precedent will probably hold sway unless the Supreme Court revisits its position on standing.

Congress: The standing of Congress is another matter. If, in the view of the legislature, an executive agency has exceeded its statutory authority, the matter might reflect as much on Congress as elsewhere, in failing to provide adequate limitations, guideposts, or oversight. However, in this case:,

“Congress duly appropriated funds for student loans,83 and the Executive is responsible for the funding’s disbursement. This means that any claim of standing due to institutional injury from compromising Congress’s control of the federal purse would fail.”

Here again, it will be left to settle by the political branches of government. To avoid such conflicts, it is up to the legislature to write laws that bind the discretion of the executive to varying degrees. Unrestrained entitlements are a damn good way to cede control of the “keys to the Treasury”.

Other borrowers who’ve managed their student loan debt responsibly will also lack standing, according to Hoover. Like taxpayers, they cannot show any direct harm or injury. In addition, standing is difficult to establish when an action or inaction by an executive agency pertains to someone else.

It’s my hope that a court challenge will be brought all the way to the Supreme Court, and at some level a court will define a new standard or test under which plaintiffs can attempt to establish standing against executive or agency actions. This is sorely needed as a check on the explosive growth of the administrative state. Furthermore, the “standing dead zone” allows all sorts of politically-motivated mischief by the executive branch, and the Biden Administration seems more than willing to push executive authority to extremes. However, I’m not too optimistic about the possibility of a new test for standing. Before all is said and done, Biden is likely to expand student loan forgiveness well beyond $20,000 per borrower. Federal finance is looking more precarious with Biden’s every step, and many of those steps cannot be walked back by Congress, no matter who holds the majority.

The Fed’s Balance Sheet: What’s the Big Deal?

08 Sunday May 2022

Posted by in Government Failure, Inflation, Monetary Policy

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The Federal Reserve just announced tighter monetary policy in an attempt to reduce inflationary pressures. First, it raised its target range for the federal funds rate (on overnight loans between banks) by 0.5%. The new range is 0.75% – 1%. Second, on June 1, the Fed will begin taking steps to reduce the size of its $9 trillion portfolio of securities. These holdings were acquired during periods of so-called quantitative easing (QE) beginning in 2008, including dramatic expansions in 2020-21. A shorthand reference for this portfolio is simply the Fed’s “balance sheet”. It includes government debt the Fed has purchased as well as privately-issued mortgage-backed securities (MBS).

What Is This Balance Sheet You Speak Of?

Talk of the Fed’s balance sheet seems to mystify lots of people. During the 2008 financial crisis, the Fed began to inject liquidity into the economy by purchasing large amounts of assets to be held on its balance sheet. This was QE. It’s scope was unprecedented and a departure from the Fed’s pre-crisis reliance on interest rate targeting. QE had the effect of increasing bank reserves, which raised the possibility of excessive money supply growth. That’s when the Fed began to pay interest to banks on reserves, so they might be content to simply hold some of the reserves over and above what they are required to hold, rather than using all of that excess to support new loans and deposits (and thus money growth). However, that interest won’t stop banks from lending excess reserves if better opportunities present themselves.

The Fed has talked about reducing, “normalizing”, or “tapering” its balance sheet for some time, but it only recently stopped adding to it. With inflation raging and monetary policy widely viewed as too “dovish”, analysts expected the Fed to stop reinvesting proceeds from maturing securities, which amounts to about $95 billion per month. That would shrink or “taper” the balance sheet at a rate of about $1.1 trillion per year. Last week the Fed decided to cap the “runoff” at $47.5 billion per month for the first three months, deferring the $95 billion pace until September. Monetary policy “hawks” were disappointed by this announcement.

Monetizing Government

So, one might ask, what’s the big deal? Why must the Fed taper its securities holdings? Well, first, the rate of inflation is far above the Fed’s target range, and it’s far above the “average Joe’s” comfort range. Inflation imposes significant costs on the economy and acts as a regressive form of taxation, harming the poor disproportionately. To the extent that the Fed’s huge balance sheet (and the corresponding bank reserves) are supporting incremental money growth and fueling inflation, the balance sheet must be reduced.

