Happy first day of spring! While Capitol Hill was focused on the confirmation hearings for Ketanji Brown Jackson, President Biden’s Supreme Court nominee, and the ongoing Russia-Ukraine war, Federal Reserve Chair Jerome Powell again signaled urgency in the bank’s fight against inflation. Here’s your fiscal news update:
Powell Says Fed Ready to Move Faster on Inflation
Reiterating his view that inflation remains unacceptably high, Federal Reserve Chair Jerome Powell on Monday signaled that the central bank is ready to move more aggressively to restore price stability.
Just days after announcing a quarter-point increase in the Fed’s benchmark lending rate, the first since 2018, Powell said the central bank would consider larger, half-point increases in the future if conditions warrant it.
"If we conclude that it is appropriate to move more aggressively by raising the federal funds rate by more than 25 basis points at a meeting or meetings, we will do so," Powell told a meeting of the National Association for Business Economics. "And if we determine that we need to tighten beyond common measures of neutral and into a more restrictive stance, we will do that as well."
Inflation outlook has deteriorated: Powell said that the Russian invasion of Ukraine has worsened the inflation outlook, but conditions were deteriorating even before then. Inflationary pressure increased "sharply" during the fall, Powell said, contrary to expectations that price increases would moderate.
Asking why the Fed’s projections of easing inflation had been so far off, Powell said it had a lot to do with the unexpected severity of problems in the supply chain. "In my view, an important part of the explanation is that forecasters widely underestimated the severity and persistence of supply-side frictions, which, when combined with strong demand, especially for durable goods, produced surprisingly high inflation," he said.
Labor market out of whack: Powell reiterated his view that the job market is currently defined by unusually — and problematically — strong demand for workers. "Overall, the labor market is strong but showing a clear imbalance of supply and demand," he said. "Our monetary policy tools cannot help with labor supply in the near term, but in a long expansion, the factors holding back supply will likely ease. In the meantime, we aim to use our tools to moderate demand growth, thereby facilitating continued, sustainable increases in employment and wages."
In other words, Powell hopes to reduce demand for labor by easing back the throttle on the economy with higher interest rates, while maintaining much of the momentum that has favored workers. "There's good reason to think that this labor market would be at a more sustainable level if it were – if some of those indicators – if demand could be brought back in line with supply," he said.
What Higher Inflation and Interest Rates Mean for the Fiscal Outlook
What does higher inflation mean for the nation’s fiscal outlook?
A trio of leading budget experts tackled that question Monday at the annual policy conference of the National Association for Business Economics.
Congressional Budget Office Director Phillip Swagel told the audience that the fiscal effects of inflation on federal revenue and spending largely cancel each other out over the 10-year budget window. "The fiscal danger is interest rates," Swagel said. Rising rates lead to higher borrowing costs for the government. "Higher inflation and higher interest rates over time lead to much higher outlays for net interest payments," Swagel said. "The fiscal challenge, at least the near-term fiscal challenge, of higher inflation is coming through the flow burden of the debt."
A recent CBO analysis found that, in a scenario where both inflation and interest rates are much higher than it projects in its baseline forecast, cumulative deficits would be $2.3 trillion larger from 2022 through 2031, but federal debt held by the public as a share of the economy would be a smidge smaller at the end of that period because debt would rise more slowly than gross domestic product. And Swagel noted that net interest payments as a share of GDP remain moderate by historical standards.
Wendy Edelberg, the director of The Hamilton Project at the Brookings Institution and a former chief economist at the Congressional Budget Office, said that net interest costs don’t look set to rise to worrying levels over the next decade. "Rising interest rates are baked in to the fiscal outlook and the fiscal outlook, at least over the next decade, to my mind, does not look particularly dire."
Edelberg also said that inflationary pressures would shift over the coming year as consumers adjust their spending and pivot away from goods and back to services. That may pose challenges to policymakers looking for historical parallels.
"It is very likely that over the next year we will at least see some months with outright goods deflation," Edelberg said, "but at the same time we’re going to see an extraordinary increase — I think, I hope — in demand for services, and that’s where the worrying inflationary pressures are, and where we should be looking. So what this means is, the ‘70s and ‘80s is not a good template and, frankly even the last year is not a good template.
