Soaring inflation is the top issue for a lot of voters heading into the midterms, with most saying Republicans would do a better job of handling the problem.
Indeed, Republican candidates are taking full advantage of voter concern about inflation by hammering Democrats on the issue and pushing their own ideas to fight inflation, such as cutting both government spending and taxes.
As a finance and economics expert, I have studied inflation, what causes it and what can bring it down. That’s why I doubt a Republican Congress would have much, if any, effect on inflation.
Inflation, or a sustained rise in consumer prices, is created in two main ways.
The first is by way of an increase in demand for products and services. For example, at the beginning of the pandemic, demand for webcams soared, as lots of employees were required to work remotely. As a result, the prices of webcams increased significantly.
Or take leisure travel, which has increased significantly as COVID-19 infections have come down. People are flying more, which has led to higher ticket prices.
When these types of demand-driven price increases occur across a large number of products and services, the result is rising inflation.
Inflation can also result from higher production costs.
For instance, gas prices are on the rise because it has become a lot more expensive to produce it. The war in Ukraine sent oil prices soaring at the beginning of 2022. They’ve come down, but a recent supply cut by OPEC+ oil-producing nations caused another spike. As oil prices increase, the higher costs are passed on to refiners, which leads to higher prices at the pump.
The increase in the price of eggs is another example of this type of inflation. Bird flu caused the deaths of about 10% of egg-laying hens beginning in January 2022. In addition, farmers faced higher fuel and fertilizer costs. These factors have caused the average price of eggs to soar to an all-time high.
An economy’s central bank – not Congress or the president – is typically the first line of defense when it comes to battling inflation. Central banks set monetary policy, and their primary way of combating inflation is by raising interest rates.
In the U.S., the Federal Reserve focuses on the so-called federal funds rate, which is the base rate that banks use in setting their own deposit and loan rates. The Fed has raised this benchmark five times in 2022, from about 0% in March to 3% – and is expected to lift rates another 0.75 percentage point on Nov. 2, 2022.
The main goal of the rate hikes is to increase borrowing costs and thus drive down demand – the first driver of inflation that I noted above. The idea is that higher interest rates lead people and businesses to borrow less. The less people and businesses borrow, the less they will spend.
The impact of higher interest rates is already being felt in the housing market, for example. Current 30-year mortgage rates are over 7% on average, more than double the rates of a year ago and the highest since 2002. This is resulting in fewer home sales and falling prices.
The problem is that this approach has absolutely no effect on the other main generator of inflation, rising production costs.
Courtesy: Kaiser Health News