The Federal Reserve just raised its federal funds rate target for the 10th meeting in a row over the last year to 5.25%–the highest since August 2007. This is in response to multi-decade high inflation rates due to government failures. While this monetary tightening was inevitable, the pain didn’t have to be this bad. But excessive government spending and money printing during the “boom” led to this bust.
The sluggish economic growth has been rough on Americans but inflation has been a killer. According to a recent CNBC survey, pessimism regarding the American economy is at an all-time high, with 69% of the public having a negative view. The leading reason is inflation in a weak economy. Inflation remains persistently high at 5%, eroding slower-growing average weekly earnings year-over-year for 24 straight months.
This is devastating lower-income households’ standard of living. The survey also noted, “Just 5% say their household income is growing faster than inflation, 26% say it’s keeping pace and 67% report they are falling behind.”
The trend of declining real wages is particularly harmful to low-income Americans. But even the wealthy feel the effects, as more than half of upper-income Americans surveyed report spending less on eating out and entertainment. This has contributed to the anemic annualized economic growth of just 1.1% in the first quarter of 2023 after rising by only 0.9% from the fourth quarter of 2021 to the fourth quarter of 2022.
As prices increase, businesses spend more on production, making it more difficult to raise workers’ wages while remaining profitable. Employees who can’t be paid enough to pay for costly goods like groceries and childcare, which has risen roughly 7%, purchase less. Businesses earning less revenue will invest less, and so goes the vicious downward cycle.
Another hit on Americans has been the cost of housing which has been rising faster than general inflation though it has started to stabilize recently, but housing prices have been “eclipsing the inflation rate by 150% since 1970.” Many Americans can’t afford owning a home and that’s getting further out of reach with higher interest rates as mortgage rates have soared.
What’s to be done about inflation threatening Americans’ livelihoods? Legendary economist Milton Friedman had some advice about rewinding sky-rocketing inflation that is valuable today.
“There is one and only one basic cause of inflation: too high a rate of growth in the quantity of money—too much money chasing the available supply of goods and services,” he argues. “These days, that cause is produced in Washington, proximately, by the Federal Reserve System, which determines what happens to the quantity of money; ultimately, by the political and other pressures impinging on the System, of which the most important are the pressures to create money in order to pay for exploding Federal spending and in order to promote the goal of ‘full employment.’”
Despite raising its target interest rate to fight inflation, the Fed has a bloated balance sheet of nearly $9 trillion, which is too high to reduce inflation down to its target of an average 2% rate. When the Fed engages in excessive money printing compared with the supply of goods and services, inflation is the result, as Friedman described.
It was appropriate for the Fed to raise its target rate but another way that it manipulates the economy directly is through its bloated balance sheet. The Fed should cut it more aggressively to reduce persistent inflation and remove many distortions throughout the economy.
And Congress must restrain spending. The national debt is over $31 trillion, with net interest on the debt set to exceed $1 trillion soon, which is a very costly situation.
The government must borrow to finance the deficit when it spends more than it makes driving up interest rates. Higher interest rates increase the cost of borrowing for businesses, leading to lower investment, which reduces the supply of goods and services. Add in the Fed buying the debt that increases the money supply with less supply of goods and services and the result is more inflation.
Fortunately, House Republicans passed a debt ceiling bill that will return spending to 2022 levels and limit spending to just 1% growth over the next decade while eliminating other bad policies. This is a step in the right direction that Democrats in the Senate and President Biden should support, though they probably won’t, which will make the debt issue an ongoing concern, further raising interest rates that weaken the economy.
This means we can expect a deeper recession this year. The Fed and Congress have a duty to stop flawed policies of excessive printing and spending. High inflation harms Americans, and the Fed and Congress must address this. If they do not take action soon, the erosion of the American dream will continue.
The future of America depends on sound, pro-growth policies instead that will let people prosper.
Vance Ginn, Ph.D., is the founder and president of Ginn Economic Consulting, LLC, chief economist or senior fellow at multiple think tanks across the country, and is the host of the “Let People Prosper” podcast. He previously served as the chief economist of the White House’s Office of Management and Budget, 2019-20. Follow him on Twitter @VanceGinn.