Oct 19, 2022 - Economy & Business

Fiscal policy missing from the inflation fight

Illustration of a child's milk carton with a straw. On the side of the carton is a MISSING ad for Benjamin Franklin.

Illustration: Aïda Amer/Axios

At the risk of oversimplifying, there are two ways to fight inflation. One involves the central bank raising interest rates to throttle the money supply. In another, elected officials craft policies that temper demand and increase supply in the economy. Each has advantages and disadvantages.

Driving the news: Right now, the United States is relying almost exclusively on the first. It's putting pressure on the economy and financial system that would be less severe with a more balanced mix of inflation-fighting tools.

Why it matters: Fiscal policy is AWOL in the campaign to bring down prices, with a mix of policies that are either neutral or tend to make inflation worse by stimulating demand.

  • In turn, it's making the Fed's job harder and the pain of bringing down inflation worse, the Committee for a Responsible Federal Budget argues in a new paper.

The tradeoffs: There's a reason the Federal Reserve is the arm of government primarily responsible for keeping inflation in check.

  • It's staffed by technocrats with independence from the rest of the government, so it can move nimbly and decisively, even in ways that will prove politically unpopular.
  • It controls interest rates and other tools that have powerful effects on demand. If the Fed moves aggressively to bring down inflation, as it is now, it will eventually work.
  • But its tools are flawed. Steep interest rate increases disproportionately wallop housing and other interest-rate sensitive industries. It risks financial breakdowns and global disruption, and has the side effect of discouraging investment that would improve the medium-term outlook.

By contrast, fiscal policy is haphazard and slow-moving. It depends on the unpredictable Rube Goldberg machine of Congressional lawmaking.

  • But it also has a greater ability to fine-tune policies — for example, curbing demand by slowing wealthy households' spending without simultaneously hitting lower-income people.
  • If fiscal policymakers do more, the Fed would see the need to do less, mitigating some of the downsides of monetary tightening.

State of play: In the actual world we live in, the Fed is the only game in town. Other areas of policy at both the federal and state level have stimulated demand at a time the Fed is trying to reduce it.

  • That list includes the Biden administration's student debt cancellation, spending on veterans' benefits and state health care reimbursements, as well as state-level actions to send citizens checks.

The options: In its paper, CRFB identifies several areas where congressional action could help reduce inflation. These include:

  • Reducing demand directly, through either tax increases or spending cuts
  • Boosting the supply side of the economy by removing Social Security work disincentives in hopes of pulling more people into the labor force
  • Using targeted policies aimed at prices, such as reducing Medicare reimbursement rates that might help curtail health care inflation

What they're saying: "Monetary policy has only one tool, and it's a pretty good tool, but if you push on it too hard, it can cause serious financial turmoil and slower long-term growth by reducing investment," Marc Goldwein, the policy chief at CRFB, tells Axios.

  • "It would be better when inflation is this high to give it assistance, supplementing it with policies that can directly reduce prices," he said.
  • "What's unique about this moment is just how large the inflation-fighting effort is going to have to be and therefore how difficult it will be for the Fed to do it alone."
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