Doing Something is Not Always Better than Doing Nothing
I came across an opinion piece in the Wall Street Journal this weekend that reminded me about why a carbon tax is not only the best solution, but it may be the only solution. Specifically, the author of the piece, Holman W. Jenkins, pointed out that subsidies for electric vehicles will lower the demand for oil and therefore oil prices. Lower oil prices mean that the owners of gasoline powered vehicles, in the U.S. and elsewhere, will drive those cars more and that purchasers of new gas powered vehicles will buy larger and less fuel efficient vehicles. In the short run this effect may be small, but in the long run it may wipe out much of the benefit of subsidizing electric vehicles. It is unlikely that the subsidies will entirely wipe out the carbon benefits, but these subsidies are not free. It is easy to imagine that the net benefit could be negative.
The Centrist Independent Voter makes the same point in the Energy Policy section as a reason for opposing Corporate Average Fuel Economy (CAFE) Standards. CAFE standards, by forcing some cars to be more efficient, lower the demand for gasoline and therefore gas prices, which encourages drivers to drive more. This problem is well documented.
Taxing carbon does not have this shortcoming. Carbon taxes raise the cost of all fossil fuels, which not only provides an incentive for buying electric vehicles, it also encourages consumers to drive less and buy smaller cars.
Why Not a Carbon Tax?
The most common argument against a carbon tax is that it will only discourage fossil fuel use in the U.S., make American manufacturers less competitive, and encourage fossil fuel use in other countries like China and India.
Those are good arguments, but the solution is to match the tax with a comparable tariff on the carbon content of imported goods. A few countries in Europe are experimenting with just such a tax and tariff scheme. Imports from countries that impose the same tax and tariff scheme on themselves would be exempt from the tariff. When you think about it, why would any country allow its exports to be taxed by a foreign government when it could avoid the tariff and capture the tax revenues for itself by imposing its own carbon tax? It is easy to see how such a scheme could rapidly result in a virtuous cycle leading to a nearly universal global carbon tax.
Another argument against a carbon tax is that it is a political impossibility. To this I have to ask, what is the politically palatable action that will actually solve the problem? The carbon tax has something for everyone. It would actually work to address climate change and it would produce a revenue stream that could be used to reduce the deficit. It works, politically, precisely because it asks everyone to bear at least some of the cost of dealing with the problem.
Is Climate Change an Existential Problem?
If you think climate change is an existential problem, I would think that you might be willing to accept that the most, perhaps the only, effective way to deal with it is a carbon tax. Progressives seem to shy away from this solution because they like to pretend that the problem can be solved by taxing the rich to subsidize low-carbon technologies. As the analysis above suggests, these subsidies may not be capable of solving the problem.
What should be done with the revenues collected from a carbon tax? The left would like to see them redistributed. That could be done and it would be better than not having a carbon tax at all. However, if the left expects to get centrists and moderate Republicans to buy into a carbon tax, it might help if the revenues were used to offset the deficit.
In addition, it would be helpful if the left would get out of the way with respect to the use of nuclear power. In the presence of a significant carbon tax, nuclear power could be scaled up far more quickly than solar and wind power. Are there risks? Sure, but I thought we were talking about an existential problem.
Mitch McConnell was right. The U.S. Senate will probably not flip to Republican control in 2022. He was also right about the reason: poor candidate quality on the Republican side. Republicans will not control the Senate after 2022 for the same reason that they lost control of the Senate in 2020: Donald Trump.
It is almost certain that Trump’s interference in the elections in Georgia, and his efforts to discourage Republicans from voting in the runoffs that followed, cost the Republicans at least one Senate seat. It now appears that Donald Trump is about to reprise his role as spoiler in 2022, by successfully endorsing candidates in the primaries who will be unelectable in the general election.
Centrist Independent Endorsements for the U.S. Senate General Election Races
Georgia is perhaps the most obvious case of Trump endorsing a weak candidate and discouraging potentially strong candidates from entering the Senate primary race.