In that connection, the Fed’s investment in government debt represents monetized federal debt. That means the Fed is essentially printing money to meet the Treasury’s financing needs. Together with profligate spending by the federal government, nothing could do more to convince investors that government debt will never be repaid via future budget surpluses. This dereliction of the government’s “full faith and credit”, and the open-armed acceptance of the inflation tax as a financing mechanism (à la Modern Monetary Theory), is the key driver of fiscal inflation. Reducing the balance sheet would represent de-monetization, which might help to restore faith in the Fed’s ability to push back against fiscal recklessness.

Buyer of First Resort

Perhaps just as critically, the Fed’s heavy investment in government debt and MBS represents an ongoing distortion to the pricing of financial assets and the allocation of capital. Some call this interference in the “price discovery process”. That’s because the Fed has represented a market-altering presence, a willing and inelastic buyer of government debt and MBS. Given that presence, it’s difficult for buyers and sellers to discern the true values of alternative uses of capital, or to care.

QE was, among other things, a welcome institutional development for the U.S. Treasury and for those who fancy that fresh money printing is an ever-valid form of government payment for scarce resources. The Fed’s involvement also means that other potential buyers of Treasury debt need not worry about interest rate risk, making public debt relatively more attractive than private debt. This is a dimension of the “crowding out” phenomenon, whereby the allocation of capital and flows of real resources between public and private uses are distorted.

The Fed’s presence as a buyer of MBS depresses mortgage rates and makes mortgage lending less risky for lenders and investors. As a result, it encourages an over-investment in housing and escalating home prices. This too distorts the allocation of capital and real resources, at the margin, toward housing and away from uses with greater underlying value.

Conclusion

The magnitude of the Fed’s balance sheet is an ongoing testament to an increasingly dominant role of central authorities in the economy. In this case, the Fed has served as a conduit for the inflation tax. In addition, it has unwittingly facilitated crowding out of private capital investment. The Fed’s purchases of MBS have distorted the incentives (and demand) for residential investment. These are subtle effects that the average citizen might not notice, just as one might not notice the early symptoms of a debilitating disease. The long-term consequences of the Fed’s QE activities, including the inflation tax and distorted allocations of capital, are all too typical of failures of government intervention and attempts at central planning. But don’t expect anyone at the Fed to admit it.

Social Insurance, Trust Fund Runoff, and Federal Debt

28 Thursday Apr 2022

Posted by in Deficits, Social Security

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The Social Security and Medicare trust funds are starting to shrink, but as they shrink something else expands in tandem, roughly dollar-for-dollar: government debt. There is a widespread misconceptions about these entitlement programs and their trust funds. Many seem to think the trust funds are like “pots of gold” that will allow the government to meet its mandatory obligations to beneficiaries. But, in fact, the government will have to borrow the exact amounts of any “assets” that are “cashed out” of the trust funds, barring other reforms or legislative solutions. So how does that work? And why did I put the words “assets” and “cashed out” in quote marks?

The Trust Funds

First, I should note that there are two Social Security trust funds: one for old age and survivorship income (OASI) and one for disability income (DI). Occasionally, for summary purposes, the accounts for these funds are combined in presentations. There are also two Medicare trust funds: one for hospitalization insurance (HI – Part A) and one for Supplementary Medical Insurance (SMI – Parts B and D). The first three of these trust funds are represented in the chart at the top of this post, which is from the Summary of the 2021 Annual Reports by the Boards of Trustees. It plots a measure of financial adequacy: the ratio of trust fund assets at the start of each year to the annual cost. The funds are all projected to be depleted, HI and OASI much sooner than DI.

Fund Accumulation

The first step in understanding the trust funds requires a clearing up of another misconception: the payroll taxes that workers “contribute” to these systems are not invested specifically for each of those workers. These programs are strictly “pay-as-you-go”, meaning that the payroll taxes (and premiums in the case of Medicare) paid this year by you and/or your employer are generally distributed directly to current beneficiaries.

Back when demographics of the American population were more favorable for these programs, with a larger number of workers relative to retirees, payroll taxes (and premiums) exceeded benefits. The excess was essentially loaned by these programs to the U.S. Treasury to cover other forms of spending. So the trust funds accumulated U.S. Treasury IOUs for many years, and the Treasury pays interest to the trust funds on that debt. On the upside, that meant the Treasury had to borrow less from the public to cover its deficits during those years. So the government spent the excess payroll tax proceeds and wrote IOUs to the trust funds.

