Biden and Congress Can Fight Inflation Too | Opinion

Last month the Bureau of Labor Statistics released data showing that inflation is rising at the fastest pace in 40 years—7.5 percent over the past 12 months. This has led to speculation that the Federal Reserve will raise rates more aggressively at its March meeting, underscoring that everyone is looking to monetary policy as the key to bring down rising prices.

There is no doubt that the Fed must raise rates several times this year to protect the economy from rising inflation. But to keep Fed Chair Jerome Powell from having to slam the brakes too hard on the current economic recovery, it's important that the president and Congress use fiscal policy to combat high inflation as well.

The Federal Reserve has taken some initial steps to pull back the reins on the monetary stimulus issued to help the economy rebound from the onset of COVID-19. The central bank has begun to taper back its policy of quantitative easing—purchasing Treasury bonds and mortgage-backed securities—that flooded the economy with liquidity. In addition, the Fed is forecasting multiple federal funds rate increases starting next month.

Meanwhile, the White House and Congress have focused on the transitory causes of inflation, such as bottlenecks in the supply chain and spikes in energy prices. While important, these efforts do not cancel all that two years of stimulus did to stoke inflation.

There have been moments in the past when the Fed, the White House and Congress worked in concert to align monetary and fiscal policy. In 1993, the Federal Reserve—under the leadership of Alan Greenspan—kept interest rates at low levels to offset the effects of the spending cuts and tax increases in President Bill Clinton's deficit reduction deal. This cooperation led to eight years of strong economic growth and low inflation, and helped shift the budget from decades of deficits into surpluses.

But for the most part, elected officials in Washington have been willing to let the Federal Reserve tackle inflation alone. This has forced the Fed to adopt an aggressive approach on interest rates, which has on occasion sent the economy into a tailspin. The best-known case occurred in the early 1980s, when the Paul Volcker Fed raised rates to a high of 20 percent to get inflation back down to single digits. But there have been other instances as well. Both the 1990 and 2001 recessions were predated by at least five consecutive hikes in the federal funds rate.

Federal Reserve Chairman Jerome Powell
US Federal Reserve Chairman, Jerome Powell, testifies before the House Financial Services Committee on Capitol Hill, in Washington, DC, on March 2, 2022. - The impact of the conflict in Ukraine on the US economy is "highly uncertain," and the central bank will need to adjust quickly to ensure the post-pandemic recovery continues, Powell said Wednesday. Stefani Reynolds / AFP/Getty Images

Fortunately, Democrats and Republicans have it in their power to give the Federal Reserve the flexibility to raise rates more slowly. This could allow interest rates to peak at a lower level and help prevent the economy from slipping back into recession.

First, both parties must resist the temptation to use rising federal revenues to finance new spending or tax cuts. In Fiscal Year 2021, federal revenues jumped by $627 billion from the prior year, and they are expected to increase again in 2022. At the same time, the deficit is projected to drop by over a trillion dollars next year (although the deficit will still remain higher than it was before the pandemic). Those savings must be protected so that the Fed's job to tame inflation does not become more difficult.

Second, Congress and President Joe Biden can reduce some of the inflationary impact of the nearly $6 trillion in pandemic stimulus by reducing the deficit through tax increases and spending cuts. Just as deficit-financed tax cuts and spending stimulated economic growth the last two years, raising taxes and cutting spending can lessen the excess demand that has helped drive higher inflation.

Several policymakers (and apparently some in the White House), have proposed increasing revenues by $1 to $2 trillion, up to half of which would be dedicated to deficit reduction, and the rest used to fund key public investments such as energy infrastructure and universal access to pre-K. If Congress wanted to go further, it could cut some types of spending as well. Some possible tax and spending offsets include tightening the step-up basis loophole, capping itemized deductions for people in higher tax brackets and passing Rep. Scott Peters' compromise proposal to allow Medicare to negotiate prescription prices for drugs that have no competition.

Furthermore, enacting some of the climate provisions within Build Back Better (as long as they are fully offset and do not increase the deficit), would help reduce America's long-term dependence on oil and gas, a driver of inflation today, and reduce our exposure to economic shocks emanating from Russia or the Middle East. Senator Joe Manchin—a critic of Build Back Better—has indicated support for the $325 billion in tax credits related to clean energy, advanced manufacturing and electric vehicles included in the Senate version of the Build Back Better legislation.

Today's high inflation rate is threatening America's economic prosperity. To get inflation under control without pushing the economy into another recession, we need both monetary and fiscal policy to be aligned.

Paul Weinstein Jr. is a senior fellow at the Progressive Policy Institute and directs the MA in Public Management program at Johns Hopkins University.

The views expressed in this article are the writer's own.