These Reforms Would Increase Economic Growth And Help Alleviate Inflation

The latest Consumer Price Index (CPI) report is in, and it is not good. Inflation rose by 1% in May and 8.6% over the last 12 months. Both are increases from April, meaning inflation does not seem to be slowing down. The Federal Reserve has increased interest rates to combat inflation, which is appropriate, but more can be done despite what President Biden says. Federal and state policy changes that generate faster economic growth would also help alleviate the harm caused by inflation.

The May CPI report shows inflation is occurring across the economy. Nearly every category tracked—including food, shelter, apparel, and new and used vehicles—increased by 5% or more since last year. Energy price increase are the most dramatic: The CPI for gasoline is up 49%, fuel oil is up 107%, electricity is up 12%, and utility (piped) natural gas is up 30%.

Energy is used in every industry—to power factories, heat and cool offices, and fuel delivery vehicles—so these large price increases impact other prices throughout the economy. It will be difficult to get inflation under control without getting energy prices under control.

In economic jargon, inflation is the result of aggregate demand outpacing aggregate supply. Put more simply, inflation is the result of too much money chasing too few goods. This means there are two ways to reduce inflation: Reduce the amount of money relative to the amount of goods or increase the amount of goods relative to the amount of money.

The Federal Reserve tries to control inflation through the money supply, namely keeping the supply of money aligned with the productive capacity of the economy. The Fed does this through various open market operations, the most well-known being setting the target for the federal funds rate. The Fed already raised the federal funds rate target twice this year to try to slow inflation, and more increases are expected.

The second way inflation could be controlled is through the productive capacity of the economy. Usually this is not relevant since economic output at the national level is influenced by a lot of variables that are difficult to meaningfully change in the short run, such as population growth, overall education/skill level of workers, tax policy, and private-sector investment. If inflation is running hot now, we do not want to wait years for new factories to be built, for more babies to turn into working adults, or for adults to learn new skills to increase their productivity.

But sometimes the supply side of the economy can impact inflation in the short run. The Covid-19 pandemic drastically disrupted supply chains, international trade, and the domestic labor market. China’s “zero-Covid” strategy shut down many of its factories for months, which reduced global output and contributed to higher prices. China is slowly reopening its cities, but production will not snap back immediately.

Clogged ports have contributed to higher shipping costs and shortages as goods languish on docks or out at sea, waiting to be transported to consumers. The war in Ukraine is disrupting global food and energy supplies, both directly due to the destruction and indirectly due to the economic sanctions placed on Russia, which is a large exporter of oil and natural gas.

Domestically, a shortage of workers is leaving employers understaffed or forcing them to pay higher wages to attract workers. Despite months of strong job growth, the labor force is still smaller than it was prior to the pandemic and non-farm employment is still lower by over 800,000 jobs.

All these factors contribute to higher prices, and all are big problems without single solutions. But that does not mean there is nothing policymakers can do now to tame inflation.

At the national level, an obvious thing to do is rescind tariffs on various goods from China. U.S. tariffs on goods including solar panels, steel, and washing machines are costing American consumers $51 billion annually via higher prices. Retaliatory tariffs from China on U.S. agricultural products, meat, steel pipes, and other goods also reduce U.S. exports by 10% and GDP by 0.04% per year—or $9.2 billion—according to one study. So, both producers and consumers are being harmed by President Biden’s tariffs.

More immigration would help alleviate the U.S. labor shortage. The border situation and U.S. immigration system are both a mess right now, but it is possible to have more legal immigration and secure borders. The Dignity Act would implement policies to secure the border and provide better pathways to permanent residency and visas. This would make it easier for immigrants to live and work in America and provide a needed boost to our labor force.

Short of passing new legislation, U.S. Citizenship and Immigration Services could extend more work permits as it deals with its renewal backlogs. Renewals are currently taking up to two years, making it impossible for many immigrant workers to keep their jobs at a time when they are desperately needed.

Regulation is also a problem and President Biden is first among regulators. So far, the Biden administration’s final rule costs and added paperwork hours eclipse former President Obama’s by 31% and 108%, respectively. President Trump imposed significantly less regulation than both.

Studies show that more regulation increases prices, increases poverty, increases income inequality, reduces employment, and lowers business investment. All these negative effects exacerbate the harm caused by inflation. Reducing regulation would have the opposite effect and alleviate inflation.

Instead of growing the pile of regulation, Biden could implement some common-sense reforms like a regulatory budget and sunset rules. Both reforms would help rationalize the convoluted Code of Federal Regulations while also helping Biden advance his own agenda on issues such as housing affordability and clean energy.

State officials can also pursue reforms to mitigate inflation. Pro-growth tax reform that lowers rates and eliminates especially harmful taxes—such as a gross receipts tax—allows workers and entrepreneurs to keep more of their incomes while increasing the incentive to work and invest. An analysis from economist Noah Williams estimates that eliminating Wisconsin’s income tax while slightly increasing the state’s sales tax would boost state output by 8% and employment by 7%. Similar effects are likely to occur in other states that implement pro-growth tax reforms.

And like the federal government, states can implement regulatory reforms. Rhode Island, Ohio and Virginia all passed laws to cut superfluous red tape in their states, and other states should follow their lead.

Inflation is a monetary problem and the Federal Reserve, as the country’s monetary authority, has an important role to play in reducing it. But stimulating economic growth in the short run and setting the stage for stronger growth in the long run can also help offset the harm of inflation. The Congressional Budget Office’s (CBO) recent economic projections forecast real GDP growth of between 1.4% and 1.8% per year from 2024 to 2032. This is unacceptable. Not only does such slow growth make it harder for the Fed to reduce inflation without causing a recession, but it also undermines the living standards and economic opportunities of future generations.

America has had the most innovative and dynamic economy in the world for decades. Right now, there are enormous global economic challenges, but it is crucial that we rise to the occasion. We must not be passive observers, content with allowing these global challenges to dictate our economic future. More immigration, more international trade, less regulation, and better tax policy would increase our productive capacity and ensure that we determine our economic future.