Where Does the Research Point? Tight Labor Markets and Excessive Federal Spending
The administration’s policies triggered tight labor markets and excessive government spending, which research shows can explain for most of the rise in core inflation.
The Most Significant Policy Problem Facing Americans
Americans believe inflation is the most significant policy problem that we currently face. This is not surprising as it has eroded purchasing power over the past four years. As of July 2024, it takes $1.20 to buy the same basket of goods and services that one could buy for only $1 in January 2021.
Tight Labor Markets Exacerbated by Policies that Reward Non-Work over Work
Core inflation was, in part, motivated by tightness in the labor market as job vacancies increased relative to the unemployment rate. When businesses reopened following the pandemic closures, many older workers retired while younger cohorts were slow to enter or return to the workforce. Research from EPIC Visiting Fellow in Workforce, Rachel Greszler, reveals there are still about 2.9 million fewer workers than we would expect relative to before the pandemic.
The reduction in employment precipitated by government-imposed business closures led to a chain reaction that affected more than just the cost of living. At the macroeconomic level, the reduction in employment lowers productivity and output, which reduces the level of government revenues and increases the deficit.
At the individual level, not entering the workforce after school, or continuing to expand skills by going to post-secondary school, can have profound consequences on income, economic opportunity, and even health for many years. Furthermore, research has demonstrated that decisions not to enter the workforce are motivated, in part, by public policy that rewards non-work over work.
Job Vacancies and Increasing Deficits Can Account for up to 80% of Core Inflation
Another significant cause of inflation has been increasing federal budget deficits. Since the first quarter of 2020, 76 percent of all additional spending has been paid for with debt while 14 percent has been paid for by printing money
New research by economists at the London School of Economics has found that large fiscal stimulus enacted in 2021 can explain about a third of the inflation over the 2021-2022 period.
This means that the increase in job vacancies following the pandemic closures and higher deficits fueled by government spending can explain as much as 80 percent of core inflation. Other causes of inflation since 2021 have been price volatility for energy and supply chain disruptions caused by the pandemic.
The Inflation Reduction Act of 2022 Likely Increased Inflation
Because of these factors, the Biden-Harris Administration’s Inflation Reduction Act of 2022 (IRA) likely made inflation worse by contributing to short-term deficits. According to the Congressional Budget Office (CBO), the IRA increased spending by $110 billion over the fiscal year 2022-2026 period and the deficit by nearly $60 billion. This increased the inflation that had already been caused by the American Rescue Plan Act of 2021 (ARPA).
Congress Should Increase Workforce Participation and Reduce the Deficit
Rather than enact more fiscal stimulus, the most significant thing that policymakers can do to reduce the cost of living is to focus on policies that increase workforce participation while reducing the deficit. This will also improve economic opportunity for younger workers who are entering the labor force.
