Economic Contraction

Inflation and high gas prices are too complex and widespread for a quick fix

  • Inflation is still at its highest level in four decades, but the potential solutions all have major drawbacks.
  • Raising interest rates is the Fed’s main tool to curb inflation, but it could trigger a recession.
  • The options for lowering gas prices are either geopolitically strained or too short-sighted.

Choose your poison. Inflation is at its highest level in more than four decades, and every feasible solution to combating it has serious downsides.

Faster-than-usual price growth first emerged in early 2021 as a side effect of the country’s reopening. The rollback of nationwide lockdown measures triggered an almost immediate surge in pent-up demand. Companies, meanwhile, are slow to catch up. Historical spending collapsed into limited supply, and companies quickly raised prices.

The following year, inflation went from a sector-specific phenomenon to an economy-wide pain. Prices rose 8.6% on the year to May, reflecting the fastest price growth since 1981. Soaring food and gasoline prices are leading the way, but there is little pockets of the economy that do not experience high inflation.

Yet, as high prices threaten to plunge the country into another economic crisis, viable solutions are few. Virtually every solution to the inflation problem is either too slow, too risky, or too divisive.

The problem of inflation needs to be addressed, but the answer will not please everyone.

Expect some pain from Fed efforts

No matter what is fueling dangerously high inflation, it is


Federal Reserve

to curb it, and the central bank has already taken significant steps to slow the price spike. The Federal Open Market Committee raised interest rates by 0.75 percentage points on June 15, backing the biggest rate cut since 1994 just days after new data showed inflation rising again in may. Fed Chairman Jerome Powell hinted that similar hikes could follow at the committee meeting in July.

The aggressive hiking cycle has a decent chance of cooling inflation. Higher rates increase borrowing costs on everything from mortgages to credit card debt, which weakens spending and helps close the supply-demand imbalance that fuels inflation.

Still, it comes with a fair share of drawbacks.

On the one hand, higher rates are somewhat slowing the broader recovery. Many bearish economists — including a former New York Fed chairman — worry that rate hikes will slow growth and lead to corporate layoffs en masse. With labor demand currently at historic highs, rising rates could quickly stifle spending and send the economy into a tailspin.


recession

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Even if the Fed can avoid a self-inflicted slowdown, higher rates could leave countless Americans with heavy financial burdens. Mortgage rates are already nearly double what they were at the start of the year, leaving new homebuyers with much larger monthly payments. Credit card rates, meanwhile, are approaching record highs. After months of record spending, the hike could pose a bigger risk for those falling behind in paying their balances.

Rate hikes are the Fed’s primary tool for fighting inflation, and they have a strong track record of slowing price growth. But with extremely high inflation, this effort will come at a cost.

“The process of reducing inflation to 2% will also involve some pain, but ultimately the most painful thing would be if we fail to deal with it and inflation has to take root,” Powell told Marketplace in May.

Untangling supply chains will take time

Strengthening supply could also solve the inflation problem, but several obstacles stand in the way. Recent COVID-19 outbreaks in China have pushed the country’s manufacturing centers back into partial shutdowns, again upending supply chains as it looked like the situation was beginning to recover. The decades-long shift to a globalized economy has produced cheap labor and lower prices for a whole range of products, but unraveling the current mess will likely be a slow and turbulent process.

There are also several logistical issues at home. Shortages of truck drivers, port backlogs and overcrowded warehouses hampered the national supply chain throughout 2021, and many issues have not been fully resolved. The Biden administration has touted its $1 trillion infrastructure bill as a solution, but such an investment takes years to pay off. Without additional and faster action from Congress, it is up to the private sector to address supply chain issues.

There is no good option to lower gas prices

Much of the inflation problem comes down to gasoline prices. Costs at the pump are up nearly 50% from levels a year ago, and the national average price for a gallon of gas is now just under $5. As with general inflation, there is simply too much demand for gas and too little supply for everyone. And there are no attractive options for finding more gas to sell.

The spike in energy prices accelerated when Russia invaded Ukraine in late February, raising fears of further supply problems in natural gas and oil markets. The recovery intensified in March when the United States, United Kingdom and European Union imposed severe energy embargoes on Russia’s energy sector. The measures were intended to cripple one of the Kremlin’s main sources of revenue, but they left the West paying significantly higher energy prices. The United States and its allies could roll back those sanctions to provide quick relief, but that would mark a blow for Ukraine and a capitulation to Putin.

The United States could also turn to Saudi Arabia as an emergency oil source, but that option has its own hurdles. President Joe Biden is due to visit the kingdom in July and meet Saudi Crown Prince Mohammad Bin Salman, and some expect the president to push for an increase in oil production.

Yet Biden has vowed to reprimand Saudi Arabia for its role in the 2018 murder of journalist Jamal Khashoggi, and many Democratic allies in Congress are uncomfortable with the visit. Dating MBS is a “bad idea,” Sen. Tim Kaine of Virginia told Insider’s Joseph Zeballos-Roig earlier in June.

“I see very little evidence that the Saudis are going to lower gas prices,” said Sen. Ron Wyden of Oregon. “I see a lot of evidence of their horrific human rights abuses.”

Left with little other form of relief, the Biden administration on Wednesday urged Congress to approve a three-month federal gas tax break. The option would temporarily levy the 18-cent-per-gallon tax on gasoline and the 24-cent tax on each gallon of diesel, but it looks more like a band-aid than a meaningful solution. The strong imbalance between gas supply and demand could continue to drive up prices even after the approval of a tax holiday.

There are also doubts on both sides of the aisle that the savings would reach consumers. House Speaker Nancy Pelosi declined her support for such a measure in March, raising fears that oil companies could take the lion’s share of the aid. With Republicans uniformly opposed to such a vacation, even the most temporary relief from soaring gas prices is unlikely to win congressional support.

“Whatever you think of the merits of a gas tax exemption in February, it’s a worse idea now,” said Jason Furman, a top economist in the Obama administration. wrote on Twitter.