By Mark Jamison

The recent inflation surge has many consumers and businesses upset — as they should be. Inflation makes it costly to hold liquid assets, which both groups need. Declining dollar values make it more costly for foreign entities to buy from American businesses. Inflation also punishes senior citizens whose savings shrink through no fault of their own.

Congress, the White House, and the Federal Reserve are to blame for the situation, but they are choosing to scapegoat big business. The White House recently issued attacks on large meat processors, saying they have bought up rivals and are raising prices. Sen. Elizabeth Warren (D-MA) has called for the breakup of Kroger, a leading retail grocer.

This rhetoric echoes business-blaming by economist John Kenneth Galbraith during the inflation of the 1970s. Galbraith was wrong in his assertion that big businesses were causing inflation, as then-Chairman of the Federal Reserve Paul Volcker demonstrated: He clamped down on money supply growth, and inflation came to a screeching halt without the government assaulting the companies that Galbraith blamed.

Scapegoating works because some people are often confused about inflation, which is an increase in the general level of prices in the economy. The consumer price index (CPI) is a common measure, but it omits prices for resources that businesses buy. The gross domestic product price deflater is a better indicator than the CPI, as it encompasses most of the economy.

In general, inflation results
from the amount of money in the economy growing faster than the amount of
production. For example, suppose the economy was comprised of 10 loaves of
bread and two consumers, each with $10 to spend. Also assume the consumers want
all the bread they can get and spend all the money they have. Competition would
cause the price of bread to be $2 per loaf.

Now suppose that both
production and the money supply increase 20 percent: There are now 12 loaves of
bread and consumers have $24 to spend. The price of bread stays at $2 per loaf.
But if the amount of money increased, say, 80 percent, so that each consumer has
$18 to spend, and production still only increased to 12 loaves, the price of
bread would jump to $3 per loaf.

Notice what happened in the
last scenario: The growth in money was greater than the growth in output, so
prices increased. That’s inflation. Inflation is often associated with growth in
government spending. It is true that such spending can be inflationary, but that
is because the spending is often enabled by growth in the money supply that is
not matched by an increase in production, or the growth in government triggers
a suppression of production that is not matched with a comparable change in the
money supply.

Today’s inflation dilemma matches what I just described: The federal government has gone on a spending spree, the Federal Reserve has accommodated Congress’s splurge with easy money, and production is physically unable to match these surges even though production has grown rapidly since the early days of the COVID-19 recession.

One can imagine scenarios in
which expanding market power suppresses production growth, and the government,
not recognizing the situation, allows money to outgrow production, thereby
leading to inflation. But one of two things is necessary. One is that market
power is growing in that moment, allowing businesses to newly suppress production.
The other is that the firms have had the market power for some time, but in
prior years declined to exercise it.

Neither of these situations apply today. We have no evidence that the accused firms have suddenly acquired market power, and no evidence that they are restricting production. We also have no evidence that the accused firms feared antitrust enforcers during the presidencies of George W. Bush, Barack Obama, and Donald Trump, and have now discovered courage or opportunity with the presidency of Joe Biden. What we have is plenty of evidence that our government officials have chosen to spend and to grow the money supply.

What should be done? Congress and the White House should act quickly to curb spending, and the Federal Reserve should slow money supply growth. If they do not do this, we will soon have a repeat of the late 1970s, when the economy slumped and many businesses that had borrowed money to keep up with what looked like a boiling economy suddenly found themselves facing bankruptcy as interest rates skyrocketed and consumer spending slowed.

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