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Vance Ginn and Alexander William Salter: We Need Binding Rules to Solve Our Inflation and Debt Problems

Broken fiscal and monetary policies are part of a single pathology. We need to tackle them both. The U.S. is trapped in a vortex of money mischief and fiscal folly. The problem is bad federal policy. Without binding rules on irresponsible spending and money-printing, American households and businesses will continue to suffer.

Since the onset of the Covid-19 pandemic, the Fed’s excessive money creation has been a major driver of inflation. Prices across the economy have surged, reducing the dollar’s purchasing power. The most popular measure of inflation is the consumer price index. It’s up 7.5 percent year-over-year. The Fed’s preferred measure, called the personal consumption expenditures price index, has risen at 5.8 percent year-over-year. Both are 40-year highs.

Inflation is a tax. It transfers resources from users of dollars to printers of dollars. When the government prints money it gains purchasing power, but this comes at the expense of depreciated cash balances elsewhere in the economy. While Uncle Sam undoubtedly needs revenue, this stealth-redistribution is unfair and inefficient. However, Congress lacks the political will to raise revenue honestly by raising taxes. This brings us to the second source of inflation: massive deficit spending.

The Fed is in the driver’s seat, but Congress is riding shotgun. Deficits indirectly contribute to inflation. Since January 2020, the national debt has increased by nearly $6 trillion, crossing the $30 trillion mark for the first time. Much of this debt was monetized by the Fed. Central banks can’t resist underwriting fiscal ineptitude.

Congress’s prodigal spending forces us to confront some uncomfortable truths about debt. The 2021 interest payment on the national debt was $562 billion. And that’s with historically low interest rates. If borrowing costs start to rise, merely servicing the debt will consume an ever-larger share of the federal budget. We’re already on track for debt to exceed 200 percent of GDP over the next generation. Even moderately higher interest rates could crowd out important federal programs.

Here’s the bottom line: American households and businesses are getting squeezed by a weakening dollar and a voracious public sector. This threatens our continued economic recovery, as well as national viability for decades to come. Neither the private nor public sectors can perform their essential tasks when fiscal and monetary policy are dysfunctional.

We need to make lasting reforms to Fed policy and congressional spending. These opaque, special interest-dominated processes have long defied citizens’ efforts to rein them in. To be clear, we don’t want politicians on short-term election cycles to juice the economy with fiscal or monetary stimulus. Nevertheless, we absolutely need reforms that force public spending and money printing to serve the general interest, not special interests.

Broken fiscal and monetary policies are part of a single pathology. We need to tackle them both.

Almost 250 years ago, Adam Smith wrote about the juggling trick of deficits, debts, and monetary debasement. Governments spend beyond their means to please existing constituencies at the expense of future generations. The national debt creeps ever upward. To lessen the debt burden, governments run the printing press, creating new money instead of enacting unpopular spending cuts or tax hikes. The inevitable result is inflation, which hits ordinary families the hardest.

These days, too many making policy recommendations dress them up in the technical language of academic economics. Yet doing so doesn’t make them fundamentally better, as fiscal and monetary prodigality are still economically destructive. Instead of papering over Congress’ irresponsible fiscal profligacy, it should be leading the world in practicing responsible fiscal prudence.

Fiscal and monetary misbehavior reinforce each other. Strict rules are the only solution.

On fiscal policy, we need to keep spending growth below economic growth. Doing so would ensure that the tax base keeps pace with demands on the public purse. If we follow this rule, debt as a share of GDP will fall over time. We don’t need to necessarily balance the budget right away to get back to a sustainable fiscal trajectory. Except during a national emergency, such as the early part of the pandemic, it should be much harder for Congress to ratchet up spending.

On the monetary side, we need to narrow the Fed’s mandate to price stability alone and impose penalties when central bankers goof. Monetary policymakers can’t achieve full employment except by keeping the dollar’s purchasing power predictable, so there’s no need for an employment component in the mandate. Repeated bungling by Fed officials should come with professional consequences.

Again, we don’t want politicians to turn central bankers into scapegoats. But no-confidence proceedings against top Fed officials, triggered automatically by persistent deviation from a well-specified inflation target, can keep central bankers honest. By “well-specified,” we mean the target path of the Fed’s preferred price index must be clearly stated to the public. No more guessing games about what the “average” in “average inflation targeting” means.

Policymakers’ incentives often diverge from the public interest. That’s why constraining them with rules and holding them accountable for their excesses is essential. We’ve learned the hard way we must reform fiscal and monetary policy at the same time. Unless we solve both problems, the ship of state will continue taking on water faster than we can bail it out.

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Posted: February 17, 2022 Thursday 06:30 AM