Rev. Raphael Warnock is a progressive Democrat. He is endorsed by the Working Families Party (think Bernie Sanders, Elizabeth Warren, and Alexandria Ocasio-Cortez). It is unlikely that, in normal times, Warnock would receive the endorsement of the Centrist Independent Voter. These are not normal times. Making sure that Donald Trump loses his control over the Republican Party, and potentially the country, is far more important than keeping a Progressive Democrat out of the Senate.
As mentioned above, Donald Trump endorsed Herschel Walker in the Republican primary in Georgia and actively discouraged other potentially more viable candidates from running. Apart from opposing Walker because he is a Trump acolyte, we also find Walker to be unqualified for the U.S. Senate. His answers on the campaign trail seem bizarre and uninformed. I have nothing against famous football players, but there is nothing about that job that qualifies you for the U.S. Senate.
You might say that there is nothing about being a minister that qualifies you for the U.S. Senate either. It is not my favorite background for a member of the Senate. Nevertheless, ministers are public speakers and they have presumably spent many years wrestling with philosophical and ethical questions. While Warnock is hardly a centrist, he has at least spent a lot of time thinking about public policy positions and articulating positions on those issues.
We, therefore, endorse Sen. Raphael Warnock to be re-elected to the U.S. Senate from Georgia.
It was by no means a foregone conclusion that we would be endorsing the Democrat for the U.S. Senate seat in Pennsylvania. Donald Trump, by endorsing Dr. Mehmet Oz, made the endorsement of John Fetterman inevitable. Fetterman is no centrist. He is a populist Democrat. That would normally disqualify him from endorsement by the Centrist Independent Voter.
However, making sure that Donald Trump loses his control over the Republican Party, and potentially the country, is far more important than keeping a populist Democrat out of the Senate.
Apart from Trump’s endorsement, we have other concerns about Dr. Oz.
The second concern is about his allegiance to the United States. Oz has dual citizenship with Turkey. He has served in the Turkish military. He defends this on the basis of his desire to be able to easily visit and care for his aging mother. Maybe there is nothing more to it than that. There is nothing inherently wrong with maintaining dual citizenship. As many as 40% of Americans may be eligible for dual citizenship and millions of Americans maintain dual citizenship. However, very few of these people have the need to handle sensitive national security information.
You might say that Turkey is an ally. Yes, they are a member of NATO, but they often take positions and actions that are inconsistent with U.S. interests. Consider Turkey’s attitude toward the Kurds during the fight against ISIS and their initial opposition to Sweden and Finland joining NATO. Even the best of allies will occasionally be at odds with U.S. national interests.
Dual citizenship, even with an ally, raises some legitimate concerns, considering that Senators are granted access to sensitive national security information as a matter of course. Oz has said he would forego any security clearances that might pose a problem, but Senators don’t need security clearances to have access to sensitive information. At the moment, there are no U.S. Senators holding dual citizenship.
In addition, I think you may all remember that in 2016 Donald Trump pledged to put his assets in a blind trust. That was an obviously meaningless pledge, since even if he did it, he would still know what actions hurt or help his business interests unless the trust was directed to sell them. In addition, we know that he never honored that pledge. What guarantee would we have that Oz, Trump’s acolyte, would honor his pledge.
You will notice that I did not mention Oz’s dubious claim to be a Pennsylvania resident. I suspect there are many Pennsylvanians who care about this issue. I am not concerned. There are many cases of U.S. Senators with dubious connections to the states they represented.
To be clear, the Centrist Independent Voter endorses John Fetterman for the U.S. Senate seat from Pennsylvania.
August 16th Wyoming Republican Primary for the U.S. House
It might surprise you that the Centrist Independent Voter is endorsing Liz Cheney. You could not find a more reliably conservative voter in the U.S. House of Representatives than Liz Cheney. She is no centrist. Nevertheless, she deserves to be re-elected to the House because of her devotion to the U.S. Constitution and her willingness to take on Donald Trump and the Trumpists within her party. As a result of her courageous opposition to Trump’s attempts to overturn the 2020 Election, she lost her leadership position within the Republican Party. She has been vilified for her participation in the January 6th hearings in the House.
