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To fight inflation, we should look for ways beyond the Fed’s policies

This article was first published in The Hill on April 22, 2024


Federal Reserve Chair Jerome Powell and the Fed Board have had people guessing since December about when they will cut interest rates. Cuts appear further off now because Powell is afraid that inflation may be heating up. This worry increased when the Consumer Price Index (CPI) on April 10 confirmed what the Personal Consumption Expenditures Index (PCE) had shown on March 29, that inflation may be stuck at a level the Fed thinks is too high. 


The PCE is the Fed’s preferred inflation index. What it suggests in 350 rows of data is important. It is that Powell and the Board are not paying enough attention to detailed information about the sources of inflation in that index. Average PCE prices were 2.5 percent higher in February 2024 than in February 2023, which is higher than the Fed’s 2.0 percent target. What should be getting Powell and the Board’s attention is the PCE’s data showing which goods and services are driving the average up.


The surge in prices caused by COVID-related supply chain and energy issues in 2022 and early 2023 is over. Inflation in goods that make up 33 percent of the index is way down. It is services like health care, housing and insurance that are pushing the average up. 


U.S. health care costs have risen faster than the averages for decades and rose about 52 percent more than the average from February 2023 to February 2024. The result is that per capita expenditures for health care in the U.S. were $12,555 in 2022, compared to $6,651 in an average of other developed countries.  


Why do health care prices outstrip the average year after year? It is largely because they are set by thousands of local hospitals that don’t compete on price, and don’t make their suppliers do so. Middlemen, suppliers and hospitals make opaque deals for the purchase of pharmaceuticals, devises like stents, medical machinery, disposables and services that inflate prices. The complex arrangements around insurance plans are similarly inflationary.


Housing prices, rents and utility costs also are rising faster than average inflation. Local regulatory bodies and zoning rules inflate prices and existing owners make it hard to develop less costly options like in-fill houses and apartments. Rents and home prices also are pushed up by rising interest rates engineered by the Fed.  


Housing and health care each are 17 percent of the PCE so their impact on average inflation is significant. It is important to recognize that the drivers of inflation have changed over the years. Autos, steel and machine tools were the culprits during the post-World War II period. There also were legal price-fixing arrangements in important sectors carried over from the Great Depression. Most economists and political leaders then believed that corporations and interest groups with the power to set prices were primary causes of inflation. 


Telecommunications are an example of how near monopolies and government regulators set prices in the post-war period. Telecom was dominated by the original AT&T, aka “Ma Bell.” It controlled 80-85 percent of the market. The Federal Communications Commission (FCC) allowed it to prevent newcomers from offering services if Ma Bell could show that they were not needed. 

 

AT&T kept price-cutting challengers out by marshalling stables of lawyers to block them. Government leaders and the courts in the 1970s and ’80s, however, came to side with challengers and consumers, allowing them to take on the monopolist. Prices of telecom services fell dramatically as did prices for trucking, rail and airlines services, energy, finance and other areas that were opened to competition in the late ’70s, ’80s and ’90s.  


Concern about monopolies and oligopolies powering inflation was shared by Republican and Democratic administrations. Presidents Harry Truman, John F. Kennedy, Lyndon Johnson, Gerald Ford, Ronald Reagan, Jimmy Carter and congressional leaders all took political risks to roll back monopolistic arrangement in a roster of industries.  


The Fed played a more limited role in fighting inflation during that period than it does today. It had been discredited during and after the stock market crash, and the Treasury and several New Deal agencies filled the vacuum. The Fed’s successes in recapturing power, beginning in the 1950s, have drastically altered the way economists and political leaders think about the economy and inflation.  The conviction today is that inflation fighting is about Fed policies rather than price-fixing and structural issues in sectors like health care, housing and insurance. Sectoral views of the causes of inflation don’t get the attention that presidents and Congress gave them in the earlier era. 


The obvious problem is that almost total reliance on the Fed to defeat inflation by slowing the economy will not work in sectors where price-fixing and structural issues are its principal causes. Worse, slowing the economy to fight inflation when the U.S. faces severe political, economic and geo-political challenges that demand money and resources is courting problems that are much bigger than modest inflation. 

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