US can fight inflation and still 'build back better'
Opinion by Jeffrey D. Sachs | CNN.com
November 13, 2021
Editor's Note: Jeffrey Sachs is a professor and director of the Center for Sustainable Development at Columbia Universit and president of the United Nations Sustainable Development Solutions Network. His most recent book is "The Ages of Globalization" (Columbia University Press, 2020). The opinions expressed in this commentary are those of the author; view more opinion on CNN
(CNN) - Consumer prices in October 2021 were 6.2% higher than a year ago. This is the highest year-over-year price inflation since 1990. It raises three main questions. What is the cause? What should be done? And in particular, how should it affect the design of the Build Back Better (BBB) legislation?
There are several factors at play. None, however, should deflect from the importance of the longer-term Build Back Better agenda. The Wall Street Journal's editorial page, which leads the media campaign against tax increases on the rich and corporations, is calling on Congress to "kill the bill" in the supposed interest of fighting inflation. Sen. Joe Manchin, working tirelessly in favor of the rich and the corporate lobbyists, is also pointing to inflation as a reason to delay, cut, or oppose the legislation.
Such opposition to BBB completely mixes up the short-term and the long-term, and utterly confuses deficit spending to fight Covid-19 with fully paid-for spending to fund long-term reforms. BBB is not about the next month, or the next year; it is about the next generation.
We need to set a long-term direction for the country toward a fairer and more productive society by enabling the working poor in America to get health care, family leave, affordable drug prices, child care, and affordable community college.
Unlike the temporary Covid-19 spending, the long-term BBB outlays should be fully paid for by higher taxes on the rich and corporations, which have enjoyed a massive windfall in the past two years. If BBB is paid for with taxes, then it won't add to the public debt or create long-term inflationary pressures.
Inflation results when the overall demand for goods and services exceeds the available supply at today's prices. Therefore, inflation can result from a rise in demand, a fall in supply, or some combination of the two. Analyzing the current inflation requires that we parse the demand-side and supply-side factors at play.
This is not simple. The Covid-19 pandemic has whipsawed the economy, both in the US and globally, more than any other shock since World War II. The swings in demand and supply, because of lockdowns and government policies, are bigger than the 1970s oil shocks and the 2008 financial crisis.
We are in somewhat uncharted territory. Still, we can identify some of the key factors driving demand and supply.
The story starts, of course, with Covid-19. In March 2020, the US and world economy partially shut down to slow the spread of the virus. The shutdown mainly affected travel, tourism, hotels, entertainment, restaurants, and schools. Most of agriculture, mining, and manufacturing (the goods-producing sectors) continued operations, as did most office-bound activities that could be shifted online.
With tens of millions of service-sector jobs quickly ended, the government resorted to a massive transfer of income -- payments to households and businesses funded by deficits -- especially to keep household disposable income from plummeting. Money sent by the government to most Americans prevented the disastrous loss of income of tens of millions of households, which could have led to a massive collapse of consumer spending. In fact, households saved most of the government payments, as they were unable to spend the money on activities out of the home.
These payments were provided by Congress in three distinct packages, two under Trump, in March 2020 (CARES Act) and December 2020 (Consolidated Appropriations Act of 2021), and one under Biden, in March 2021 (American Rescue Plan). The federal government ran unprecedented peacetime deficits, around 14.9% of GDP in 2020 and 10.3% of GDP in 2021, to pay for the increased outlays.
In the meantime, the Federal Reserve bought up a remarkable amount of public debt, thereby expanding the monetary base by around $2.4 trillion between March 2020 and August 2021, and thereby preventing a liquidity crisis -- that is, a sudden drying up of lending and borrowing as occurred, for example, in the 2008 financial crisis. Much of the cheap money found its way into stock prices, which have soared. That in turn has boosted the wealth of the superrich.
These were extraordinary measures, certainly the largest fiscal and monetary expansion in peacetime history. It was indeed very hard to calibrate the proper magnitude of the response given the uncertainties over the size and timing of the Covid-19 disruption.
In retrospect, the demand measures were a bit too large, but we should still credit these strong steps with preventing a much deeper and prolonged economic downturn. The economy might well have fallen into a deep contraction or even a depression but for these proactive policies.
At the same time, the supply side has been negatively impacted, especially in three areas that account for a considerable amount of the recent price increases. First, when petroleum-based transportation plummeted in 2020, oil prices collapsed (even reaching a negative price in Texas one day in April 2020).
Saudi Arabia responded by cutting daily oil production by around 1 million barrels (from roughly 10 million to 9 million barrels per day). Yet when demand picked up this year, Saudi production was brought back online gradually, causing world oil prices to soar in the short term.
Second, a surge in demand for electronics components, notably microchips, has led to a shortage of parts for new car production, and a sharp fall in monthly automobile production in the US, from 197,000 cars in September 2020 to just 84,000 cars this September. This supply shortfall has caused the prices of new and used cars to soar.
Third, after a sharp fall in consumer demand for and production of meat products early on in the pandemic, demand for meat is now soaring while production and shipments are still lagging behind, causing sticker shock on consumer meat prices.
In summary, both demand-side and supply-side factors are at play. Overall, demand is high, pumped up by enormous budget deficits and easy money, while supply shortages are hitting energy, food products and automobiles. While energy prices are up 30% in October (over October 2020), meat prices are up 14.5%, new car and truck prices are up 9.8%, and used car and truck prices are up 26.4%, services other than energy are up by only 3.2%.
So, the question is what to do. First, the economy does not need any more fiscal or monetary stimulus. The budget deficit is expected to drop from 10.3% of GDP this year to around 4.6% of GDP in 2022, according to CBO estimates, and this is a good thing. The Fed, likewise, should tighten monetary policy step by step, with interest rates rising from today's rock-bottom levels (0.05% on 3-month treasury bills) to more historically normal levels in the next few years.
OPEC should increase production to reduce sky-high oil prices in the short run, and also plan for a downward trajectory of production over the coming years as electric vehicles replace cars with internal combustion engines, thereby driving down the global demand for oil.
In summary, inflation in the coming months should be controlled by ending stimulus spending, tightening monetary policy, slashing the budget deficit and increasing OPEC monthly oil production to counter the recent surge in global oil and gas prices.
At the same time, we should persevere in making long-term federal investments in health, education, and child care for the working poor, paying for those policies with higher taxes on the superrich and corporations.