The rise in inflation to just over 9 percent in June 2022 is no mystery. Excess demand and insufficient supply were caused by a combination of an abrupt supply disruption due to the COVID-19 pandemic and a spike in demand from the Trump and Biden stimulus expenditures. The fall in inflation more recently to between 3 and 3.5 percent is more interesting and more complicated.
On the supply side American manufacturers have learned that minimizing inventory costs following just-in-time delivery of their products that they manufacture cheaply overseas has caused them dearly in the face of the sudden supply disruption. Their revenues and profits dropped dramatically in the face of the sudden cutoff in the supply of their products. With the encouragement of the Biden administration, manufactures have created just-in-case production facilities here in America. They now want to have some manufacturing production in America that is designed to be easily expanded in the face of another overseas supply disruption. This is especially important in the face of the increasing tension between China and the United States, especially if China were to invade Taiwan.
The demand for construction workers initially put upward pressure on wages and prices. But the resulting increase in the supply of manufactured products here in America in addition to the renewed supply from overseas has put downward pressure on inflation. Economy-wide demand is also falling due to the end of the stimulus expenditures, the end of the deferment of student loan payments, and the increase in work requirements for welfare recipients recently imposed by Congress. This combination of increased supply and decreased demand is putting downward pressure on the rate of inflation. Prices are then rising at not nearly the rate that they were at the height of this inflationary cycle.
But what role has the Federal Reserve played in all this? What effect has the Fed’s raising of interest rates had on our economy? When the Federal Reserve raises interest rates, wealthy people say: “Oh, good. I will be earning more on my savings.” Poor and middle class people say: “Oh, no. I will have to pay more on my debts.” People often need a loan to buy a car, purchase a home, or get a college degree. Raising the cost of borrowing blocks these options for many people. During times of excessive inflation, people need to spend their money quickly before it loses more of its purchasing power. The longer they wait, the less their money is worth. Consequently, by raising the cost of borrowing when too much money is chasing too few goods, the Fed just shifts the inflation from things that require a loan to less expensive things that don’t require a loan.
However, raising the cost of borrowing stops excess inflation by suppressing supply in a manner that ultimately effectively suppresses demand. Many firms borrow money to operate. Some retail firms run in the red most of the year until reaching the holiday season at the end of the year where they cover their costs and make their profit. Farmers borrow to prepare fields with plowing, fertilizing and watering their crop and then pay back their loans when the harvest comes in. When the cost of borrowing goes up, firms that borrow money will cut hours, lay off workers, and close outlets. Workers get less money and some lose their paychecks altogether. They can’t spend money they don’t have, so this effectively suppresses demand and stops excessive inflation, but at the risk of creating a recession.
The current Federal Reserve strategy that relies exclusively on their cost-of-borrowing tool rewards the rich and punishes the poor for inflation. A more equitable approach that avoids the threat of recession is for Congress to reissue the Postal Savings Act of 1910 to allow the Federal Reserve to off 10 percent interest on savings for relatively small amounts (no more than ten thousand dollars) for any person with a Social Security number. As explained in introductory economics, prices are set on the margin and not on the average. Stopping inflation requires getting the marginal saver to save more and spend less. The poorest of the poor cannot afford to save any money and the richest people are just moving their money around to get the best return with little or no effect on their consumption behavior. Two thirds of Americans have no college degree and typically earn fifty thousand dollars a year or less. These are the marginal savers who have to decide whether to buy that new expensive pair of shoes or instead put that money in a savings account. A big sign at the entrance of each neighborhood post office offering ten percent on savings might be just what is needed to stop too much money chasing too few goods.
Asking your Congressional representative to support reissuing the Postal Savings Act of 1910 would provide the Federal Reserve with a return-on-savings tool that will help stop excessive inflation without causing a recession so that the Federal Reserve does not have to rely exclusively on their cost-of-borrowing tool. This will not have a big impact on banks when the Fed is trying to slow the economy because banks typically have excess reserves under our fractional reserve banking system and cut back on loans when the Fed is trying to slow the economy. Banks don’t want to be overextended with lots of loans in default as the economy slows. At such a time banks do not want to have to pay for more savings that they don’t need and don’t want. The Federal Reserve can run the postal savings accounts with its own money from the profits and fees it makes in the financial markets so reissuing the Postal Savings Act of 1910 would not cost the taxpayer a penny. Typically the Federal Reserve makes profits of fifty billion dollars or more each year. The Federal Reserve could afford to run these postal savings accounts without having to print any additional money. In any case there would be no need to increase taxes to pay for these postal savings accounts and inflation could be brought under control without punishing the poor by using this new return-on-savings tool and not relying exclusively on the Fed’s cost-of-borrowing tool.