State of the Union and Inflation

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Presidents, like quarterbacks, get too much blame when things go badly, and too much when things go well. Look for President Biden to take advantage of this dynamic during his State of the Union speech. He deserves a little blame, shared with his predecessor, for making inflation worse through overspending. But he deserves no credit for stabilizing money supply growth over the last year. Inflation has to do with the money supply, which is the Federal Reserve’s purview. Neither the president nor Congress has much say over monetary policy.

The Federal Reserve grew the money supply by 40 percent in response to the COVID-19 pandemic. Some increase was necessary to make up for a slowing velocity of money during lockdowns, but 40 percent was overkill. For context, over those same two years, real goods and services grew by about 4 percent.

Good monetary policy plays a close matching game between the money supply and real output. Forty percent monetary growth against 4 percent real growth—a 10-fold difference—is enough of a mismatch to literally change the exchange rate between money and real goods. That’s where most of the recent inflation came from. Blame the Fed, not the president or Congress.

The Fed started walking back that runaway money growth about a year ago. Since then, it has done a better job at playing the money supply matching game. The inflation rate started moving back down almost immediately, after accounting for the usual lag times with monetary policy adjustments. Again, the Fed, not the president or Congress, should get credit for recent improvements.

That said, spending policy does have some effect on inflation. Presidents Trump and Biden, along with Congress, made inflation worse. And they are making the Fed’s repair job more difficult than it needs to be—which could make a potentially soft landing harder than it needs to be.

Much of the $5 trillion of COVID spending the political branches passed had little to do with COVID. And it was all deficit spending. This forced the Fed’s hand somewhat, as it has to work with the Treasury Department to scramble for ways to finance it all.

If Presidents Trump and Biden and Congress had been a little more responsible about COVID relief, the Fed might have been a little more responsible in its money supply management.

Inflation is getting better. But it shouldn’t have happened in the first place. The Federal Reserve overreacted, and so did the political branches. And the comedown is bumpier than it needs to be because of that overreaction.

President Biden’s speech will likely not reflect those nuances. Instead, since things are starting to improve, he’ll likely take credit for the Fed’s work in fixing its own mistakes that it made in the first place, and made worse by Biden, his predecessor, and Congress.

For more CEI commentary on the State of the Union, see a short CEI video. CEI’s Agenda for Congress offers policy ideas for many of the issues President Biden will address.