Draining the Funds

The demographic profile of the population is no longer favorable to these entitlement programs. The number of retirees has increased so that benefit levels have grown more quickly than program revenue. Benefits now exceed the payroll taxes and premiums collected, so the trust funds must be drawn down. Current estimates are that the Social Security Trust Fund will be depleted in 2034, while the Medicare Trust Fund will last only to 2026. These dates are reflected in the chart above. It is the mechanics of these draw-downs that get to the heart of the first “pot of gold” misconception cited above.

To pay for the excess of benefits over revenue collected, the trust funds must cash-in the IOUs issued to them by the Treasury. And where does the Treasury get the cash? It will almost certainly be borrowed from the public, but the government could hike other forms of taxes or reduce other forms of spending. So, while the earlier accumulation of trust fund assets meant less federal borrowing, the divestment of those assets generally means more federal borrowing and growth in federal debt held by the public.

Given these facts, can you spot the misconception in this quote from Fiscal Tiger? It’s easy to miss:

“In the cases of Social Security, Medicare, and Medicaid, payroll taxes provide some revenue. Social Security also has trust funds that cover some of the program costs. However, when the government is short on funds for these programs after getting the revenue from taxes and trust funds, it must borrow money, which contributes to the deficit.”

This kind of statement is all too common. The fact is the government has to borrow in order to pay off the IOUs as the trust funds are drawn down, roughly dollar-for-dollar.

A second mistake in the quote above is that federal borrowing to pay excess benefits after the trust funds are fully depleted is not really assured. At that time, the Anti-deficiency Act prohibits further payments of benefits in excess of payroll taxes (and premiums), and there is no authority allowing the trust funds to borrow from the general fund of the Treasury. Either benefits must be reduced, payroll taxes increased, premiums hiked (for Medicare), or more radical reforms will be necessary, any of which would require congressional action. In the case of Social Security (combining OASI and DI), the projected growth of “excess benefits” is such that the future, cumulative shortfall represents 25% of projected benefits!

Again, the mandatory entitlement spending programs are technically insolvent. Charles Blahous discusses the implications of closing the funding gap, both in terms of payroll tax increases or benefit cuts, either of which will be extremely unpopular:

“How likely is it that lawmakers would immediately cut benefits by 25% for everyone, rich and poor, retiring next year and beyond? More likely, lawmakers would phase in reforms gradually, necessitating much larger eventual benefit changes for those affected—perhaps 30% or 40%. And if we want to spare lower-income individuals from reductions, they’d need to be still greater for everyone else.”

It should be noted that Medicaid is also a budget drain, though the cost is shared with state governments.

Discretionary vs. Mandatory Budgets

When it comes to federal budget controversies, discretionary budget proposals receive most of the focus. The federal deficit reached unprecedented levels in 2020 and 2021 as pandemic support measures led to huge increases in spending. Even this year (2022), the projected deficit exceeds the 2019 level by over $160 billion. Joe Biden would like to spend much more, of course, though the loss of proceeds from his student loan forgiveness giveaway does not even appear in the Administration’s budget proposal. Biden proposes to pay for the spending with a corporate tax hike and a minimum tax on very high earners, including an unprecedented tax on unrealized capital gains. Those measures would be disappointing in terms of revenue collection, and they are probably worse for the economy and society than bigger deficits. None of that is likely to pass Congress, but we’ll still be running huge deficits indefinitely..

In a further complication, at this point no one really believes that the federal government will ever pay off the mounting public debt. More likely is that the Federal Reserve will make further waves of monetization, buying government bonds in exchange for monetary assets. (Of course, money is also government debt.) The conviction that ever increasing debt levels are permanent is what leads to fiscal inflation, which taxes the public by devaluing the public debt, including (or especially) monetary assets. The insolvency of the trust funds is contributing to this process and its impact is growing..

Again, the budget discussions we typically hear involve discretionary components of the federal budget. Mandatory outlays like Social Security, Medicare, and Medicaid are nearly three times larger. Here is a good primer on the mandatory spending components of the federal budget (which includes interest costs). Blahous notes elsewhere that the funding shortfall in these programs will ultimately dwarf discretionary sources of budgetary imbalance. The deficit will come to be dominated by the borrowing required to fund mandatory programs, along with the burgeoning cost of interest payments on the public debt, which could reach nearly 50% of federal revenues by 2050.