Trump has, of course, endorsed Cheney’s opposition. Trump would endorse anyone who ran against Liz Cheney.
Centrists are not going to get an ideologically centrist representative in Wyoming. What Wyoming centrists can get is an honest, courageous representative who respects the truth and the Constitution. If you are eligible to vote in the August 16 Republican primary, please vote for Rep. Liz Cheney.
For all of the Centrist Independent Voter’s endorsements during the 2022 primary season, to date, click here.
First, let’s all admit the “Inflation Reduction Act” of 2022 (IRA) has virtually nothing to do with controlling inflation. Whatever its merits or failures are, they are not about controlling inflation. The name of the act is shameless marketing. The non-partisan Congressional Budget Office estimated the Act’s effect on future prices to be between +0.1% and -0.1%. Some news sources have been referring to the IRA, more accurately, as the climate, health care, and tax act or something similar. Although a number of economists support this legislation, I am unaware of any serious economist who believes that the IRA will have a meaningful impact on inflation. However, for simplicity I will refer to it as the “IRA,” but don’t be fooled.
The IRA has a number of subsidies, tax credits, and regulatory incentives to encourage faster adoption of electric and hydrogen cars. It has incentives for rapid development of solar, wind, and nuclear power. It also provides for subsidized loans to encourage consumers to buy various kinds of equipment to reduce their use of energy and/or carbon emissions. Finally, it includes subsidies to make existing energy production, including fossil energy, cleaner.
The Bargain with Manchin
In order to get this package of incentives past Sen. Joe Manchin (D) of West Virginia, Sen. Chuck Schumer (D-NY), the Democratic Majority Leader in the Senate, had to facilitate additional fossil fuel production through promises about federal lease sales and facilitating future build out of energy infrastructure. The fulfillment of these promises is dependent upon separate legislation that could not be passed as part of the reconciliation process. This energy infrastructure legislation faces threats from both the right and the left.
If Sen. Manchin’s quid-pro-quo for supporting the IRA, a separate bill facilitating faster build out of energy infrastructure is passed, that would be a good thing. If it fails because of resistance from progressive environmentalists, we should expect to see a new Republican senator from West Virginia in a few years. If it fails because of mean-spirited resistance from Republican senators, maybe we will end up with two Democratic senators from West Virginia.
Are the Climate Provisions Good Public Policy?
None of the climate change legislation in the IRA is especially bad and some of it may be good, but all of it is suboptimal when compared to a carbon tax and tariff system. Such a system would not only be more efficient in reducing green house gas emissions, it would also have provided a new source of government revenue. If the government did not turn around and spend those additional funds on new programs but simply used them to reduce the deficit, this approach might actually reduce inflation. (But that is a more complicated issue best addressed elsewhere.)
Are the IRA’s climate provisions better than nothing? The climate change provisions, while suboptimal, will encourage the deployment of electric vehicles and electric vehicle infrastructure. These climate change provisions will also encourage the development of solar, wind, and nuclear energy production which will all certainly play a part in addressing climate change in the long run.
We can only hope that, in the not too far distant future, these kinds of credit and subsidy approaches will be replaced by a broad based carbon tax and tariff approach. If this happens, the capital investments encouraged by the IRA will not have been wasted. Unfortunately, the costs of these investments will be born disproportionately by the general taxpayer rather than carbon consumers. In addition, uncountable other activities that would have contributed to reducing carbon emissions under a broad based tax and tariff plan will have been passed over by focusing on a few governmentally favored solutions.
