‘Inflation Reduction Act’ — What’s in a name?
Last week, a few days before the Bureau of Economic Analysis announced a 1 percent monthly rise in the Personal Consumption Expenditures (PCE) price index — higher than expected and the highest inflation in decades — Sens. Joe Manchin (D-W.Va.) and Chuck Schumer (D-N.Y.) announced that they had reached a deal on a climate, tax, and health care bill after long negotiations. The bill is called the “Inflation Reduction Act of 2022.” Inflation reduction would certainly be nice right now, but whatever the merits of the legislation, this is a misleading title at a time when we need to be especially clear about the state of the economy and what’s being done about it.
The bill would increase tax revenues by imposing a corporate minimum tax rate of 15 percent, closing what’s known as the “carried interest loophole” and increasing tax enforcement. It would increase spending on domestic energy production and subsidies for Affordable Care Act premiums. Because the projected increases in tax revenue are larger than the projected increases in spending, the legislation would (eventually) reduce the government’s budget deficits. This deficit reduction is being touted as anti-inflationary. Additionally, the bill would allow Medicare to negotiate drug prices, which is supposed to reduce health care costs, and the energy investments are intended to slow energy price increases.
So why is the “Inflation Reduction Act” such a problematic name? Even if all of these policies work just as intended, Congress has already delegated price stabilization to the Federal Reserve. Central bank independence requires that the Fed be allowed to pursue its price stability mandate — which it interprets as 2 percent annual PCE inflation — regardless of what Congress and the president do. In other words, no matter the stance of fiscal policy, the Federal Reserve is expected to use monetary policy to keep inflation near its target over the longer run. Central bank independence is a valuable norm that is intended to promote macroeconomic stability by keeping politics out of monetary policy.
It is true that over shorter time periods, inflation can differ from the 2 percent target due to supply issues like oil shocks and supply chain disruptions, which the Fed — which works by influencing aggregate demand — does not and should not offset. So, it is plausible that fiscal and regulatory policies can lower inflation in the short run if they alleviate supply constraints. Ideally, Congress’s fiscal and regulatory policies can also improve growth in the long run if they make the economy more efficient and increase potential output. And they can address social and distributional issues as the voters desire. But it is nonsensical for Congress to talk about fiscal and regulatory policy reducing inflation years into the future if lawmakers are fully committed to an independent Federal Reserve.
Naming legislation the “Inflation Reduction Act” when that legislation is not about the Federal Reserve risks confusing the public about the Fed’s role and casting doubt about its independence. This is a real concern. Sen. Elizabeth Warren (D-Mass.), for example, recently wrote an op-ed criticizing the Federal Reserve for its interest rate hikes and discouraging Chairman Jerome Powell from pursuing a “painful and ineffective inflation cure.”And not long ago, former President Trump was regularly making his own disagreements with Fed Chair Powell public. If this type of political pressure becomes even more common, it could further politicize the Fed and undermine its credibility at a time when tough decisions about managing inflation need to be made based on the best possible analysis and data.
Politically convenient labels on legislation are nothing new. Neither is political pressure directed at the Fed. But this type of rhetoric should be resisted rather than encouraged.
Carola Binder is an associate professor of economics at Haverford College and a visiting scholar at the Mercatus Center at George Mason University. She has published more than 25 journal articles on inflation, inflation expectations, and central banking. She is on the advisory board of the Catholic Research Economists Discussion Organization and is an associate editor at the “Review of Economics and Statistics” and the “Journal of Money, Credit, and Banking.” Follow her Twitter @cconces