Subhead from the newspaper of record today, “The Consumer Price Index climbed 8.5 percent in July, a bigger slowdown than expected, but inflation may remain uncomfortably high for some time.” Let’s dig into the article:
The Consumer Price Index climbed 8.5 percent in the year through July, compared with 9.1 percent the prior month, a bigger slowdown than economists had projected. After stripping out food and fuel costs to get a sense of underlying price pressures, prices climbed by 5.9 percent through July, matching the previous reading.
On a monthly basis, the price index did not move at all in July. That’s because fuel prices, airfares and used cars declined in price, offsetting increases in rent and food costs.
Core inflation was also slower than economists had expected on a monthly basis, climbing by 0.3 percent. In June, that figure was 0.7 percent.
The best official number that we have for the current inflation rate is actually 0 percent (“the price index did not move”). Or perhaps 3.65 percent (0.3 percent per month, annualized). But we are informed that inflation is a frightening 8.5 percent because of price changes that occurred at some point prior to July.
Do we believe that the 0 percent rate will endure? On the one hand, the typical American has bought so much since 2020 that it is tough to believe he/she/ze/they could fit anything more into his/her/zir/their house or apartment. On the other hand, every kind of service enterprise, including travel and tourism, is jammed, struggling to raise wages enough to attract labor, etc. (As noted here previously, one would expect that these enterprises would be half empty as the Followers of Science shied away from crowded environments so as to #StopTheSpread, but it seems that Science says the best way to end the COVID-19 pandemic is to gather unmasked in airliners, theme parks, concert halls, etc.)
Here’s the saddest photo from our Oshkosh trip, a donut shop in Chattanooga that has cut its hours due to “staffing shortages”. When they finally decide that they need to pay a high enough wage to open long enough to make enough profit to pay the rent, won’t they also have to contribute to inflation by raising donut prices?
In other words, until the labor market has cleared via employers raising wages, shouldn’t we expect more inflation? Also, we are still addicted to deficit spending since we can’t accept that the appropriate size for government is whatever we’re willing to pay in tax. It is tough to imagine inflation staying anywhere near 0 percent while politicians in D.C. are, at our behest, borrowing and spending (and then having the Fed magically absorb the new debt?).
Related:
- Inflation running at 13 percent is characterized as being 8.6 percent (June 2022; same phenomenon, but in the opposite direction)
Not sure what “absorb the new debt” means in this context.
The debt did not magically disappear, neither did the US government default on interest payments. The old debt is rolled over thanks to willing Treasury buyers, that’s all.
https://fred.stlouisfed.org/series/GFDEBTN
I think by “absorb the debt” he meant “monetize the debt”, aka buy the treasury bills. The Fed will buy whatever treasury bills no one else wants (which in typical years leaves the Fed as the primary buyer of treasury bills) so that the federal government never has to worry about running out of money and not being able to roll over their debt.
How does the fed afford to buy all those treasury bills? They print money.
The only way to reduce inflation will be to reduce expansion of the money supply. That’s a fact as basic as economics can get. The fed won’t be successful in reducing the money supply if it has to keep printing money to monetize federal debt.
What if the fed, which is supposed to operate independently of the federal government, decided not to buy treasuries? Then the government would no longer be able to roll over its debt and continuously deficit spend. That would be an interesting scenario indeed. My bet, however, is that that will not happen, and instead we will see ongoing inflation.
Ivan: As RS notes, I was talking about the debt monetization voodoo that has been practiced in the U.S. for roughly the past 14 years. https://en.wikipedia.org/wiki/Debt_monetization explains it. See also https://seekingalpha.com/article/4432181-is-fed-monetizing-americas-debt and then https://taylorshiroff.substack.com/p/is-the-fed-monetizing-the-debt for a dissenting perspective.
RS:
The fed does not buy bills directly from the the government, that would be illegal according to FRA Section 14. They buy/sell bills on the competitive open market:
https://www.federalreserve.gov/faqs/money_12851.htm
It is true that buying bills injects money into the banking system, but no new fictitious “value” out of thin air is created by this act because the bill holder merely exchanged one asset for another. OMO are used primarily to adjust interest rate, not to provide money to the general population as in Zimbabwe or Weimar Republic.
Inflation causes are more subtle and complicated, easy credit due to the fed monetary policy is one of them. The simplistic money-printing picture that exists only in Mosler’s (and some other folks’) feverish imagination, but not in reality, is not helpful at all to understand what is going on..
