Fuel for inflation?

The House of Representatives recently passed the Build Back Better Act. If enacted, it’s expected to increase government spending by $1.75 trillion over 10 years.

With the legislation’s tax increases and tougher IRS enforcement, the Congressional Budget Office estimates a smaller $250 billion increase in the deficit. But if temporary and sunset provisions designed to keep the official cost down are eventually made permanent, the total could increase by as much as $2.5 trillion over those 10 years.

President Biden claims that because of the benefits to American workers and their families, it would reduce inflation. But the more it adds to the national debt, the more inflation will rise.

Inflation is the result of the money supply, which is controlled by the Federal Reserve, increasing faster than the output of goods and services. Government deficits are funded by selling treasury bonds. If deficits are not too large, they can be funded by borrowing from the public and from foreign investors. But foreign investors have been buying fewer U.S. government bonds in recent years, and U.S. investors have not increased their purchases of bonds as the deficit has increased.

Thus, the only way for the federal government to sell the trillions of dollars of additional bonds required to fund our recent rapid growth in government debt is for the Fed to buy those bonds.

We’re already experiencing the highest rates of inflation in 30 years, and it can be blamed on the expansion of the money supply since the beginning of the pandemic.

As households spend the additional money they accumulated from the stimulus programs over the last two years, prices will continue to increase—unless the Fed reduces its purchases and raises the interest rate it pays on bank reserves. But large government deficits in the future would make it harder to reduce bond purchases and could increase political pressure on the Fed to keep interest rates low.

That’s why the president’s claims that the Build Back Better Act would reduce inflation is not based on sound economic analysis. In addition to its impact on deficits, some of the spending, such as the expanded child tax credit (CTC), is likely to discourage work. The original CTC provided a benefit that increased with earned income. The expanded CTC reduces this incentive because parents with little or no income receive the full amount of the credit as a check from the government.

Why not focus on fully funding Social Security and Medicare benefits for retired Americans, since those programs’ trust funds will soon run out of money? It’s not exciting, but taxes earmarked for those programs no longer bring in enough to cover promised program benefits— which increase with inflation.