Analysis 08-23-2022


Will the Inflation Reduction Act Reduce Inflation?


It is ironic that 51 years ago last week, American President Nixon announced that he would “temporarily” stop redeeming US dollars for gold.  What Nixon had temporarily instituted has in many ways come true when the US passed the Inflation Reduction Act, an Orwellian name for legislation that will likely increase inflation.

Nixon’s move did more than stop the use of gold in monetary transactions, it also eliminated the age-old monetary theory that government spending should generally equal government revenues and that governments should back their currency with gold or silver.

The discipline that curbed politicians was eliminated.

Today, gold and silver are archaic metals, except in countries like Zimbabwe, which is issuing gold coins for circulation because its own paper currency is worthless.

But gold isn’t so archaic that central banks have sold their gold reserves.  Central banks hold vaults of gold, and many banks are even buying more.  And, the US, which has the largest reserve of gold, keeps it in a vault at Fort Knox, surrounded by the Second Armored Division.

The Inflation Reduction Act reflects Modern Monetary Thought, and although it has never been proven in the real world, it has become popular with central bankers and politicians who want an easy, painless way to budget government spending.

In short, Modern Monetary Theory (MMT) holds that government revenues are unimportant.  It holds that countries that make their own money like the US, UK, Japan, and Canada needn’t worry about spending, taxing, or borrowing because they can pay their debts, since they can print as much money as they need.  Government budgets should not be constrained by fears of a rising national debt.

MMT also holds that conventional monetary thinking is merely a holdover of the gold standard.  It also allows for politicians to pass expensive, popular programs like healthcare, free college education, and other programs for favorite voter groups and corporations because government debt shouldn’t lead to monetary collapse.

The Inflation Reduction Act mirrors these MMT beliefs.  $430 billion goes to new green energy programs although current evidence shows that these programs will not pay for themselves over time.

The current US national debt is over $30.7 trillion dollars and that doesn’t include obligations like Social Security.

Much of that growth in debt came under administrations that preferred politically popular MMT over conventional, but politically painful monetary thought.  Obama added $8.3 trillion to the deficit – a 70% increase.  Trump increased the debt by $7.8 trillion.  Biden has added $2.26 trillion in his first year, which will outpace Trump and Obama if he continues this pace for the rest of his administration.

Any economist will tell you that inflation is demand divided by supply.  And demand is a function of money supply.  The $430 billion in new programs will only increase the demand for goods by $430 billion.

Unfortunately, it appears that supply will not grow enough to tamper down inflation.  From 1992 to 2021, the average growth of the US economy was 2.4%.  However, the Congressional Budget Office projects that the average growth of the US economy from 2022 to 2052 will only be 1.7% per year.

Clearly the supply of goods provided by the economy will not keep pace with the additional demand caused by the increased demand caused by government spending and MMT.

The Penn Wharton Budget Model, which is associated with the University of Pennsylvania’s Wharton Business school, showed that the new law would not invigorate the economy or curb inflation.

“We project no impact on GDP (Gross Domestic Product) by 2031,” the study noted.  “The Act would very slightly increase inflation until 2024.”

The study also noted that benefits also reduced the incentive to work, which would result in a small decline in hours worked, which would reduce the supply of goods produced.

There, however, was one aspect of the law that did fit conventional monetary thought – increasing the number of tax collectors to conduct audits for those making less than $200,000.

Traditionally, audits were focused on companies and richer individuals to maximize the amount recovered because those making less weren’t profitable enough to audit in the eyes of the IRS.

The law allows for an increase of 87,000 new IRS agents.  To give a better idea of how large that number is, there are three US Armored Brigade Combat Teams in Europe, with about 4,700 soldiers in each brigade.

Those who monitor the erosion of rights for American citizens are especially concerned as the IRS has become a tool to silence government opponents.

The Obama Department of Justice refused to seek criminal charges against her although she did apologize for improper targeting of some organizations.

Another concern was an online ad for IRS applicants that said they must be willing to “Carry a firearm and be willing to use deadly force if necessary.”

The ad was quickly edited as word spread about the ad and its requirements.

Former Speaker of the House Newt Gingrich said, “When people realize that most of the IRS agents will not be going after billionaires and big companies – but will instead be auditing waitresses, Uber drivers, self-employed people, and small businesses – I expect the opposition will grow even more intense.”

Clearly, the Inflation Reduction Act has created a lot of controversy, both in economic and civil rights areas.  However, since it has been passed by Congress and signed into law by Biden, we will have to wait to see the results.