There were some questionable actions by the fed in 2008, the first major fed balance sheet expansion, but as you might recall, that huge money injection did not result in inflation for which there was some hope at the time. Despite those questionable actions in 2008 and recent Covid related abuses, no Zimbabwean style money printing ever occurred in the fed recent history:
https://www.richmondfed.org/publications/research/goodfriend/plosser
The second reference Phil gave is quite close to reality, too.
I meant the *last* reference, not the second one/
Ivan, thanks for the detailed response. I agree with everything you say, and my comment was a gross oversimplification of Fed operating practice.
At the same time, I think that practically speaking, my comment is largely correct. Yes, it is illegal for the Fed to directly print money to give to the government. And it’s illegal because every time a country does this, it ends up in big hyperinflationary trouble. But, in my opinion, the way the Fed operates has the same ultimate effect. The complicated nature of their operations gives them an air of technical sophisticiation, but, in my opinion, all that complexity is just to produce a backdoor to allow them to do what their government masters insist they do: monetize the debt.
What does the Fed actually do: They print money and use it to buy treasuries. They don’t literally print money, but they deposit new, previously unexisting money into the accounts of commercial banks, which can then work its way out into the economy. This is, practically speaking, the same thing.
And they don’t buy those treasuries directly from the government, instead they buy them in the open market from other people who bought them from the government. The introduction of this intermediary purchaser allows them to avoid breaking the law. But is it really any different than if they had bought them directly from the government? If the market knows that the Fed will buy a large number of treasuries, then that encourages them to buy them from the government, because they know they’ll have a willing buyer in the Fed whenever they want to sell. It is clear that the Fed actions significantly increase demand for treasuries, which reduces the cost of federal debt and enables the federal government to continue deficit spending and to obtain cheap new debt to pay off old debt.
Actually, it’s a bit worse than that. When the Fed buys these treasuries in the open market, they then effectively stop charging the government interest! That is, nearly all of the interest that the government pays is returned as a donation to the government. So it becomes an interest-free loan that is used to pay off old debt and fund the deficit. And again, how did the Fed get the money to give the government this interest-free loan? They created it de novo.
You note that from the point of view of the bill holder, they have only changed one asset class, from treasuries to cash, and so nothing was created out of thin air. This is a really interesting point. Let’s say I have $100, which is all the money in the economy and I used it to buy some treasuries. The Fed then printed $100 and used them to buy those treasures. I’m back to having $100, and so for me it was just an asset swap. Yet, 100 new dollars were created, and the total money in the economy is now $200. Where did they go? I believe the answer is, to the government. Previously, my $100 could not be spent at the same time as the $100 that I loaned to the government. Now they can be spent at the same time, and we should expect price inflation. When the government pays its $100 back to the Fed then the economy will be back to having a total of $100, and we’d see a corresponding deflation. But not if the government just takes another (interest free!) loan from the Fed to avoid paying it back, and the extra money stays in the economy. This is deficit spending.
Lastly on your comment that Fed open market operations (like buying assets from newly created money, or destroying money by selling those assets) is used primarily to adjust interest rates and not to provide money to the general population. This is definitely their purpose, but is another place where practically I see little difference. And that’s because the Fed does use OMO to maintain cheap government debt. So far QE has been sufficient to do that, but in a future where it isn’t, the Fed has already started floating the concept of yield curve control, which is basically “we will buy however many treasuries it takes to keep the debt cheap” (https://www.stlouisfed.org/on-the-economy/2020/august/what-yield-curve-control). So the Fed gives the federal government cash that it otherwise would not have. And what does the federal government do with that cash? It gives it away as stimmies, welfare, and political favors. Thus while the direct purpose of OMO is to adjust interest rates, the indirect effect is to fund the deficit which provides new money to the general population. That this is happening in reality is, I think, apparent from looking at the inflation in the money supply.
That’s really long winded, I apologize, but I thought you raised some really interesting points and wanted to explain why I think that the Fed is playing with fire by making sure that the debt stays funded, even if they aren’t the ones directly doing it.
And a note about inflation. I’m a fan of Milton Friendman’s famous quote: “Inflation is always and everywhere a monetary phenomenon, in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.” Who controls the money supply? The Fed. They do this by controlling (1) their own printing of money, and (2) the amount of fractional reserve lending done by banks. The Fed dramatically increased the money supply in the last two years, and so we should not be surprised to see price inflation. I acknowledge that there have also been supply chain disruptions that have exacerbated price inflation, but even if the same number of goods were being produced now as in 2019, there are stlil many more dollars chasing those goods, and so we are guaranteed price inflation.
