I am not normally hung up on comparing today's inflation to that of the 1970s. The oil-price shocks back then were uniquely harmful to consumers, as were ham-fisted policy attempts to impose various price controls that ultimately backfired. If anything, I worry today's economic backdrop more resembles the gathering storm clouds of 2007-08.
But in one important way, there is a troubling parallel today to what happened back in the '70s. And it's the fact that fiscal policy is pushing one way, while monetary policy is pushing the other. If you really want to "Whip Inflation Now," you need both parts of government rowing hard in the same direction. Yet today, even while the Fed is jacking rates up, fiscal policy is so stimulative that it is undermining the central bank's efforts.
It all goes back to three key pieces of legislation: one, the Biden administration's infrastructure bill that was signed in November 2021; two, the CHIPS Act from August 2022, and three, the "Inflation Reduction Act," which followed just a week later. All totaled up, those overlapping bills aimed at boosting domestic U.S. production "introduce $2 trillion in new federal spending over the next ten years," according to analysts at McKinsey.
It amounts to a windfall for state and local governments, who are announcing some of their largest spending projects in history. Take, for instance, TSMC's $40 billion semiconductor plant in Phoenix, Micron's $20 billion factory in upstate New York, or Panasonic's $4 billion battery plant currently under construction in Kansas. Over 50 projects in 20 states had already been announced by last December from the CHIPS Act alone, according to the Semiconductor Industry Association.
And as a result, construction spending in the U.S. is soaring. As of April, it hit an annualized run rate of nearly $2 trillion, up from less than $1.5 trillion pre-pandemic, and far above the $750 billion it was languishing at a decade ago. We continue to steadily add construction jobs each month, which are one of the highest-paying industries outside of technology and finance, even while the Fed is trying to slow wage pressures and the broader labor market.
Fed Chair Powell needs to call this out, a former Fed official recently told us at a CNBC gathering. Or if he is reluctant to, then at least other regional Fed presidents or high-profile economists need to be more vocal about the extent to which fiscal policy is interfering with the central bank's inflation fight. The more money that keeps flowing from fiscal projects, the higher the Fed will need to jack up rates, which risks further crushing bank profitability and deepening a potential future downturn.
And there are some policy moves that could help to better align fiscal and monetary policy right now, taking the pressure off the Fed to keep hiking. For instance, Congress could move to extend the current December 2024 deadline for spending so-called "ARPA" funds from Biden's infrastructure bill. That way, state and local governments could spread out their spending on projects over many more years to come, instead of hurrying to spend it all now.
This "pre-loaded" fiscal stimulus also presents another risk; that of leaving us less room to ramp up a needed future rescue package when the recession actually hits. Federal spending is already 5 percentage-points of GDP higher than its historical average, as Dan Clifton of Strategas points out. The recent debt-ceiling fight did little to change that. We're running larger budget deficits than we were pre-pandemic, thus adding to the growing national debt; and the interest costs to service that debt are themselves increasing the deficit.
If now is not the time for "austerity" that could right-size the deficits while helping the Fed achieve its inflation goals, then when is? And why is the Fed being asked to solve an inflation problem that the government itself keeps feeding? These would be great questions for Chair Powell to answer on Capitol Hill today.
See you at 1 p.m!
Kelly
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