James Carville, as head of Bill Clinton’s first presidential campaign, made famous the phrase “It’s the economy, stupid.” His purpose was to keep campaign workers, volunteers and probably even Bill Clinton focused on what mattered to the campaign at the time — the state of the economy. I have paraphrased this today to have us focus on what is, and what is not, important if we are to worry about inflation in our future.

Here is some data: the year-to-date change in the Consumer Price Index is 5.4 percent; for just 2021 so far, the CPI has increased by 7.1 percent, while the Producers Price Index increased 10.6 percent between January 2021 and June. In my opinion, we should be concerned, but let’s be concerned about the right things.

Inflation is defined as a continual rise in the general level of prices. In introductory economics we teach that a price rises when the quantity demanded exceeds the quantity supplied — when there is excess demand. As the price rises, excess demand diminishes and, eventually, the price stops rising. Inflation requires that excess demand is everywhere and continual even as prices rise.

At present, spokesmen for the Fed and others are saying that current inflation is only temporary. They argue that the pandemic reduced supply by disrupting supply chains and that supplemental unemployment compensation discouraged people to return to work. In addition, federal government pandemic relief packages increased demand in many sectors of the economy. With such things going on, demand should be greater than supply and prices should rise. However, with time, supply chain issues will be corrected while enlarged unemployment payments will end along with pandemic relief spending. This will bring excess demand to an end, and prices will stop rising.

For the attentive reader, this is not inflation. The underlying argument is popular in use, but it is wrong. Excess demand is correcting itself, not all prices are rising, and temporary does not mean continual.

Next, contrary to the opinion of many, excessive government deficit spending is, in and of itself, not inflationary. Deficits bring government borrowing. If the Treasury sells new deficit-required debt to private individuals and institutions, then these entities must spend less. So, spending is offset, and prices will not rise, and most certainly, not continually. Some prices may change temporarily as spending moves between the private and public sectors, but not continually.

Inflation requires that there is continual excess demand everywhere, not just somewhere. Reaching back to graduate school, Walras Law (not the relative of the sea lion and ignore the ‘s’) states that excess demand can be everywhere in every market only if there is an excess supply of money. Drawing on Milton Friedman, inflation is purely and simply only a monetary phenomenon.

Thus, worries over inflation need to be aimed at Federal Reserve policies, the associated changes to the monetary base and other monetary aggregates, and the issues that are driving central bank policymakers. Here is some more data. Concurrent with the start of the pandemic and continuing today, the Fed is buying $120 billion in Treasury securities and in mortgage-backed securities every month. Since then, the Fed has added $4 trillion to its balance sheet. The Fed is supporting Treasury borrowing and, no doubt, will continue doing so with the proposed $1.5 trillion in new infrastructure spending and the $3 trillion spending in new human infrastructure (whatever that is).

The Fed is in a tight spot. It is using monetary policy to finance unprecedent fiscal policy spending. This has added to the monetary base which is slowly leading to an excess supply of money and to our inflation potential.

So, if you are worried about inflation, worry about the Federal Reserve. Fed Chairman Jay Powell is up for reappointment by the President (with advice and consent in the Senate), and I bet he wants reappointment. What incentive does this create for him? Does the Fed have the courage to lean against the wind of rapidly expanding government deficit spending and stop budget accommodation? Until they do, the words of former Nobel Laurette Thomas Sargent (paraphrasing Milton Friedman) are very appropriate when he said, “Persistent high inflation is always and everywhere a fiscal phenomenon.”

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