You correctly note that the Fed began to inflate the money supply back in 2008, yet this inflation of the money supply did not translate to significant price inflation. Economists much smarter than me do not have a clear sense of why this is. My personal theory is that it is because of the way the money supply was inflated. In 2008, the money supply was inflated by increasing the money that commercial banks had available to lend out. This money made its way into the economy from the top down. My personal theory is that I think a lot of this extra money went into markets that aren’t attached to real goods: If I as a rich banker now have an extra $100,000, I’m not going to use it to buy 50,000 gallons of gasoline, rather I’m going to put it into the stock market. Or into cryptos. We have since 2008 seen massive price inflation in these markets, which I think is where most of the 2008 QE money went.
With the COVID inflation of the money supply, a lot of it was dumped more directly into the economy into the hands of people who needed to buy real things. And so instead of chasing stocks and cryptos (which can go to the moon without changing anything in the real world), we see price inflation in the real world.
That’s my theory, but a real economist could probably tell me why I’m wrong. Or maybe they couldn’t because real economists seem to not understand this either. And real economists a year ago were saying that inflation is transitory / doesn’t exist, and so they have a pretty bad track record of understanding these issues.
But I do believe strongly that, in line with Friedman, the only way to reduce inflation will be to reduce the money supply. This means taking money from people that currently have money. The Fed can take money from consumers (by raising interest rates) or it can take money from the government (by reducing its balance sheet, a.k.a. not printing as much money to (indirectly) buy government debt. If the first strategy is insufficient and they have to seriously pursue the second, things will get real interesting.
Let’s focus on this specific point. Base/interbank money injection despite various abuses of FRA 13(3) in 2008 did not lead to inflation then.
This single fact means that the inflationary mechanism is much subtler than being perceived as a direct result of base money injection. You say: “This money made its way into the economy from the top down”. There is no mechanism for that money to percolate into economy in the current financial system structure in the US, so for me the futility of *that* QA exercise was not surprising. If the money did percolate we would have experience inflation in 2008 and thereafter, but we did not.
I do not want to dwell on this boring subject, but the old textbook assertion that banks lend out depending on the amount of base money(“money multiplier”) is incorrect. I do not know whether the antiquated requirement of having 10?% in cash reserves for banks in the US is still in place, but I should mention that neither Canada nor the UK do not have any such requirement. Again, the 2008 situation indicates that the US banks lending behavior was not affected by the huge injection of base money then.
I have to admit that I did not monitor the Covid era fed behavior due to lack of interest at this time in comparison to 2008, so they may have indeed abused the system more than then but I doubt that.
Further, you seem to think that the fed always plays the “buyer of the last resort ” role for government bonds. That is not the case. I recall at least one failed bond action in 1979 when some quantity of the issue remained unsold. I do not remember any more if the primary dealers are specifically forbidden to buy issues if the fed is the only “non-competitive” bidder. I would not be surprised if that is the case even today.
Regarding Friedman. When Friedman talked about money being a “monetary phenomenon” he implied bank created money via credit extension, not so much base money. Recall that until 2008 base money constituted about, what, 5% of all money stock, the rest being bank credit money, roughly. The situation changed dramatically after 2008 and now, I think, base money constitutes about 30% of the total.
So, when Friedman talks about “easy money” of his time, he means bank created money via loans rather than the minuscule fed generated amount of money at *his* time. A natural governor of bank created money is interest rate manipulation using which Volker was able to limit credit money availability dramatically and thus defeat inflation.
Ivan, there are many ways treasuries can flow into economics. One example, as you noted banks can get them at interbank/special rate and use them as discounted collateral for highly leveraged position propagating discounted rate that makes critical difference in huge leveraged portfolio to crony traders who can transform them in huge bonuses that propagates into economy. In 2008 – 2010 this did not happen because investment banks were winding down their leveraged positions, since than they again increased. Why would inflation happen if banks were given money to cover their short positions? Just the opposite, it was deflationary move, taking money out of US economy (part that was not newly minted/entered into database)
Bank lending is important too, as it may result in hiring, and still does, but not at the rate in highly regulated economy that does not make many things.
