To Jonathan Edwards, America’s current economic dilemma would look familiar. Right now, Americans are simply consumers in the hands of an angry market god. It’s not that the market god has always been angry; in fact, for generations his invisible hand has kept our economy at equilibrium. Unfortunately for America today, that same hand has pushed us to a new equilibrium with less growth and more inflation.
So why is America at a seemingly paradoxical equilibrium? Commonsense economics tells us that if the economy slows down, inflation rates should go down, not up. There is less demand pulling inflation upward when people have less money to spend. Unfortunately, we aren’t dealing with demand-pull inflation, which the federal government can battle effectively using fiscal and monetary policy. What we’re facing is cost-push inflation, the result of a dreaded supply shock.
Supply shocks are like acts of God to traditional economists: They do incredible damage and are seemingly unstoppable. Input prices rise dramatically, resulting in decreased production and greater cost per unit for each of the lesser number of units produced. Hence, economic growth slows while prices continue to rise.
The current supply shock is largely the result of a massive increase in the price of oil. The vast majority of consumer products rely on oil, including all plastics, most agricultural products and the lion’s share of transportation. When oil prices began to rise a few years ago, it became more expensive to produce just about anything. As they have continued to rise to this day, the toll on the economy has grown too by enormous proportions.
The federal government has become keenly aware of the acute supply crisis, and has taken dramatic action in recent months in an attempt to alleviate the worst of it. On the fiscal end, transfer payments are up and taxes are down. On the monetary side, the Fed has been cutting rates at breakneck speed in an attempt to induce expansion.
Unfortunately, history shows that none of this is going to help. Our last supply shock was strikingly similar to the current one. In the late 1970s, oil prices rose after the Oil Embargo and the Carter Stagflation Recession nearly crippled all of America. Carter was unable to solve America’s economic woes using traditional government market interventions, which fall uniformly on the demand side of the equation. Every attempt to stimulate growth resulted in devastating inflation, and every backtrack aimed at reducing the lethal inflation rate destroyed millions of jobs. Carter lost his re-election bid because of his inability to see that the solution to the supply shock he faced lay in supply-side economics.
Reagan promptly began an economics program known as Reaganomics that combined catchy supply-side buzzwords and the occasional supply-side deregulation with more ineffective demand-side expansionary policy. Contrary to popular belief, most of Reagan’s policies were not “supply-side,” they were simply massive demand-side policies offset by limited supply-side deregulation. America finally pulled out of the economic tailspin in 1983 when oil prices fell. Reagan’s heretofore ineffective policies actually started promoting significant growth once the supply shock had ended.
Considering the past sheds light our best options in the present. America’s economy will not recover until the supply shock is dealt with. Oil prices must be forced downward to shift the aggregate supply curve rightward, back to a healthier equilibrium with the demand curve. If America’s economy is ever going to recover, the OPEC nations must be forced to dramatically increase production. All other economic policies will lead us back into the era of stagflation. Federal Reserve rate cuts with increased transfer payments will stimulate some growth but may increase inflation dramatically. The failure to close the budget deficit due to increased spending will weaken the dollar further and add more fuel to the inferno that America’s inflation problem is rapidly becoming.
President Bush does not want to put pressure on the Mideast, since he needs cooperation from the Persian Gulf states to stabilize Iraq. Unfortunately, there is no other way out of our present economic mess. Bush needs to find a way to incentivize increased oil production and lowered oil prices, otherwise we’ll be mopping up the Bush Stagflation Recession for years to come.
Trevor Wagener is a freshman in Pierson College.