Conclusion

It would be less painful to address these funding shortfalls in mandatory programs immediately than to continue to ignore them. That would enable a more gradual approach to changes in benefits, payroll taxes, and premiums. Politicians would rather not discuss it, however. Any discussion of reforms will be controversial, but it’s only going to get worse over time.

Political incentives being what they are, current workers (future claimants) are likely to bear the brunt of any benefit cuts, rather than retirees already enrolled. Payroll tax hikes are perhaps a harder sell because they are more immediate than trimming benefits for future retirees. Other reforms like self-directed Social Security contributions would create better tradeoffs by allowing investment of contributions at competitive (but more risky) returns. Medicare has premiums as an extra lever, but there are other possible reforms.

Again, the time to act is now, but don’t expect it to happen until the crisis is upon us. By then, our opportunities will have become more hemmed in, and something bad is more likely to be promulgated in the rush to save the day.

Fiscal Inflation Is Simple With This One Weird Trick

03 Thursday Feb 2022

Posted by in Fiscal policy, Inflation

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I’ll get to the weird trick right off the bat. Then you can read on if you want. The trick really is perverse if you believe in principles of sound credit and financial stability. To levy a fiscal inflation tax, all the government need do is spend like a drunken sailor and undermine its own credibility as a trustworthy borrower. One way to do that: adopt the policy prescriptions of Modern Monetary Theory (MMT).

A Theory of Deadbeat Government

That’s right! Run budget deficits and convince investors the debt you float will never be repaid with future real surpluses. That doesn’t mean the government would literally default (though that is never outside the realm of possibility). However, given such a loss of faith, something else must give, because the real value government debt outstanding will exceed the real value of expected future surpluses from which to pay that debt. The debt might be in the form of interest-bearing government bonds or printed money: it’s all government debt. Ultimately, under these circumstances, there will be a revised expectation that the value of that debt (bonds and dollars) will be eroded by an inflation tax.

This is a sketch of “The Fiscal Theory of the Price Level” (FTPL). The link goes to a draft of a paper by John Cochrane, which he intends as an introduction and summary of the theory. He has been discussing and refining this theory for many years. In fairness to him, it’s a draft. There are a few passages that could be written more clearly, but on the whole, FTPL is a useful way of thinking about fiscal issues that may give rise to inflation.

Fiscal Helicopters

Cochrane discusses the old allegory about how an economy responds to dollar bills dropped from a helicopter — free money floating into everyone’s yard! The result is the classic “too much money chasing too few goods” problem, so dollar prices of goods must rise. We tend to think of the helicopter drop as a monetary policy experiment, but as Cochrane asserts, it is fiscal policy.

We have experienced something very much like the classic helicopter drop in the past two years. The federal government has effectively given money away in a variety of pandemic relief efforts. Our central bank, the Federal Reserve, has monetized much of the debt the Treasury issued as it “loaded the helicopter”.

In effect, this wasn’t an act of monetary policy at all, because the Fed does not have the authority to simply issue new government debt. The Fed can buy other assets (like government bonds) by issuing dollars (as bank reserves). That’s how it engineers increases in the money supply. It can also “lend” to the U.S. Treasury, crediting the Treasury’s checking account. Presto! Stimulus payments are in the mail!

This is classic monetary seigniorage, or in more familiar language, an inflation tax. Here is Cochrane description of the recent helicopter drop:

“The Fed and Treasury together sent people about $6 trillion, financed by new Treasury debt and new reserves. This cumulative expansion was about 30% of GDP ($21,481) or 38% of outstanding debt ($16,924). If people do not expect that any of that new debt will be repaid, it suggests a 38% price-level rise. If people expect Treasury debt to be repaid by surpluses but not reserves, then we still expect $2,506 / $16,924 = 15% cumulative inflation.”

FTPL, May I Introduce You To MMT

Another trend in thought seems to have dovetailed with the helicopter drop , and it may have influenced investor sentiment regarding the government’s ever-weakening commitment to future surpluses: that would be the growing interest in MMT. This “theory” says, sure, go ahead! Print the money government “must” spend. The state simply fesses-up, right off the bat, that it has no intention of running future surpluses.

