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THE PRICE IS WRONG

The US can do more to make sure the Fed doesn’t cause a recession

Oil pumps at work in Texas.
Reuters/Nick Oxford
Drill here, drill now?
  • Tim Fernholz
By Tim Fernholz

Senior reporter

Published

The Federal Reserve’s .75 percentage point interest rate hike this week was designed to send a message to consumers and businesses: The Fed will not tolerate elevated inflation.

But the Fed itself isn’t sure it can rein in price increases on its own. Close watchers of the central bank’s official statement on monetary policy noticed a missing line this time around: “With appropriate firming in the stance of monetary policy, the Committee expects inflation to return to its 2 percent objective and the labor market to remain strong.” That, in essence, was a prediction of a soft landing.

Asked about the sentiment’s absence, Fed chair Jay Powell said he needed more help. “The sentence that we deleted said that we believe that appropriate monetary policy effectively alone, can bring about the result of 2 percent inflation with a strong labor market,” Powell said in his post-meeting press conference. “So much of it is really not down to monetary policy… What’s becoming more clear is that many factors that we don’t control are going to play a very significant role in deciding whether that’s possible or not. And there I’m thinking, of course, of commodity prices, the war in Ukraine, supply chain, things like that where [our] monetary policy stance doesn’t affect those things.”

In other words, the Fed fears that even if tightening financial conditions lower demand for goods and services, prices could still rise due to supply factors. That, in turn, means the Fed can’t promise a soft landing on its own.

But there are other tools in the government’s kit for fighting inflation. They might not be as straightforward as interest rate hikes, but they are arguably more important to dealing with the current problems.

Get rid of tariffs.

The Trump administration imposed billions of dollars of new import taxes on Americans in a misguided attempt to gain leverage against China and benefit a few domestic industries. The tariffs haven’t achieved any of their stated objectives, but they have increased the prices people pay for goods and services. President Joe Biden recently waived some tariffs on solar panels, but he could do more. One recent study suggests that a program of broader tariff roll-backs could reduce CPI by 1.3%, which would save American families nearly $800 as the effects pass through the economy, but even ending the China tariffs alone could lower inflation by a quarter of a percentage point. That’s not a lot, but the Fed decided to hike an extra quarter-point this week in part because last month’s CPI reading was .3 percentage points above expectations.

Roll back sanctions. 

One big cause of higher prices are rising oil prices. The US has sanctioned a lot of oil-producing countries, including Russia, Iran, and Venezuela. Sanctions on Russia aren’t going away anytime soon. The US has made some effort to lift sanctions on the Maduro regime in Venezuela, which contributed 200,000 barrels of oil a day to US markets as recently as 2019. But just this week, the US also imposed new restrictions on Iranian oil in an effort to convince Tehran to rejoin a pact limiting its nuclear weapons development. There are reasons for these restrictions, but US policymakers need to think seriously about their priorities and whether they will be more or less constrained on the global stage with a shrinking or growing economy.

Boost investment in oil production.

The Biden administration has been a bit paralyzed about energy prices: It’s committed to decarbonization, but today’s economy runs on fossil fuels. Its efforts to reduce the prices of key energy inputs by permitting more drilling on public land have been criticized as not enough by the oil industry and a betrayal by environmentalists. But if the administration wants to prioritize the wellbeing of low-income people facing high gas prices—as well as the political survival of the climate agenda—it will need to lower gas prices somehow. Right now, US producers are only slowly increasing production, having been burned by over-capacity in the last business cycle. One way to change that is use the strategic petroleum reserve (SPR) to put a floor on US crude prices, so that American producers can invest without worrying that OPEC price wars will leave them bankrupt.

Do the same for other critical commodities.

Commodity price shocks are causing currency problems abroad: Rising prices mean foreign exchange reserves are being stressed in countries that depend on imported food, energy, and other goods. The US Treasury has a tool to address these issues called the Exchange Stabilization Fund (ESF), which has famously saved the Mexican peso, protected money markets during the 2008 crash, and backstop Fed lending during the pandemic. Researchers at Employ America argue that, like the SPR, the ESF could be used to boost investment in the production of oil, fertilizer, copper and other vital goods by offering financing and guaranteed purchases contingent on investment in expanded capacity.

Ditch the Jones Act.

A US law requires any freight moving between two American ports to be carried by American-owned, flagged, and crewed vessels. This has led the US shipbuilding industry to be dramatically uncompetitive and driven up the cost of moving goods around. The US government often waives this act in emergencies; Trump did it briefly after Puerto Rico was devastated by a hurricane in 2017, and Biden did so in a limited fashion last year. Waiving the Jones Act now for a longer period of time, or repealing it entirely, would ease supply chain pressure by making it cheaper to move goods around the country.

None of these measures would solve the inflation problem on their own. But if they allow price increases to slow even marginally, that could give the Fed more flexibility in how quickly it tightens financial conditions and reduces growth in the economy. And if inflation expectations matter, then expecting more supply should lead to lower inflation next year.

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