Home Consumer debt Getting Inflation Wrong – Milford-Orange Times

Getting Inflation Wrong – Milford-Orange Times


By Kevin McNabola
Orange Finance Council

Kevin McNabola

In June, the Federal Reserve raised its target interest rate by 75 basis points, the biggest increase since 1994. To make matters worse, retail sales unexpectedly fell and gross domestic product for the second quarter should be stable or slightly negative.

With a first quarter at -0.5%, this raises the question of whether we are currently in a recession. The true definition of a recession is two consecutive quarters of negative growth. However, all signs point to us being about as close to a recession now as we have been since 2008.

The latest statement from the Federal Reserve is breathtaking. A press release read: “Overall economic activity appears to have recovered after declining slightly in the first quarter.

Oh good? The Federal Reserve totally miscalculated inflation early on, calling inflation transitory in nature, meaning inflation will be short-lived due to the negative impact of the pandemic on supply chains. But the pandemic is only one driver of the current inflation equation.

Three main factors are behind the current 40-year high inflation rate of 8.6%: excessive debt levelsmonetary stimulus and rising energy prices.

The United States is more indebted today than it has ever been, with a total non-financial debt-to-GDP ratio of nearly 300%, including government, corporate, and consumer debt. This excessive indebtedness is a financial time bomb that, left to its own devices, could lead to a deflationary explosion involving widespread defaults, stock and housing crashes, and bank failures.

Faced with this real and worrying threat, political decision-makers are leaving nothing to chance. It has become increasingly clear that a high level of inflation is becoming a policy objective to reduce indebtedness and the risk of a deflationary burst that accompanies excessive indebtedness.

There is good reason to assume that this was also the policy objective in 2011, only the policy makers failed in their objective. The US debt-to-GDP ratio has not declined, but has actually increased by around 50% of GDP since then. Today’s excessive level of indebtedness is therefore not an engine of inflation in itself; however, it is a driver of government policies that cause inflation.

The Fed did not mention that M2 money supply (an indicator of money supply and future inflation) has increased by 40% over the past year. The Fed also bought almost two-thirds of the bonds sold by President Joe Biden’s $2 trillion bailout, which is a major factor behind the inflation we are experiencing today. Additionally, the Fed has funded spending with the purchase of more than $4 trillion in US Treasuries and other financial assets since March 2020.

These gargantuan stimuli have been accompanied by the growing popularity of modern monetary theory among economists, according to which the only limit to budget spending is excessive inflation. With inflation being the only limit on deficit spending, it’s no wonder policymakers describe the current inflationary impulse as transitory.

The third factor is rising energy prices. Look back to 2008; the world has seen record oil prices and energy industry profits have increased dramatically. The increase in profits has been accompanied by an extraordinary level of investment in future oil production. The resulting oil boom in the 2010s and a rapid increase in global oil production dampened energy prices.

In 2020, historically low oil prices driven by the pandemic led to losses among energy companies and significantly reduced capital expenditures in energy exploration projects. Due to the lack of investment and the reduced number of new discoveries, the growth of supply in the world is limited and the decline in supply is already being felt.

Although supply is likely to be tight given policymakers’ aggressive plans to invest in infrastructure, demand for oil and other commodities is expected to remain robust, even assuming considerable growth in electrification in transportation. With limited supply and growing demand, energy prices are expected to continue to rise in coming years, putting upward pressure on the costs of a wide range of goods and services, including supply food (while also allowing the development of more energy-efficient alternative modes of transport).

These three inflationary factors will no doubt force the Federal Reserve to raise its target rate by a full percentage point at every meeting from now until the actual inflation rate begins to decline significantly.

Connecticut has already started to feel the effects, with an additional 9 cents per gallon diesel fuel tax starting July 1, which will most certainly have a negative ripple effect on small businesses and consumers.

This increase in diesel taxes couldn’t come at a worse time. Inevitably, this essentially means that the cost of goods and services, clothing, and food will also rise in Connecticut over the next six to 12 months. Rising gasoline prices will eventually siphon off discretionary income and consumer spending, ultimately causing the economy to crash into a hard landing in the near future.

Kevin McNabola is a member of the finance board of Orange and chief financial officer of the city of Meriden.