To be clear, and perhaps more fair, economists who subscribe to MMT believe that deficits financed with money printing are acceptable when inflation and interest rates are very low. However, expecting stability under those circumstances requires a certain level of investor confidence in the government fisc. Read this for Cochrane’s view of MMT.

Statists like Bernie Sanders, Alexandria Ocasio-Cortez, and seemingly Joe Biden are delighted to adopt a more general application of MMT as intellectual cover for their grandiose plans to remake the economy, fix the climate, and expand the welfare state. But generalizing MMT is a dangerous flirtation with inflation denialism and invites economic disaster.

If This Goes On…

Amid this lunacy we have Joe Biden and his party hoping to find avenues for “Build Back Better”. Fortunately, it’s looking dead at this point. The bill considered in the fall would have amounted to an additional $2 trillion of “infrastructure” spending, mostly not for physical infrastructure. Moreover, according to the Congressional Budget Office, that bill’s cost would have far exceeded $2 trillion by the time all was said and done. There are ongoing hopes for separate passage of free community college, an extended child tax credit for all families, a higher cap for state and local income tax deductions, and a host of other social and climate initiatives. The latter, relegated to a separate bill, is said to carry a price tag of over $550 billion. In addition, the Left would still love to see complete forgiveness of all student debt and institute some form of universal basic income. Hey, just print the money, right? Warm up the chopper! But rest easy, cause all this appears less likely by the day.

Are there possible non-inflationary outcomes from ongoing helicopter drops that are contingent on behavior? What if people save the fresh cash because it’s viewed as a one-time windfall (i.e., not a permanent increase in income)? If you sit on such a windfall it will erode as prices rise, and the change in expectations about government finance won’t be too comforting on that score.

There are many aspects of FTPL worth pondering, such as whether bond investors would be very troubled by yawning deficits with MMT noisemakers in Congress IF the Fed refused to go along with it. That is, no money printing or debt monetization. The burgeoning supply of debt would weigh heavily on the market, forcing rates up. Government keeps spending and interest costs balloon. It is here where Cochrane and critics of FTPL have a sharp disagreement. Does this engender inflation in the absence of debt monetization? Cochrane says yes if investors have faith in the unfaithfulness of fiscal policymakers. Excessive debt is then every bit as inflationary as printing money.

Real Shocks and FTPL

It’s natural to think supply disruptions are primarily responsible for the recent acceleration of inflation, rather than the helicopter drop. There’s no question about those price pressures in certain markets, much of it inflected by wayward policymakers, and some of those markets involve key inputs like energy and labor. Even the median component of the CPI has escalated sharply, though it has lagged broader measures a bit.

Broad price pressures cannot be sustained indefinitely without accommodating changes in the supply of money, which is the so-called “numeraire” in which all goods are priced. What does this have to do with FTPL or the government’s long-term budget constraint? The helicopter drop certainly led to additional money growth and spending, but again, FTPL would say that inflation follows from the expectation that government will not produce future surpluses needed for long-term budget balance. The creation of either new money or government debt, loaded the chopper as it were, is sufficient to accommodate broad price pressures over some duration.

Conclusion

Whether or not FTPL is a fully accurate description of fiscal and monetary phenomena, few would argue that a truly deadbeat government is a prescription for hyperinflation. That’s an extreme, but the motivation for FTPL is the potential abandonment of good and honest governing principles. Pledging an inflation tax is not exactly what anyone means by the full faith and credit of the U.S. government.

Price Controls: Political Gut Reaction, Gut Punch To Public

06 Thursday Jan 2022

Posted by in Price Controls, Shortage

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In a gross failure of education or perhaps memory, politicians, policymakers, and certain academics seem blithely ignorant of things we’ve learned repeatedly. And of all the dumb ideas floated regarding our current bout with inflation, the notion of invoking price controls is near the top. But watch out, because the Biden Administration has already shifted from “inflation is transitory” to “it only hurts the rich” to “it’s fine because people just want to buy things”, and now “greedy businessmen are the culprits”. The latter falsehood is indeed the rationale for price controls put forward by a very confused economist at the University of Massachusetts-Amherst named Isabella Weber. (See this for an excerpt and a few immediate reactions.) She makes me grieve for my profession… even the frequently ditzy Paul Krugman called her out, though he softened his words after realizing he might have offended some of his partisan allies. Of course, the idea of price controls is just bad enough to gain favor with the lefty goofballs pulling Biden’s strings.

