The Cure for Inflation

Every politician promises to fight inflation. Every election brings new proposals to lower prices. Yet very few public officials spend much time explaining what inflation is, why it occurs, or how they plan to fix it. That is unfortunate because understanding inflation is quite simple. Implementing the cure, however, is exceedingly difficult.

It all begins with supply and demand. When supply and demand are out of balance, prices change. If demand exceeds supply, prices rise until economists' favorite word, "equilibrium," is reached. With rising prices, demand decreases and supply increases until prices stabilize. Conversely, if supply exceeds demand, prices fall until equilibrium is restored. This is Economics 101, and most Americans understand it intuitively.

We see these price changes every day in individual products. Last year, for example, egg prices skyrocketed because millions of chickens died from avian influenza. There simply were not enough eggs to satisfy consumer demand. Prices rose sharply until producers rebuilt their flocks and supply recovered. Once supply increased, egg prices fell. The government neither created nor solved that problem. Markets did exactly what they are designed to do. Higher prices encouraged producers to increase production, additional supply entered the market, and prices came back down.

That was not inflation. It was simply supply and demand at work.

Inflation is very different. Inflation is a general increase in prices throughout the economy, and it occurs when the supply of money grows faster than the supply of goods and services. If consumers suddenly have more money to spend while businesses are producing roughly the same quantity of goods, people compete for a limited supply of products. The inevitable result is that prices rise across virtually every sector of the economy.

The uncomfortable truth is that government policy is usually responsible. The Federal Reserve controls the nation's money supply, and when that money supply expands too rapidly, inflation follows. We saw it unfold during 2021 and 2022. In the wake of the pandemic, the money supply expanded at extraordinary rates, exceeding 20 percent annually. Inflation did not appear immediately because it takes months for the money supply to impact inflation, but once that excess money began circulating throughout the economy, inflation surged above 9 percent. Eventually, the Federal Reserve tightened monetary policy, slowed the growth of the money supply, and moderated inflation.

Bad monetary policy is often the consequence of bad fiscal policy. Washington continues to spend far more money than it collects. Annual federal deficits now exceed $2 trillion, and the Congressional Budget Office projects deficits approaching $3 trillion per year in the years ahead. Those deficits must be financed somehow.

There are only two ways to do it. The government can borrow from the public, which simply transfers existing savings from private investors to the Treasury without increasing the money supply. Or it can effectively borrow from the Federal Reserve, which creates new money. That approach expands the money supply and fuels inflation. Even borrowing from the public carries significant economic costs because every dollar invested in government debt is a dollar unavailable for private investment, business expansion, technological innovation, or job creation. Productive capital is diverted from the private economy to finance government.

The cure is obvious — balance the damn budget.

If Washington reduced spending and ended chronic trillion-dollar deficits, inflationary pressures would abate, along with reducing interest rates. Doing this — increasing capital for investment and lowering interest rates would dramatically increase economic growth. Everyone benefits from this.

History demonstrates this.

Following World War II, the United States carried enormous debt accumulated during the war. Unlike today's structural deficits, however, those obligations resulted from a temporary national emergency. During the following two decades, government remained relatively small, and fiscal discipline largely prevailed as federal debt grew less than one percent annually. The result was one of the greatest periods of prosperity in American history. The economy expanded by roughly 6 percent annually, ultimately more than tripling in size. Businesses flourished, wages rose, families accumulated wealth, and living standards improved dramatically across the board.

What is difficult is getting Congress to do this. Congress is focused on the next election, not the next generation, and has little incentive to balance the budget. Many voters expect more government services while opposing the taxes necessary to pay for them. Politicians respond by promising benefits today while mortgaging our country’s future.

America's debt increasingly resembles a financial structure dependent upon perpetual borrowing simply to sustain itself — a classic Ponzi scheme. Every Ponzi scheme eventually fails when new borrowing is no longer available to pay old obligations and cover new losses. When that day finally arrives, our kids and grandkids will be asking: Didn’t Congress understand economics?

Les Rubin is the Founder and President of Main Street Economics.

Editor's Note: Do you enjoy Townhall's conservative reporting that takes on the radical Left and woke media? Support our work so that we can continue to bring you the truth.

Join Townhall VIP and use promo code FIGHT to receive 60% off your membership.