Why inflation is so tough to curb

Inflation is proving tougher to curb than Federal Reserve Chairman Jerome Powell anticipated or, with an eye toward the next election, President Biden is inclined to admit.

In January, American consumers and businesses burst from their annual starting blocks. Retail sales jumped 3%, and employers added 517,000 jobs, but the consumer price index increased 6.4% from a year earlier.

When inflation peaked at 9.1% in June 2022, analysts attributed about half of the problem to supply side bottlenecks. The sudden juxtaposition of the shift in purchases from services to goods — instigated by retail and office closings and work-from-home — against slowing production at Chinese and U.S. factories, clogged ports and fires at critical semiconductor factories.

Inflation eased as those were resolved, but it remains at an uncomfortable level because both U.S. fiscal and monetary policies remain expansionary.

The federal budget deficit — thanks to increased entitlement spending, the CHIPS and Science Act, the Inflation Reduction Act, bailouts for union pension systems and war in Ukraine — is estimated by the Congressional Budget Office at $1.410 trillion for fiscal 2023. That’s a whopping increase from 2019, the last pre-pandemic year, when the gap between what the federal government took in and paid out was $984 billion.

Overall, the deficit has increased from 4.6% to 5.4% of GDP from before to after COVID-19 and is slated to jump to 6.1% by 2025. Those figures may not appear large to lay readers, but through the lens of an economist, that’s a lot of added stimulus.

The president boasts that his proposed budget, due March 9, will curb deficit spending by $2 trillion over 10 years. That’s a drop in the bucket next to the $52 trillion leap in federal debt the CBO expects by 2033.

With Congress likely to face new pressures to increase defense spending to send more weapons and ammunition to assist Ukraine in a protracted war and counter the growing Chinese threat in the Pacific and the CBO's projections not building in another unforeseen crisis like COVID-19 over the next decade, this column is betting that neither the CBO's nor the administration’s projections will hold up.

Blame what you like — the Trump tax cuts or the grip progressive groupthink on Mr. Biden — the federal deficit and debt ceiling negotiations are degrading into political farce.

Sixty-four percent of federal spending is entitlements, and 9% is debt service. Republicans may be demanding substantial spending cuts to authorize an increase in the debt ceiling, but they don’t have a plan to reduce entitlement spending.

The president baits Republicans by saying they want to cut Social Security and Medicare. Republicans deny any such intentions, but there can be no genuine budget discipline without entitlement reform.

Substantially reducing the federal budget deficit is not possible without returning Social Security and Medicare to long-term solvency by raising the retirement and eligibility ages. And reasonable measures to curb other safety-net programs — for example, limiting eligibility for the child tax credit and food stamps to adults willing to work, the disabled and older Americans.

Against this backdrop, monetary policy is hardly restrictive.

When former Federal Reserve Chairman Paul Volcker faced down the Great Inflation, the pace of price increases peaked at 14.8% in March 1980, and the Fed ultimately raised the federal funds rate to about 19%.

Last June, inflation peaked at 9.1%, and the Fed has so far raised the effective federal funds rate to little more than half that amount. And against an annual pace of inflation of about 6.4%, the rates on one- and 10-year Treasuries are 5% and 4%.

No matter how it’s sliced, real interest rates are negative.

In the first 12 months of the pandemic, the Fed kept the federal funds rate at near zero, with inflation running at 1.1%. Now it keeps it at less than 5%, with inflation running at 6.4%. That larger gap makes monetary policy less restrictive now than when the economy was shut down.

The Fed puts great stock in consumer expectations. Expected one-year inflation, as measured by the average of the Conference Board, New York Fed and University of Michigan surveys, is 5.4%. And inflation expectations, as measured by spreads between nominal and inflation-adjusted one-year Treasury rates and consumer surveys, have consistently underestimated inflation a year later.

Surveys are nice, but observing real consumer behavior is better. So let’s take a field trip to the housing market.

In October, the 30-year mortgage rate peaked at 7.1% but fell to 6.2% by mid-January. Homebuilders reported a surge in buyer interest — mortgage applications for home purchases bounced up.

Households don’t see a 6.2% mortgage as burdensome if they expect inflation to keep roaring. With weekly visits to the grocery store creating sticker shock — food prices were up 11.4% as of January — they believe Trader Joe's about inflation more than Mr. Powell or Mr. Biden.

• Peter Morici is an economist and emeritus business professor at the University of Maryland, and a national columnist.