Only noticed food prices continuing to surge & sure enough the government reported 13.5% food inflation. In a month when NY & Calif* set records for the highest rent in history, it just shows how the government report is an average. The average just shows more people moved back to cities.
I picked up a half-pound of Boars Head chicken breast from my local FL Publix deli today w/o looking at the price. When I got home I realized the price was $15/lb!
Serious question: What is the right amount of taxation relative to benefits? Republicans believe that all taxes are evil, especially for the billionaire and hundred-millionaire idle rich (aka “Dr” Phil) who can least afford them. But they also think almost a trillion dollars a year for the defense budget is not nearly enough. Can’t have it both ways!
Mike: How about doing a homework assignment… leave your bunker (applying double N95 mask just before opening the front door to #StopTheSpread) and find some Republicans to talk to in-person. Then come back and tell us how many said that they “believe all taxes are evil” and, simultaneously, that our military budget was too small. You’re winning your argument right now, of course, but you might find that your opponent is a straw nonbinary person (“straw man” being an obsolete term).
(Separately, to your question of how big government should be… https://www.heritage.org/index/country/taiwan is competently governed on 17.6 percent of GDP and has minimal debt so taxation is 15-17 percent of GDP. https://www.heritage.org/index/country/singapore is similar (18 percent of GDP). Somewhere around 15-20 percent is probably what it takes to run the kind of government that citizens demand if we assume (a) intelligent and productive residents, (b) efficient government.)
I think Mike is a dumb dumb!
>>trillion dollars a year for the defense budget
but that ensures American hegemony, no? – which helps it keep the dollar as dominant currency in the world – which probably allows it to prosper even with such an excess debt?
Believe it or not, I live in a red state and talk to my friends/family/neighbors all the time!
More than half of them boil with rage, with steam coming out of their ears, face turning red, and blood pressure up 40 points, at any mention of the “T” word. Asked for the ideal tax rate, more than half would, with all sincerity, say 0%. They don’t know how to think or reason (“Wait, that would mean no military”) beyond the talking points Fox News/Brietbart/Hannity/Shapiro feed into the mush matter in their heads.
Our local teachers make an average of $60k. One prominent Republican faction wants them to have annual NEGATIVE 2% cost of living adjustments until the average drops to $50k. Then they could reduce property taxes by 10% and declare some minor victory.
Defund the police? No! Defund the federal police (FBI) because they make my orange god look bad? Yes!
Mike: Why do you continue to live in a red state?!!? There is value to you in being surrounded by stupid Science-denying insurrectionists? Wouldn’t you rather live in a small studio apartment surrounded by Followers of Science, if necessary, than continue among the ignorant?
To your point about Republicans promoting a 0% tax. The state with the highest percentage of incorrect votes in the 2020 election was Wyoming (only 27 percent voted for the legitimate candidate). So we can infer that Wyoming is Republican-controlled. https://taxfoundation.org/state/wyoming says that the state collects 7.5% of residents’ income to fund state and local government. So I think that reflects what Republicans will choose when Democrats cannot interfere with their choices. (https://taxfoundation.org/state/new-york shows that a correctly governed state will tax and spend 16 percent of residents’ income to fund the same function.)
My 85-y/o father “boils with rage” over spending on public employees. He calms down, just a little, when I remind him he worked for Raytheon for 35 years.
Raytheon is a private company, Had it no federal clients it could easily find new clients, in the Middle East for example. US defense company already like Middle Eastern clients a lot.
Former soviet military complexes mostly survived after collapse of socialism/communism due to foreign orders.
@Mike, the issue I have with paying taxes, isn’t the “how much”, it this a) the constant increase of taxation being imposed on us as well as the increase of fees (those are also taxes) we have to pay for government services and b) the return on our investment by paying taxes.
Law makers justify an increase in the name of improving the quality of life or promise that this is a “temporary” increase. When was the last time you saw a decrease in taxation or fees for government services? In fact, new fees are invented every year on top of existing ones. And are the services offered by our government any better off today then say 5, 10 or 20 years ago? Are our roads better? Quality of education better? Less “poor” people? So on and so forth. The answer to each of those questions is emphatically “no”.
Take a recent example from the Blue State of Maskachu$etts.
