(A quick note: My apologies for a long absence. The past month has been very busy. But this article is just a relevant now as when I started writing it a month ago. Thank you for your patience!)
How do we fight inflation?
Source: Pixabay. CC0.
Inflation has taken off. It was under control for over a decade. Now it’s accelerated to more than 8%. Some are concerned that we could see double-digit inflation soon.
Inflation is caused by too many dollars chasing too few goods. It’s a fire that’s burning out of control. There are two ways for policymakers to fight inflation – take away the dollars (limiting the oxygen in the room), or increase the amount of goods (spraying a little water on the fire). Federal Reserve policy is focused on the first, trying to hold back the demand-side of the economy. They do this by tightening credit conditions, making it harder to borrow money. Tighter credit slows corporate expansion plans and can slow consumer demand: loans are more expensive, banks ask for more documents, dodgy lending companies get a harder time from regulators, etc. The job of the Federal Reserve, according to longtime Chair William Martin, is to “take away the punchbowl just as the party is getting going.”
This isn’t a fun job. Fed Chairs are not generally popular. Rather, they’re often punching bags for members of Congress looking to make headlines or score a few sound bites that they can use during their election cycle.
The other way to fight inflation is to provide more goods. The Fed can’t do that.
Consumer Price Index, all items. Source: BLS.
The Fed can’t fly more airline flights or pump more oil or ship wheat from Odessa to Alexandria. But the global economy can. The Fed’s role is to restrain a red-hot economy by limiting the oxygen in the room, hopefully not asphyxiating the entire economy in the process. The Federal and State governments can also do their part as well, by getting the government out of the way of people who want to provide more goods and services. Enhanced productivity is the sprinkler system that can tame inflation.
That’s the lesson we learned the last time inflation was out of control. Paul Volker is lauded as an “Inflation slayer” when he led the Fed, but the Federal government’s supply-side initiatives made an equally huge impact. Capital gains taxes were cut under both the Carter and Reagan Administrations from 40% to 20% between 1978 and 1981, spurring massive investments. These investments led to productivity-enhancing innovations, which ultimately provided the additional goods necessary to drive inflation lower. In 1978 the Iranian Crisis caused oil prices to quadruple. By 1986, increased oil production caused them to fall back to their pre-crisis levels. It’s a lot less painful to cool off with water than by sucking all the air out of a room!
Two fighters: Ronald Reagan and Muhammad Ali, 1983. Source: Wikipedia. Public Domain
We can fight inflation personally, by focusing on being more productive, creating more value with fewer resources. In my business today I’m far less occupied with bureaucratic details and far more focused on getting stuff done. For each of us, this may mean investing in productivity enhancements – a faster computer, a more efficient car, an advanced course. Credentials and status aren’t as important as the skills and expertise we bring to our jobs.
Inflation is here and it’s real, but it doesn’t have to derail our economy or our lives. The key to fighting inflation is recognizing its reality and making changes where we need to.