Health Care Legislation
Extending Subsidies Under the Affordable Care Act
The IRA would extend, for three years, the Affordable Care Act subsidies that were included in the 2021 American Rescue Plan. Subsidies are wealth transfers. They are not anti-inflationary. The right level of subsidy for health care insurance is a legitimate area for debate. I would be more inclined to support larger subsidies for ACA premiums, if they were matched with higher deductibles and co-pays. For more on this question visit the Centrist Independent Voter’s policy position on Health Care.
Allowing Medicare to “Negotiate” Drug Prices
For those of you who think that the IRA fights inflation by controlling health care costs, please remember subsidies and price controls do not lower prices. Subsidies and price controls simply hide costs or shift them to other consumers or to the taxpayer.
Giving the government the ability to “negotiate” prices with drug companies is really just a kind of price control. In this case, the government’s ability to “negotiate” arises because it can forbid drug companies from charging more than the government’s offered price for the drugs. Without that, the government’s offer to pay, say $100/dose, might be met with “fine pay what you want, but we (the drug companies) are going to charge the patient $500.” The government “negotiation” only works because it can prevent the drug company from charging the patient any more than the government offer.
This is not to say that giving Medicare the ability to negotiate prices with pharmaceutical companies is a bad thing. Within limits, it might be a good thing. But follow the process through. (I am ignoring co-pays here for simplicity.) Let’s assume that Medicare says that it will only pay $100 for a given drug and the drug company is forbidden from selling the drug to Medicare patients for any more than $100. The drug company has a number of choices, it can: 1) accept that price and produce as much as is demanded at that price; or 2) it can accept that price, but limit the amount of the drug that it produces, creating shortages and possibly black markets; or 3) it can simply refuse to sell the drug to Medicare patients at all.
The challenge for the government is to figure out the price that will induce the drug company to provide the amount demanded at that price. This is not always an easy thing to do, but it can be done. The challenge for the drug company in these negotiations will be to persuade the government that, absent a higher price, the company will choose option 2 or 3 above.
The drug company also has a choice to make about investments in research on future drugs. Drugs that are likely to face enormous demand, if successful, may well be developed normally even in the face of possible limits on prices imposed by Medicare. But research on drugs with more limited potential demand may simply not receive funding. This has been the case pushed by the pharmaceutical industry, and it has at least a little bit of merit. If the government uses its power under the IRA aggressively, it may lower the price on drugs in the short run, but choke off the supply of many new drugs in the future.
International Equity in Funding Drug Research
For a long time, U.S. consumers have been providing benefits to drug consumers in other countries. The highly profitable market in the U.S. encouraged the development of new drugs and Canadian, European and other consumers benefited by being able to buy those drugs at substantially lower prices. The best policy for Medicare, in the long run, might be to demand “most favored nation status.” That would mean that drug companies could not charge Medicare patients any more than the lowest price that they charge in any other developed country. This will discourage U.S. drug companies from offering drugs at heavily discounted prices outside of the U.S. Most favored nation treatments will, therefore, not result in U.S. consumers paying the current heavily discounted prices that many non-U.S. customers now get. It will result in higher prices outside of the U.S. and lower, but equivalent, prices in the U.S. In this way, the burden of supporting the development of future drugs will be more equitably shared across the developed world.
Capping Out-of-Pocket Drug Costs for Medicare Recipients
Similarly, capping out-of-pocket costs for those on Part D of Medicare does not curb inflation. It simply shifts the costs of these drugs to others. How does that happen? Drug companies confronted with the out-of-pocket cap will simply raise the premium for all those insured under their plans. This is not collusion. It will be driven by the underlying economics in the presence of the cap. The losers will be those people who opted for low cost “catastrophic coverage” plans and were never confronted with the need for expensive drugs. In the face of higher premiums, some people may forego Part D drug plans altogether. Is this good public policy? I don’t know; I much prefer the current situation in which individuals can choose the amount of risk they are willing to take.
The provisions for capping out-of-pocket costs are a wealth transfer plan between various low and middle income people. The only unambiguously bad thing about this plan is that it will probably discourage some people from carrying any Part D drug coverage.