Douglas Holtz-Eakin, a former CBO director who now heads the conservative American Action Forum, said that the nation’s fiscal trajectory and its structural budget problems concern him, especially as they limit our ability to invest in areas of need for the future. "We do not have the political capability to even stabilize debt relative to GDP and since at some point you have to have that capability, that troubles me a lot."
Watch the full panel discussion here.
A Tax on Oil Profits That Would Be ‘Efficient and Progressive’: Report
Even though gasoline prices have come down slightly in the last few days, they remain quite high by historical standards and Democrats headed into what could be a tough election this fall are looking for ways to ease the pain at the pump.
As we told you last week, one of the options Democrats are discussing is a special tax on windfall profits earned by the major oil firms, with the revenues being used to provide rebates to low- and middle-income consumers. But economist Thornton Matheson of the Urban-Brookings Tax Policy Center says that lawmakers should be careful as they approach this idea.
Structured the wrong way, a tax on "excess" oil profits could backfire, reducing output and raising prices as companies attempt to pass along their higher costs. Matheson argues that the similar proposals from Sen. Sheldon Whitehouse (D-RI), which would impose a tax of 50% on the price of oil sold by large producers above its 2015-2019 average, and Rep. Peter De Fazio (D-OR), which would impose a 50% tax on excess earnings relative to a 2014 to 2019 baseline, run the risk of distorting the oil market while failing to achieve the goal of lower costs for consumers.
Instead, Matheson says that an oil tax should focus on the corporations and partnerships that produce petroleum and typically see ballooning profits when prices suddenly rise — and are overwhelmingly owned by upper-income households. Those excess profits are a kind of rent, Matheson says, which can be taxed efficiently without affecting output or prices. A natural resource rent tax, which has been deployed in oil-producing nations such as Norway and the United Kingdom, applies a special higher rate on elevated profits while leaving depreciation schedules in place, allowing producers to claim full deductions for the cost of their investments.
At the same time, the U.S. provides roughly $3.5 billion in subsidies for fossil fuel producers, which have not been shown to increase output and could be safely eliminated. "Instead of subsidizing petroleum profits, Congress could introduce a permanent petroleum profit surtax to raise revenue in an efficient and progressive manner," Matheson says.
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News
- Powell Says Fed Will Hike Further and Faster if Necessary – Associated Press
- Biden’s Plan for New Normal Spurs Worries About Next Covid Surge — and Who Is Being Left Behind – Washington Post
- Two States Passed Gas Tax Suspensions. More May Follow – CNN
- It’s a ‘Unicorn Year’ for Mid-Income Taxpayers, Thanks to Pandemic Aid – Politico
- Millions of Children Will Miss Healthy School Meals When Pandemic Relief Expires – NPR
- The South’s Health Care System Is Crumbling Under Covid-19. Enter Tennessee – Politico
- As America Returns to Work, Child Care Remains a Serious Obstacle – Politico
- Fewer Hot Showers, Less Meat: How Retirees on Fixed Incomes Are Dealing With Inflation – Washington Post
- China Bets on $1.5 Trillion of Tax Cuts in Quest for Growth – Bloomberg Businessweek
Views and Analysis
- Let’s Be Honest About What Really Caused the Gas Price Spike – Washington Post Editorial Board
- Petroleum Profit Tax Would Be Efficient and Progressive – Thornton Matheson, Tax Policy Center
- Democratic Centrists Want to Say Politics Is Simple. They’re Wrong – Paul Waldman, Washington Post
- The Democratic Party’s Biggest Problem Is Its Conservative Wing – Ryan Cooper, American Prospect
- Obamacare Is Boosting Economic Health – Matthew A. Winkler, Bloomberg
- When It Comes to Inflation, Our Focus Should Be On the Cost of Housing – Jonathan T.M. Reckford, Politico
- Steny Hoyer, a Member’s Member, Leads the Effort to Get More Benefits to Lawmakers – Paul Kane, Washington Post
- The Biden Administration Can Stop H-1B Visas From Fueling Outsourcing – Ron Hira and Daniel Costa, Economic Policy Institute
- The Fed’s Actions Don’t Match Powell’s Words – Clive Crook, Bloomberg
- Ignore the Naysayers. Dollar Dominance Is Here to Stay – Sebastian Mallaby, Washington Post