To understand the inflation process, it’s helpful to distinguish between two different dynamics:

1. When prices change we usually look for explanations in supply and demand conditions. We have supply constraints across a range of markets at the moment. There’s also a great deal to say about the ways in which government policy is hampering supplies of labor and energy, which are key inputs for just about everything. It’s fair to note here that, rather than price controls, we just might do better to ask government to get out of the way! In addition, however, consumer demand rebounded as the pandemic waned and waxed, and the federal government has been spending hand over fist, with generous distributions of cash with no strings attached. Thus, supply shortfalls and strong demand have combined to create price pressures across many markets.

2. Economy-wide, all dollar prices cannot rise continuously without an excess supply of a monetary asset. The Federal Reserve has discussed tapering its bond purchases in 2022 and its intention to raise overnight interest rates starting in the spring. It’s about time! The U.S. money supply ballooned during 2020 and its growth remains at a gallop. This has enabled the inflation we are experiencing today, and only recently have the markets begun to react as if the Fed means business.

Weber, our would-be price controller, exhibits a marked ignorance with respect to both aspects of price pressure: how markets work in the first instance, and how monetary profligacy lies at the root of broader inflation. Instead, she insists that prices are rising today because industrialists have simply decided to extract more profit! Poof! It’s as simple as that! Well what was holding those greedy bastards back all this time?

Everyone competes for scarce resources, so prices are bid upward when supplies are short, inputs more costly, or demand is outpacing supply for other reasons. Sure, sellers may earn a greater margin on sales under these circumstances. But the higher price accomplishes two important social objectives: efficient rationing of available quantities, and greater incentives to bring additional supplies to market.

So consider the outcome when government takes the advice of a Weber: producers are prohibited from adjusting price in response to excess demand. Shortages develop. Consumers might want more, but that’s either impossible or it simply costs more. Yet producers are prohibited from pricing commensurate with that cost. Other adjustments soon follow, such as changes in discounts, seller credit arrangements, and product quality. Furthermore, absent price adjustment, transaction costs become much more significant. Other resources are consumed in the mere process of allocating available quantities: time spent in queues, administering quotas, lotteries or other schemes, costly barter, and ultimately unsatisfied needs and wants, not to mention lots of anger and frustration. Lest anyone think this process is “fair”, keep in mind that it’s natural for these allocations to take a character that is worse than arbitrary. “Important people” will always have an advantage under these circumstances.

Regulatory and financial burdens are imposed on those who play by the rules, but not everyone does. Black market mechanisms come into play, including opportunities for illegal side payments, rewards for underworld activity, along with a general degradation in the rule of law.

Price controls also impose rigidity in relative prices that can be very costly for society. “Freezing” the value of one good in terms of others distorts the signals upon which efficient resource allocation depends. Tastes, circumstances, and production technology change, and flexible relative prices enable a smoother transitions between these states. And even while demand and/or input scarcity might increase in all markets, these dynamics are never uniform. Over time, imbalances always become much larger in some markets than others. Frozen relative prices allow these imbalances to persist.

For example, the true value of good A at the imposition of price controls might be two units of good B. Over time, the true value of A might grow to four units of good B, but the government insists that A must be traded for no more than the original two units of B. Good B thus becomes overvalued on account of government intervention. The market for good A, which should attract disproportionate investment and jobs, will instead languish under a freeze of relative prices. Good B will continue to absorb resources under the artificial tradeoff imposed by price controls. Society must then sacrifice the gains otherwise afforded by market dynamism.

The history of price controls is dismal (also see here). They artificially suppress measured inflation and impose great efficiency costs on the public. Meanwhile, price controls fail to address the underlying monetary excess.

Price controls are destructive when applied economy-wide, but also when governments attempt to apply them to markets selectively. Posturing about “strategic” use of price controls reveals the naïveté of those who believe government planners can resolve market dislocations better than market participants themselves. Indeed, the planners would do better to discover, and undo, the damage caused by so many ongoing regulatory interventions.

