Politics in the Fight Against Inflation

4/23/24

One of the disturbing features about economics as a field of study is that it really doesn’t have a particularly good handle on inflation and how to cure it. Our best remedy is a blunt effort to try to slow economic growth to broadly limit inflationary pressures, thereby threatening to substitute higher unemployment and slower job creation for lower inflation.

Many economists see inflation as a monetary phenomenon caused by too much money chasing too few goods. Those with this perspective see tight money as the cure-all — i.e., retarding the growth of the money supply and forcing interest rates higher. Paul Volcker famously applied this policy in the early 1980s. He’s been credited with bringing inflation down from just under 15 percent to less than 3 percent over a three-year period. In so doing, Volcker raised the federal funds rate, a key bank borrowing rate, to 20 percent and precipitated an unemployment rate above 10 percent. Volcker showed that this policy works, but at a cost that was disproportionately shouldered by the unemployed.

The more Keynesian view is that inflation derives from an excess of aggregate demand when the aggregate supply is constrained to its full-employment level of output. This view allows for fiscal policy– i.e., policies involving government spending and taxation — to play a role in…