New “Inflation Reduction Act” Does No Such Thing

In today’s letter, I will explain why the Inflation Reduction Act will not reduce inflation and could well do just the opposite. While I try to stay away from purely political topics in Forecasts & Trends, this is one every American needs to understand because this legislation is likely to have the opposite effect and make inflation even worse. Let’s jump in.

Inflation Reduction Act Is A Sham, Will Not Work

One of the more enduring fallacies regarding discussions of the economy is that there are a couple of levers located in a vault somewhere in Washington that officials can turn this way or that to control employment, output, inflation — even the price of gasoline.

Anytime something good happens, some politicians inevitably step forward to claim credit for having got the levers just right. And anytime something bad happens, you can be sure the media and political opponents will blame officials of the other party for turning the levers to the wrong settings.

That’s what happened earlier this year when inflation began to take off and the president, Congress and the Federal Reserve were criticized for overstimulating the economy in response to the pandemic. We heard it again late last month when the government reported a second quarterly decline in Gross Domestic Product, triggering dire and exaggerated predictions of recession from Republicans.

And now Democrats in Congress are embracing the same fallacy as they ram through a package of climate, tax and healthcare initiatives fancifully marketed as the “Inflation Reduction Act of 2022” (the IRA). They even ran television ads on major networks over the weekend touting the benefits of the IRA. This is very unusual, but it shows how badly the Dems wanted this piece of legislation.

Though some kernels of truth exist in all of these critiques of the IRA, they mainly derive from a faulty mental model of the economy and how it works. So, let’s step back and see what is really going on with the latest sweeping legislation passed by Democrats in Congress.

How Inflation Soared To A 40-Year High

In the spring of 2020, as the Covid global pandemic was about to plunge the global economy into what could have been a nasty depression, central banks and governments around the world effectively printed trillions of dollars out of thin air in an effort to keep businesses from closing and laying off millions of workers, while providing households with income to live on.

It worked, sort of: After a scary few months of plunging stock prices and rising unemployment, financial markets recovered, most businesses continued to operate and most people who wanted jobs could find them.

Unfortunately, as a few of us warned, the governments would go on to provide too much of this fiscal and monetary stimulus for too long. The explanation, at least in the United States, was that officials were determined not to repeat what they believed – wrongly – was the mistake of excess timidity during the financial crisis and recession of 2008, and that any jump in the inflation rate would be short-lived. They told us any rise in inflation would be “transitory.”

An equally plausible explanation, as I pointed out, is that President Biden and a Democratic Congress were eager “not to let a good crisis go to waste,” and so used it to justify big increases in public spending and investment which they said would achieve economic, social and environmental justice.

At the same time, the Federal Reserve was unwilling to begin winding down its extraordinary money-printing out of fear it would burst the bubble it had created in the stock and real estate markets and possibly weaken a labor market that was tight enough finally to deliver wage increases to low-skilled workers.

What is often forgotten is that even before the pandemic and before all this economic stimulus, the US economy was already significantly out of balance. For decades, the country had been living well beyond its means, running large and persistent trade and budget deficits made possible by an overvalued dollar, artificially low interest rates and the willingness of trading partners to recycle their surpluses back into the American economy.

Indeed, those imbalances had persisted for so long that just about everyone had come to think they were the “new normal” and they could continue in perpetuity. Given that pre-pandemic prosperity was already dependent on large doses of fiscal and monetary stimulus, it should have come as no surprise that pumping in trillions of dollars in additional stimulus over the next two years would lead to rising prices and wages.

Indeed, that was the point of these rescue efforts – to prevent a deflationary spiral, set a floor under household income, stimulate investment – and prop up prices of stocks, bank loans and real estate.

In hindsight, it is clear that policymakers ignored warnings and overdid it. What else is new? But it is equally true that economic policy is not a science, and the US and global economy is not a system which can be controlled by a couple of levers in Washington. With inflation now at the highest level in over 40 years, we can only hope the Democrats have figured this out, but I wouldn’t count on it.

And I should note, Republicans have proven when they were in control they can spend with the best of the Democrats. So, there’s plenty of blame to go around on both sides.

Will The Inflation Reduction Act Bring Down Inflation? No

The nonpartisan Congressional Budget Office estimates that, over the next two years, the Inflation Reduction Act is likely to change the inflation rate by less than one tenth of one percent – but it isn’t sure whether the change will be up or down.

Even over the next five years, according to the Committee for a Responsible Federal Budget, the Inflation Reduction Act would reduce the federal budget deficit by a piddling $25 billion – a rounding error in a $23 trillion economy. Regardless of the final number, the measure will hardly dent an annual federal budget deficit projected to run at the unsustainable rate of 5% of GDP over the next 10 years.

First off, most of us do not have sensitive enough economic antenna that we can tell the difference between a national economy that is producing 1% more goods and services than the previous year and an economy that is producing 1% less. Plus, the way we measure GDP is too imprecise, the difference too small.

Despite that, we currently find ourselves in a heated nationwide debate whether we are, or are not, in a recession today. No one really knows and furthermore, does it really matter?

At the end of the day, what we do know is the Inflation Reduction Act of 2022 will NOT work as intended. It will not bring down inflation and could possibly make it worse. The nonpartisan CBO said last week the IRA is not likely to move inflation much, one way or the other. It will raise taxes on corporations which will hurt the economy and likely cause even higher prices.

In short, the IRA is a bad bill passed by Democrats and deceptively named to deceive voters ahead of the mid-term elections. Sadly, most Americans don’t have someone to provide them the truth, and many will simply believe what the media tells them. Again, what else is new?

Parting Thoughts About The Raid On Trump’s Home

I could have written today’s entire letter on the raid on a former president’s residence by the government, especially given that this action was unprecedented in American history. I chose not to, but I do want to share one thought: I believe the raid on former President Trump’s Mar-a-Lago estate will prove to have been a huge mistake for the Democrats in the mid-term elections.

Millions of Americans, including many Democrats, are outraged by this abuse of power. I believe they will let that outrage be known in the mid-term elections by voting out a lot of incumbent Democrats. It was already looking bad for the Dems in November. This will only make it worse!

All the best,

Gary D. Halbert

© Halbert Wealth Management

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