Based on “Pioneer Institute Expects That Massachusetts Taxpayers Will Be Refunded $3.2B Due To State Revenue Cap” [1]. How is this possible? Looks like there is a law in the books about this but yet somehow it is forgotten! [2]. Forgotten?! Really?! How could any honest lawmaker “forgot” about this?! And if this is not enough, looks like there is an effort to not refund this money to the tax payers:
“This regulation is being repealed because it is obsolete; no credit has been required since 1987,” the hearing notice said. “If a credit becomes available, DOR will issue guidance and update forms specific to the year the credit is allowed.” [3]
So next time when you ask someone “what’s ideal tax rate” and you get back 0%, you now know why. But the real question you should be asking is this: “Are you better off today than you were 4 years ago after paying extra taxes”?
[1] https://pioneerinstitute.org/economic_opportunity/pioneer-institute-expects-that-massachusetts-taxpayers-will-be-refunded-3-2b-due-to-state-revenue-cap/
[2] https://commonwealthmagazine.org/state-government/long-forgotten-tax-cap-about-to-be-triggered/
[3] https://commonwealthmagazine.org/state-government/baker-changing-rules-on-tax-cap-giveback/
“Raytheon is a private company, Had it no federal clients it could easily find new clients, in the Middle East for example.”
Raytheon is a publicly-traded company. The projects my father worked on for 35 years were all US defense projects. Every paycheck he received was from the US defense department, simply passed through the Raytheon payroll office.
Raytheon put food on the table for four generations of my family. My 92 y/o grandmother is still collecting my grandfather’s Raytheon pension and he died in 1992.
Raytheon can’t sell anything overseas w/o Uncle Sam’s permission.
@DP, go to Raytheon website, check locations. It has offices in Australia, UK, United Arab Emirates and Saudi Arabia. Your uncle Sam might have some cousins there, :-). Just call your uncle the big guy.
@perplexed: “go to Raytheon website, check locations. It has offices in Australia, UK, United Arab Emirates and Saudi Arabia.”
Huh? I never denied that Raytheon had international customers. And they used to make Amana microwaves and Beech aircraft.
When I worked there, 70% of their revenues were from the US defense department.
@DP, likewise I do not claim that real Raytheon is not a crony-helped oligopoly that eaten up many original businesses and that mostly helped by $1 trillion US defense budget and that it is rivaling Boeing in new state religion (see concerned posts on this blog and various comments).
I am more about conceptual level, defense is the only function of US governments that is mentioned in US Constitution is one of the raison d’être for United States government. Shell somehow US drop any export requirements Raytheon’s profits would balloon given same level of US defense spending.
It is also important to remember that inventing and making new things is hard and that defense machinery is complex and it is not coming from politicians and government bureaucrats but from investors, entrepreneurs, businessmen, scientists, engineers and technicians, be it Kentucky rifle or F-35.
You made it sound like US Government makes things that Raytheon peddles. Sorry for the misunderstanding.
@perplexed: “You made it sound like US Government makes things that Raytheon peddles.”
Huh? What? Wow! Nevermind. Disengaging.
If inflation is 0, then why do we need an “inflation reduction act” that costs $700B?
Anon: That’ great question. But an even better one is, I think, “since inflation reduction is critical, why are we spending ONLY $700 billion on inflation reduction?”
because not throwing fuel into fire (public money on crony pet projects) could actually slow down food price increase and could indeed bring inflation down. Politicians would not want to do that, whom would serfs be then grateful for handouts to ease pain of high food prices?
0 percent inflation happened in July when gas and oil prices plummeted. So next month, when food and shelter prices continue their upward surge, and gas prices stay flat or even rise a bit, that 0 number is going to be long gone.
Anon: We should have a betting pool here to see if we can be smarter than the bond market (TIPS/Treasury spread). We have to factor in that the CPI is fundamentally fraudulent and forecast CPI rather than actual inflation that would be experienced by a consumer, e.g., having to pay a mortgage. I’ll forecast that the true cost of a decent life in the U.S. will go up by 12% from Jan 2022 to Jan 2023 and that this will be reflected by a CPI number of 6% (the CPI excludes the cost of any house and, therefore, the cost of a house that a reasonable person would want to live in). Based on the ruling elites wanting to keep their jobs, I’m thinking that they’ll want to announce in January 2024 that inflation for the preceding year was 4%. So whatever manipulations are necessary to make that happen will be conducted. And then, after elites win election in 2024, the gymnastics won’t be applied as heavily. So the CPI in January 2026 will come back up to 6% compared to Jan 2025.
Those are my second best guesses. My best guess, of course, is that the market is correct and therefore that the CPI has already reverted to approximately 2.5 percent per year.