So beware Joe Biden’s bluster about “greedy producers” in certain markets, whether they be in “Big Meat”, or “Big Oil”. Price interventions in these markets are sure to bring you less meat, less oil, and quite possibly less of everything else. The unintended consequences of such government interventions aren’t difficult to foresee unless one is blinded with the scientism of central planning.

Stagflation and the Supply of Bad Public Policy

20 Wednesday Oct 2021

Posted by in Inflation

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Price inflation is getting more attention now than it has in many years, but not everyone is convinced it will persist, most conspicuously bond investors. The Biden Administration’s initial narrative was plausible even if there were seeds of doubt: a price spike was to be expected relative to the low-ebb of price changes during the pandemic. However, the inflation data has come in strong since the spring, and events point to continuing price pressures and the potential for expected inflation to drive escalations in contract pricing. Once embedded like that, the phenomenon broadens and gets harder to squeeze out.

Broadening Price Hikes

The evidence at hand is never enough to take much comfort in predictions, and the uncertainties now are similar to those I discussed in June. At the time, the price moves had been pronounced only in the prior month or so, and there was no evidence of any breadth. Now, it’s at least clear that increases in the so-called “core” Consumer Price Index (CPI), which excludes food and energy prices, have escalated. In addition, the growth in the median component of the CPI basket reported by the Federal Reserve Bank of Cleveland has begun to jump. So has the “trimmed CPI”, which excludes the most extreme 8% of prices changes in both directions within the index. The chart below shows one-month changes in these gauges:

So the recent upward price trends have expanded in breadth, and their persistence is making it a little harder to argue that the changes are transitory rebounds from pandemic weakness.

Bond Investors Still Nonchalant

Investors are by no means convinced that the recent price pressures will persist. They have an incentive to bid-up bond yields to compensate for expected inflation, so these yields can be used to infer inflation expectations. The chart below from the Federal Reserve Bank of St. Louis shows the five-year “breakeven” inflation rate, which is derived from inflation-indexed versus unindexed Treasury securities.

The pattern does not suggest that a meaningful change in inflation expectations has taken place. In fact, the implied five-year inflation forecast has edged down a bit. Of course, we’re still worrying about a fairly short period of high month-to-month changes in prices, and five years is a long time in that context.

This “casual” reaction of interest rates to the inflation spike undoubtedly reflects investors’ belief that the Federal Reserve will tighten policy in an effort to contain inflation. Some of us have strong doubts about the Fed’s inflation-fighting resolve, however. There is little the Fed can do to relieve supply-side problems, and many would argue that the Fed should take an accommodative stance in an attempt to minimize output and job losses, but that would reinforce the inflationary effects. There is no easy way out. Risks loom in both directions, and though I might regret it, at recent yields, I’m not buying Treasury bonds.

Sources of Price Pressure

Economists have tended to divide price pressures into those driven by demand and those driven by supply. Sometimes the terms “demand-pull” and “cost-push” inflation are used for shorthand. The former is usually associated with economic growth, where rising prices indicate that demand is outpacing gains in capacity. With cost-push inflation, however, rising prices indicate that production snd supply is somehow impeded. You get higher prices and lower output. This is so-called “stagflation”. Today we seem to have a combination of those inflationary forces in play: demand has rebounded from the pandemic lows of 2020, while breakdowns in the supply chain have choked production, with a consequent need for more severe price rationing. If the latter forces win out, we will have entered a stagflationary episode.

Unfortunately, administration policies are exacerbating supply-side inflationary pressures. Officials first insisted that the jump in inflation measures would be transitory. More recently they’ve said that it really only hurts “the rich”, an assertion that is decidedly false. Biden flaks are doing their level best to put lipstick on a pig. “Peppermint” Psaki says it shows that people just want to buy things! On the other hand, the Washington Post encourages us to “lower our expectations”. Um, yeah… I think we’re there!

Burning Energy Producers and Consumers

Energy policy is an obvious case: while a hurricane moving through the Gulf of Mexico took a big bite out of domestic oil production, Biden took several steps to hamstring the domestic fossil fuel industry at a time when the economy was still recovering from the pandemic. This included revoking permits for the Keystone pipeline, a ban on drilling on federal lands and federally-controlled waters in the Gulf, shutting down production on some private lands on the pretext of enforcing the Endsngered Species Act, and capping methane emissions by oil and gas producers. And all that was apparently just a start.

