The “Inflation Reduction Act” of 2022 was one of our more inappropriately named pieces of legislation. (And there’s plenty of competition—recall FDR’s National Industrial Recovery Act.)
The Financial Times has a new piece entitled:
A scramble for workers might complicate the Federal Reserve’s efforts to cool the economy
In the article, critics complain that the legislation is boosting costs:
“You don’t hear the word globalisation anymore,” Fink told an energy conference at Columbia University this month. “We’re building new chip factories in the United States — at what cost?”
Fink said the Biden administration’s efforts to reshore manufacturing would mean US inflation was unlikely to fall below 4 per cent “anytime soon”.
While the IRA includes subsidies for clean energy worth $369bn, the credits are “uncapped”, meaning the final bill for taxpayers could eventually exceed $1tn, according to Credit Suisse, Goldman Sachs and the Brookings Institution.
Analysts say the sheer scale of the handouts will put a wrench in markets.
“You’re distorting free markets when you create these incentives and when you create rules that require you to buy from domestic firms,” said Ethan Harris, head of global economics at Bank of America. “If it was the most cost efficient way to do something, you wouldn’t need a subsidy for it.”
On the other hand, if the Fed is truly committed to bringing inflation down to 2%, then it should offset the impact of this legislation with tighter monetary policy. In that case, economic activity is non-subsidized sectors will suffer.
The government is not very good at allocating resources, and attempts to do so almost invariably reduce economic efficiency. Subsidies and trade barriers lead to a misallocation of resources. In most cases, when people complain that government policies will lead to higher inflation, the actual risk is lower real output. That’s also how much of the public thinks of inflation—something that reduces their living standards.
The final sentence in the FT article gets to the core of the problem:
[T]he Biden administration’s efforts to satisfy its decarbonisation, industrial and geopolitical ambitions at the same time — all while promising to drive down costs — are causing alarm among some analysts.
“Once you go down the national security path and don’t narrowly constrain it, boy, it’s a killer to economic efficiency,” Hufbauer said.
That’s the real issue—economic efficiency, not inflation.
