Can our government generate its own inflation spiral?

Earlier here I wondered Could our epic deficits drive inflation no matter how high the Fed raises rates? (the answer is “yes” according to one of the smartest economists in the world: Economist answers my question about high interest rates and high deficits). Regarding the latest rounds of interest rate hikes, a Democrat-voting university professor friend posted on Facebook:

If you tried to put out a fire with water, and the fire got no smaller even after 3 attempts, you’d hopefully realize this is no normal water and/or this is no normal fire. And if you were able to come to this conclusion, you would not be the Fed.

My response was “I think the government may itself be the inflation spiral. Government is nearly half the economy and everything the government pays money for is indexed to inflation. Medicare, military and similar contracts, Social Security, pensions, employee salaries, etc.”

(This was a few days before “Social Security cost-of-living adjustment will be 8.7% in 2023, highest increase in 40 years” (CNBC, today))

If everything that is part of the local/state/federal government sector is indexed to inflation, doesn’t that mean that inflation goes down only if horrific pain is being inflicted on those dumb enough to be in the private sector? If government workers are getting cost-of-living adjustments (COLA), their spending power by definition cannot change (assuming that the BLS is calculating the CPI correctly). If the CPI says prices went up by 10 percent, the government workers will have 10 percent more in salary to go chasing after a mostly fixed supply of goods. This is the classic wage-price spiral.

Government is not 100 percent of the U.S. economy, so maybe the wage-price spiral can be broken if significant spending power reductions are imposed on non-union non-government workers. But at some level of government control of the economy, the spiral should be unbreakable regardless of interest rates and regardless of how poor the private sector chumps become.

(Why “non-union”? Union workers typically would have an automatic COLA increase and we could also consider union workers part of the government sector because they depend on the government to sustain their union power.)

Loosely related… prices and government worker wages go around in the Bois de Boulogne:


  • “Inflation Is Unrelenting, Bad News for the Fed and White House” (New York Times, today): “This is a self-inflicted wound that will impact the most vulnerable members of our society the most,[” said Mohamed El-Erian] (I think that El-Erian is saying what I say above, but more succinctly; everyone involved with the government will be 100 percent protected from inflation, which means that the peasants are going to be destroyed to keep those affiliated with the government from feeling any pain)
  • “Retirees Catch a Break With the Social Security COLA” (WSJ): On Thursday, the Social Security Administration said recipients will get an 8.7% increase in their payments next year and, for the second year in a row, that actually exceeds estimates of how much their costs increased. That is according to a 35-year-old initiative to measure the true rate of inflation facing those over 62, via an experimental consumer-price index produced by the Labor Department’s Bureau of Labor Statistics, known as the CPI-E; the E stands for “elderly.” … This year, the COLA was 8.7%, more than the 8% rise in the CPI-E.

10 thoughts on “Can our government generate its own inflation spiral?

  1. In a country with 51% directly or indirectly employed by the government, the 51% can effectively enslave the rest.

    In a country with borders, the 49% who perform real work could go on a general strike. That no longer works. For example, in the EU the 51% just import fresh workers from Eastern Europe.

  2. “the government workers will have 10 percent more in salary to go chasing after a mostly fixed supply of goods.”

    The 1 to 2 million legal and illegal immigrants that pour into the US each year are chasing the same fixed supply of goods (& housing!). But, maybe that will balance out with the downward pressure immigrants put on wages, especially for entry-level (and IT) jobs the working class.

  3. My employer, a county in a southern state, just started its new fiscal year on Oct. 1st, and county employees received our annual raise: a 2.5% step increase + a 5.5% COLA. Fortunately, no increase to health insurance premiums ($0 for individual plan, $200/mo for family plan). I’m also above the max allowed for banked vacation leave (500 hrs), so I just “cashed in” 200 hours (at $50/hr). I’m going to get killed on income taxes on my next pay check!

  4. @philg: The COLA isn’t indexed to inflation, it’s just whatever the City Manager budgets for and what City Council approves. The past twenty years it’s been between 0% – 5.5%. So, I guess it’s not really a “COLA” but rather just an across-the-board pay raise; all employees get the same raise regardless of merit.

  5. On the topics of govt spending, inflation, and France here’s an informative 11:15 video on downfall of the French assignat (currency before the franc) and how it led to revolution:

  6. The government can always impose austerity measures on itself as it did in 2013. Doubt the current generation of voters have the discipline to do what generation X did in 2013 though. It might go the way of Brazil. Get a government job to keep up with inflation or do nothing because your paycheck has no value.

    • Price inflation is just basic demand/supply phenomenon: inject more money for the same amount of goods and prices will rise (monetary inflation), or reduce amount of goods for the same amount of money and prices will also rise. There is no obvious loss of productivity in US economy, at least not to the tune of 10% a year. Thus, the current inflation is simply monetary. The “elite” trying to kick the can down the road.

      Now, practically all monetary inflation is generated by banks creating new money in form of loans. This is where the prime interest rate comes in: raising it reduces demand for loans (and also makes it costlier to service adjustable rate loans, which causes defaults and write-offs.) When a loan is repaid, thr money “disappears”. Defaults DO NOT result in reduction in monetary mass – the money has been paid by the borrowers to their suppliers, and otherwise spent and keeps circulating.

      Thus, as an instrument for inflation control efficacy of raising prime rate is limited: raise interest rates and you start getting more defaults and also reduced productivity due to shortage of capital investment. Both of these increase price inflation.

      Or, to be blunt, – when there is massive monetary inflation combined with business failures or outright suppression (COVID lockdowns and other hysterical knee-jerk “measures” by the scientifically illiterate “elite” – both political and academic) the only way out is radical increase of productivity by means of getting freeloaders (bums on welfare and government “workers”, whose economic productivity is strictly negative) to start producing. “Austerity” in other words. Oh, and radical reduction in regulatory burden.

      And, yes, this works. The most stark real-world example is post-USSR Russia which basically had no government for years. Nobody enforcing any regulation, nobody paying taxes, no social welfare. Despite the obvious negative cosequences (crime wave and poverty of pensioners) it also created massive economic boom, which took the ruined country on the brink of hunger to the European standard of living in mere decades.

      But that kind of austerity is not going to happen in US, not without political revolution. Enjoy your $100 burgers in the not so distant future.

  7. What is this professor’s areas of expertise?

    This analogy sounds like someone straining to understand something they don’t understand, and doing a poor job, doesn’t it?

  8. Yup… nurses at University of Washington just landed 35% raises apparently. Must be “nice”.

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