As Mark Theisen notes, when you promise to destroy a particular industry, as Joe Biden has, by taxing and regulating it to death, who wants to invest in or even maintain production facilities? Some leftists with apparent influence on the administration are threatening penalties against the industry up to and including prosecution for “crimes against humanity”! This is moronic, of course, but perhaps these extremists are just trying to move the Overton Window. Fossil fuels have been and still are a miracle in terms of human well-being, and renewable (but intermittent) energy sources are simply not capable of replacing the lost power, as Germans, Californians, and Texans are learning. Furthermore, the effort to kill fossil fuels amounts to a war on the poor. Americans are facing steep increases in their utility bills and blackouts during the times when power is needed most. Now, Biden is actively trying to wheedle more oil production out of OPEC, as if it’s okay for those nations to extract it, but not for us to do so!

Labor Shortage

Have you heard it’s hard to get help these days? You’ll notice it pretty fast if you have regular occasion to deal with service establishments. Goods are getting scarce on the shelves as well. Food and paper goods are getting pricier. The semiconductor shortage has been prominent, impacting production and pricing of electronics, computers, and new cars, with a big cross-effect on the used car and rental car markets. Everywhere you look, sellers seem short of inventory. This year it might be tough to fill the space under the Christmas tree for lack of availability.

This isn’t just about cargo ships unable to unload at the ports, although that’s significant. Patrick Tyrell and Anthony B. Kim note the difficulty of overcoming the supply chain breakdowns even with 24/7 operations at the ports. Tyrell snd Kim offer this quite from the Financial Times:

“The US is facing a shortage of warehouse space and truck drivers, and shifting to 24/7 operation will require enormous co-ordination between the publicly operated ports and private sector groups, including large retailers and freight companies.”

There are several reasons for the labor shortage: a few workers and businesses might still be living in fear of COVID, especially in “blue” states and urban areas where the fear factor seems to have been more palpable. That’s where the high unemployment is. There has also been an apparent wave of retirements among late baby-boomers who were already on the cusp of hanging up their skates. However, the Biden Administration has instigated a set of ill-advised policies that blunt work incentives, leading to reduced labor force participation: the repeated extensions of pandemic-related unemployment benefits; increased child and dependent care tax benefits; the moratorium on evictions from rental property; the elimination of work requirements for expanded Medicaid coverage; and increased EBT and SNAP benefits. This is not hard to understand: if you pay people to stay home, they will stay home, even as you suffer through an interminable wait for your fast food. But there might not be a wait at Dunkin’ Donuts, because they’ve been running short on donuts due to “supply chain issues”!

Destructive Public Policy

COVID policy contributed to the early plunge in demand in 2020. Economic output declined, and ramping-up production is not always a simple thing. In this case, it was hindered by repeated non-pharmaceutical interventions and confused messaging from public health authorities. These are issues I’ve felt compelled to address too many times on my blog over the past 18 months. The negative economic effects of these policies continue to linger, and it should surprise no one.

The Democrats’ so-called “social infrastructure” bill, which looks mercifully unlikely to pass without major curtailments in scale and scope, would exacerbate many of the problems cited above. As I’ve noted recently, it’s more of an “infra-shackle” bill for the private economy than an infrastructure bill. For $3.5 trillion (an understatement based on budget gimmickry), we get heavy regulation and taxes, particularly on fossil fuels, subsidies for uneconomic technologies, assorted entitlements with no means testing, wage- and job-killing (and inflationary) hikes in corporate taxes, and other tax disincentives to private investment. The bill would represent a huge reallocation from the private to the public sector via coercion and public competition for scarce resources.

As if that wasn’t bad enough, now Biden has issued his legally dubious vaccine mandate, which has been met with outrage among many workers, from Chicago cops and other public servants, health care workers, truckers and workers at such corporate giants as Boeing, Southwest Airlines, and many others. Unions are furious. People are walking out. This represents a negative “supply shock”, an unexpected event that hinders production and boosts prices. Joe Biden looks to be well on his way to earning the title of “The Stagflation President”.

I’ll leave you with this gem from Brian Dunn: