President Biden took to the pages of the Wall Street Journal to defend his economic record. He claims that “as supply chains continue to unsnarl, company profit margins fall from historically high levels, and rents continue to moderate, inflation should decline further, creating more breathing room for working families.” There’s an implicit theory of inflation here—but not a good one.
The President believes in cost-push inflation: Rising prices resulting from transportation and shipping difficulties, as well as greedy corporations and landlords, cause the dollar to depreciate. He’s got it exactly backwards. Dollar depreciation is why prices are rising. The Fed’s monetary policy, aided and abetted by the President’s and Congress’s massive deficits, are the real cause. It’s old-fashioned, aggregate demand-driven inflation. By greenlighting excessive spending, which the Fed felt compelled to underwrite, the President is complicit in it.
Let’s tackle the three parts of the President’s explanation. Supply chain problems seem a likely cause of inflation. After all, as bottlenecks develop, prices rise. But what goes up must come down. COVID-induced bottlenecks have largely passed, and the relevant prices have accordingly fallen. Yet consumer prices overall have not fallen. The theory predicts deflation, when instead we’re experiencing disinflation. Strike one.
Next, the President blames corporate profits. Supposedly profit-hungry corporations are using their market power to hike prices. This “greedflation” hypothesis is very popular. It’s also astonishingly easy to disprove. Basic economic theory tells us that if firms are profit-maximizers, they can’t pass on the full value of cost markups to consumers. In fact, as costs rise, the markup falls. This is devastating for greedflation partisans because it uses the assumption of greed (profit maximization) to show the postulated conclusion (inflation) cannot follow. The most you can get is a one-time price increase, one that is smaller than the increase in business costs—and with reduced profit margins, besides. Strike two.
What about rents? Rent is a major part of consumer spending, and it’s certainly going up. But from 2020 to 2022, it’s only rarely risen faster than inflation (and even then, only if you parse the data in a certain way). If a particular component of consumer spending were behind surging prices, you’d expect that component to be larger than average, pulling inflation up. Not so in this case. Furthermore, there’s a conceptual confusion here. Inflation can cause rents to rise, but supply and demand in housing markets can, too. What we’re seeing is likely microeconomic forces in a particular segment of the economy, rather than a general macroeconomic trend. Strike three.
President Biden misses the obvious cause: massive monetary stimulus by the Fed during the COVID years. From January 2020 to 2022, the monetary base and M2 money supply rose 59 percent and 38 percent, respectively. The federal government also ran massive deficits over those years. COVID spending in excess of revenues was $6 trillion; $3.3 trillion of the resulting government bonds ended up on the Fed’s balance sheet. That means the central bank monetized more than half the deficit.
President Biden famously scoffed that “Milton Friedman isn’t running the show anymore.” The President can gripe about the great monetarist and Nobel laureate all he likes, but he can’t escape the implications of Friedman’s argument. Since inflation is a monetary phenomenon, the government’s excessive money-fueled spending is to blame.
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