CEI’s Agenda for Congress is out now. This post summarizes its recommendations for inflation. Since inflation is mostly a monetary phenomenon, it is mainly the Federal Reserve’s territory, not Congress’, but there are still some policies Congress can pursue to help:
- Acknowledge that inflation is caused by the money supply, not by the other party and not by corporate greed.
- Spend less.
- Bind the Fed to a policy rule.
The first two recommendations fall under the heading of do no harm. The two parties will grab every weapon they can to fight each other, but inflation is not a Republican-Democrat issue. It is a money supply issue, and the Federal Reserve, not Congress, controls the money supply. If the two sides can stop shouting at each other long enough to admit their lack of control over inflation, they can find other issues to fight about and let the Federal Reserve do its job.
While Congress does not control the money supply, they do control government spending, which indirectly affects the money supply. The trillions of dollars Congress has added to the deficit will likely add a percentage point or so the inflation rate for the next several years. That makes the Federal Reserve’s job more difficult than it needs to be and raises the risk of recession. While it is likely too late to roll back some recent spending excesses, the least Congress should do is restrain itself from further stimulus spending.
Congress also has some say over the Federal Reserve’s mission and structure. The Fed was able to grow the money supply as much as it did because it has nearly unlimited discretion. Congress can prevent future monetary blowups by binding the Fed to a policy rule. There are several options.
The Fed informally followed a Taylor rule for interest rates during the Great Moderation from the mid-1990s until 2007, with great results. The problem is that it abandoned the rule as soon as there was a financial crisis, and its rash actions caused a deflation and made an ordinary downturn far worse. Other possible rules include NGDP targeting or a monetary target.
Which rule is chosen is less important than that there is one, and that it is binding even during crises. The Fed usually does a fine job during normal times, but tends to freak out during crises, which got us where we are today. Congress should say no more, and bind the Fed to a rule.
Similarly, Congress should give the Fed a single mandate to keep inflation low. It currently has a dual mandate that is self-contradictory. One mandate is to keep inflation low. The second mandate is to keep employment high. This often involves raising the inflation, in contradiction with its first mandate. The Fed must choose which of its mandates to follow at a given moment, which involves a mix of discretion, politics, and personality. None of these are good for economic stability.
Congress should simplify the Fed’s mandate so it can keep its focus on inflation. There are plenty of other ways to focus on employment.