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Following a year of soaring inflation, Russia's war in Ukraine is forcing policymakers and commentators to take stock. The days of thoughtless demand stimulus, guaranteed bailouts, and active climate measures must now be put behind us, according to new macroeconomic realities.
The return of inflation is a watershed moment. The brick wall of supply has been battered by demand. Our economies have now produced everything they are capable of. Furthermore, too expansive fiscal policies are certainly to blame for this inflation. Supply shocks may boost the price of one item compared to others, but they do not affect all prices and wages at the same time.
A lot of wishful thinking will have to disappear, starting with the notion that governments can borrow or print as much money as they need to solve any crisis. To fund non-inflationary borrowing, government spending must now come from current tax collections or reliable future tax receipts. The era of stimulus spending for the sake of stimulus spending is ended.
Governments must begin spending more prudently. When there is a widespread labor shortage, spending to "create jobs" is foolishness. Unfortunately, many governments are responding to inflation by borrowing or printing more money to subsidize energy, housing, childcare, and other expenditures, or by handing out extra money to cushion the shock of inflation, such as forgiving student loans. These policies will increase inflation even further. Expanded social programs and transfers must be financed with reliable long-term tax collections, i.e., taxes that do not entail disproportionate economic costs.
These realities will make it much more difficult for policymakers to ignore finances and the disincentives that many social programs have built in. The bailout craze will come to an end. To revive the economy and bail out banks and their creditors, the 2008 financial crisis was met with a flood of borrowed and created money. The COVID-19 recession was accompanied by a tsunami. Government funds were once again used to bail out creditors, boost up asset values, and give additional stimulus.
Because of these precedents, our financial system today has complete faith in the government's ability to borrow or create money in the case of a future crisis. However, after fiscal headroom has gone out and inflation has set in, the government's power to prevent the next crisis may be lost. People will stop lending when they are no longer certain that the borrowed money will be repaid, or that the printed money will be absorbed again. Today's (so far) minor inflation is a taste of what's to come. The debate over "secular stagnation" is over. Long-term growth has dropped by half since 2000, making it one of the great untold economic tragedies of the twenty-first century. Between 1947 and 2000, real (inflation-adjusted) GDP growth in the United States averaged 3.6 percent per year. Since then, it has averaged barely 1.8 percent per year. Was this sclerosis a case of demand-side "secular stagnation" that needed to be remedied with a slew of "fiscal stimulus" due to consistently low interest rates?
Or did it result from a decrease in supply as a result of the corrosive consequences of protected and over-regulated businesses, or from more serious issues such as educational stagnation or a lack of innovation? We now know that it was supply that caused the problem, and that more stimulus will simply increase inflation. Growth will have to come from freeing supply whether we want to relieve poverty, pay for health, environmental safeguards, and transfers, or simply for its own reason. Tariffs, industrial barriers, labor market distortions, skilled immigration limitations, and other supply-constricting measures all have real costs that can't be compensated by printing more money. Inflation has returned, and Russia's war in Ukraine has ended, signaling the end of massively inefficient energy and environment policies.
Our governments have been following a dangerously myopic strategy of halting US and European fossil-fuel development before alternatives become widely available, choking nuclear energy, and supporting inefficient (and frequently carbon-intensive) initiatives like California's high-speed rail to nowhere. The foolishness of this strategy is now obvious. Following the blockade of the Keystone XL Pipeline and restrictions on oil and gas exploration, US President Joe Biden's administration has turned to Venezuela and Iran for help to make up for a shortage in energy supply. Similarly, despite the appearance of fractures, the Germans still refuse to authorize nuclear power or natural gas fracking.
Financial regulations are being used to suffocate domestic fossil-fuel industries. On March 21, for example, the US Securities and Exchange Commission decided to unveil comprehensive new climate-related disclosure regulations aimed to discourage fossil-fuel investment, just as Russia's invasion on Ukraine was driving gas prices dramatically up. For years, climate regulators have repeated the dogma that such regulation would cause fossil-fuel corporations to go bankrupt, leaving them with "stranded assets," and that this justified steps to force banks to stop financing to them. However, reality must now remind everyone of an Economics 101 lesson: when supply is limited, prices (and profits) rise, not fall. Those who have claimed that climate change poses the greatest threat to civilization or financial markets must now accept that other, more immediate concerns exist, such as plague, military aggression, and now, maybe, nuclear war.
Despite this, the spin continues. Inflation is still blamed on weak supply chains, unethical price gouging, profiteering, monopoly, and greed, according to popular belief.
The Biden administration's newest attempt to label inflation as "Putin's Price Hike" is both hilariously incompetent and demonstrably wrong. Inflation is rampant and has been for a year, and Russian President Vladimir Putin wants nothing more than to sell us a lot of oil so that he can fund his military. Such spin trivializes a conflict that is a fight for Europe's soul and the world's security; it is not about Americans' gas station inconvenience. The time for wishful thinking has passed. Those who accept this fact now will appear far less dumb in the future.
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