Analysis: Trillion Dollar Budget Deficits and Inflation

Chris Funchess
Advertising Sales Manager

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PC: Wikimedia Commons

While many Americans were celebrating Valentine’s Day, the U.S. Department of Labor released its report on inflation for the month of January. The Consumer Price Index (CPI) gauges the increase in prices of consumer goods and reflects the impacts of inflation throughout the broader economy. The CPI rose one-half of a percent, while it was expected to rise by three-tenths of a percent. The CPI measurement that excludes energy – gasoline prices for most consumers – and food prices came in at three-tenths of a percent, while the estimate was two-tenths of a percent. This report has added to the fears that inflation is on the horizon for the United States.

Some of the main causes for inflation in the U.S. are the country’s tight labor market and the addition of fiscal stimulus that would be expected for an economy in the midst of a recession.

The U.S. economy is strong at the moment and the job market is as worker-friendly as it has been in years:  which is pretty great news for the class of 2018. The unemployment rate has been ticking down consistently, nearing the point of full employment; note that full employment does not mean that everyone is employed, as there will always be frictional unemployment – people that left their previous job by choice to search for a better one, for example. Theoretically, when full employment is reached, employees can start to demand higher wages and salaries, as well as increases in bonuses, benefits and job training. Ideally, companies provide these increases to prevent their employees from leaving and finding better offers in a strong economy.

However, when wages rise drastically in a short period, inflation can result. This is modeled by the Phillips Curve, which argues that unemployment rates and inflation are inversely correlated– the lower the unemployment rate, the higher the levels of inflation. This model has drawn the ire of many economist and monetary policy experts, as it has not been proven to be empirically accurate in the long run, though it is a convincing framework for many. It can be used to explain the current increases in inflation. In summary, inflation hurts American consumers because the eroding purchasing power of the dollar cuts into the real value of their wage increases.

The current prime-the-pump mentality in Washington D.C. is also playing a heavy hand in inducing inflation. The recent tax cuts taking effect this year, as well as the large increase in spending approved by Congress in an attempt to avoid a lengthy second government shutdown, will cause dramatic budget deficits for the foreseeable future. The tax cuts themselves are expected to decrease tax revenue by about $150 billion per year for the next 10 years, while the spending deal increases both military and domestic spending. The current deficit-spending has not even factored in the large infrastructure plan that the Trump administration is pitching.

In short, this level of spending, with most of the new spending being fueled exclusively by debt, may be causing the economy to grow too quickly. These are policy initiatives that are inappropriate for a growing economy, being better suited for an economy in a rut that needs to grow quickly. Also, this increase in debt, results in a growing federal deficit. The Department of Treasury expects to borrow $955 billion to cover federal expenditures for the new budget– a staggering number which the only precedent for comes in the years of economic recovery between 2009 and 2012.

Whenever there are increases in government debt, new money must be printed to pay for it. In the case of the U.S. government, its debt needs are covered by bonds, which have had to increase their interest rates in the face of inflation concerns. And, by the virtue of more money being pumped into the economy, there is inflation that manifests itself in higher prices for the consumer, and a weaker dollar. The Republican-led fiscal stimulus has been heavily criticized by many economists as the current economic climate does not justify it.

In the clash between economists and policy makers, the battle was won by those in Congress. Unfortunately, the casualties of this battle will likely be the American people who as consumers will face increasing inflation and declining purchasing power of their wages and the prospects of a crippling national debt burden for themselves and future generations.

Categories: News, Politics

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