The Inflation Tax on Workers

An employee sorts clothes at Costco in Washington, DC July 6.


Michael Reynolds/Shutterstock

Well that was ugly. Inflation hit its highest level this year in June, rising 1.3% this month and 9.1% over the last 12 months. This means a sharper fall in real wages and further tightening by the US Federal Reserve, which is likely to affect asset prices. No wonder Americans are in a bad mood.

The price increases are “broad-based”, as the Federal Office for Labor Statistics (BLS) put it, especially for food and energy. The home food price index rose 1% this month, up 1% or more for the sixth straight month and up 12.2% over the last year. Energy prices rose 7.5% for the month, led by a rise in gasoline prices, as any American who has ever filled a gas tank knows.


Some analysts, including those in the White House, are taking solace that the “core” price index excluding food and energy is up just 0.7%, or 5.9% over 12 months. President Biden addressed this point in his statement on Wednesday. But core prices accelerated in June from May and have risen at an 8% annual rate over the past three months. Inflation cannot be dismissed as largely the result of energy prices and Ukraine.

Oil and gasoline prices have fallen in recent weeks, giving hope that July’s inflation numbers are looking better. Commodity prices have also fallen below their all-time highs. But this is also likely related to falling demand as the global economy slows. Slower growth as a solution to inflation may be inevitable after so many fiscal and monetary policy mistakes, but it is a tragedy that we have come this far.

The greatest tragedy is for American workers, who are suffering the greatest reduction in real wages since the 1970s. Real average hourly earnings fell 1% in June alone and are now down 3.6% over the past 12 months. Average real weekly earnings fell even more sharply, by 4.4%, as the average workweek fell.

Real wages have fallen in 10 of the last 13 months, and they have fallen more since President Biden took office than during the recession caused by the financial crisis. From December 2008 to a real earnings trough in February 2012, real average hourly earnings fell 1.8%, according to the BLS, measured in dollars from 1982 to 1984. They have fallen 4.8% since January 2021.

The political implications are clear enough. The Fed has every reason to tighten further. Real interest rates remain negative and the Fed only recently stopped adding to its bloated balance sheet.

The Fed is downplaying the role of money supply these days. But to the extent that the M2 boom in 2020 and 2021 played a role in inflation, the rate of money supply growth has slowed dramatically in recent weeks. Monetary policy operates with long and variable lags, as Milton Friedman taught, so by this logic today’s tightening will hit the economy in 2023.

This assumes the Fed doesn’t flinch when the unemployment rate rises and political criticism follows. Our collaborators Phil Gramm and Mike Solon point out that inflation, when it last approached 9% in 1973, rose to an average of 9% over the next eight years. Because the political decision-makers lacked the will to contain them.

As for fiscal policy, rising inflation is likely to take further spending from Congress domestically. These include a $1 trillion stripped down version of Build Back Better and the so-called Competition Act, which is now in the Senate-House of Representatives conference. The latter’s $200-300 billion cost, which will increase the deficit, will do more harm than good.

The argument that raising taxes to reduce the deficit would reduce inflation ignores the damage higher taxes would do to the supply side of the economy. With interest rates likely to rise sharply, the economy will slow and the timing for a tax hike for corporations and the wealthy couldn’t be worse. Senators Joe Manchin and Kyrsten Sinema can do the country a favor by finally ending the Beltway drama surrounding all these taxes and spending.

The return of virulent inflation need not have happened, and the experience should discredit the policies that triggered it. The spending spree in 2020 and 2021 under Presidents Trump and Biden led to excessive demand. The Fed kept the spigots open for too long as Washington fell in love with modern monetary theory.

Whatever the short-term financial help to Americans that the Democrats have provided with their trillions of dollars in welfare payments, inflation has more than offset it. The US needs a return to a growth economy based on stable money, supply-side fiscal policy, deregulation and fiscal restraint. This agenda has not been as important since 1980.

Wonderland: Responsibility for this administration’s public failures rests with the Democratic Party, not just Joe Biden. Images: Bloomberg News/Getty Images Composite: Mark Kelly

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Published in the print edition on July 14, 2022. The Inflation Tax on Workers

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