Tax Law Changes
Without the changes in the tax law incorporated in the IRA, it could have been called the Inflation, Climate, and Health Care Act. If the spending on climate and health care incorporated in the IRA had not been accompanied by higher tax revenues, it would have constituted stimulative fiscal policy. Stimulative fiscal policy, in the face of a fixed monetary policy, is inflationary. If one accepts the wisdom of the climate and health care aspects of IRA, one has to conclude that increasing tax revenues was a good idea. But what about the way in which tax revenues were increased? Did those make sense, relative to other alternatives?
The Carried Interest Provision
One thing that was stripped from the bill at the insistence of Sen. Kyrsten Sinema (D-AZ), was the taxation of capital gains as ordinary income in the case of private equity managers. Taxing capital gains at a lower rate than ordinary income makes sense on a number of grounds that I won’t go into here. However, the carried interest compensation that private equity managers receive is much more analogous to ordinary income than it is to a capital gain on an investment. I think leaving the carried interest provision in the act would have improved the IRA.
Minimum Corporate Income Tax
Progressive Democrats love to rail against large corporations that pay no or little taxes in some years. They rarely mention the reasons why these corporations pay low taxes. The reasons for low or no taxes can include massive losses accumulated over years. These corporations may also have lowered their taxes by taking advantage of tax credits and accelerated depreciation supported by the very same progressive Democrats. To fix the offensive optics of large corporations paying low taxes in some years, the IRA provides a “book” based minimum tax system.
To understand this, one must realize that Generally Accepted Accounting Principles (GAAP) differ from the accounting rules used to calculate corporate income taxes. Reported corporate income is calculated using GAAP. Taxes are based using a different set of rules that generally result in lower taxable income because of things like accelerated depreciation and tax credits. I have not read the details of the bill, at this time, but I am guessing that, like the Alternative Minimum Tax for individuals, the Corporate Minimum Tax allows firms to roll forward their Alternative Minimum Tax payments as credits for future years. In large part, this results in front loading tax revenue, increasing it in the near term but lowering it in the future. If one focuses on the first ten years following adoption (as many analysts do), this aspect of the act will overstate the amount of revenues raised.
In response to complaints that the alternative minimum tax would hurt manufacturing, the Democrats allowed “manufacturers” to retain accelerated depreciation. This of course means that corporations must maintain essentially three sets of books. One set based on GAAP for SEC reporting purposes, one based on the regular tax code, and one based on a complicated hybrid of GAAP and tax accounting rules.
This is all incredibly complicated and largely pointless. In fact, the minimum corporate tax undermines the effectiveness of many of the tax credits included in the IRA to help on climate change.
Taxation of Stock Buybacks
The IRA includes a 1% excise tax on stock buybacks. Stock buybacks used to be considered a tax efficient way for corporations to return money to shareholders. It was tax efficient because it returned money to shareholders in the form of capital gains rather than as dividends which were taxed as ordinary income. Now that corporate dividends are typically treated as Qualified Dividends for tax purposes and receive the same treatment as capital gains, this is a moot point. Progressives, like Sen. Elizabeth Warren (D-MA), continue to complain about stock buybacks for reasons that elude me. All this accomplishes is to push corporations to return money to shareholders in the form of dividends. I expect that the Democrats are counting the revenue from this tax as part of their fiscal restraint. In all likelihood, there will be little to no revenue raised by this tax.
Fossil Fuel Taxes
The IRA imposes a number of taxes on fossil fuels. Some of these may make sense, but they are definitely suboptimal when compared to a broad based carbon tax. Some of these taxes are reasonable apart from their climate effects, such as making permanent an excise tax on coal mining that is the chief source of funding for the Black Lung Disability Trust Fund.
Additional Funding for the IRS
The IRA provides some funding to improve the audit capabilities of the IRS. I think this is a good thing, although some of the money will be wasted on ensuring compliance with the new Corporate Alternative Minimum Tax.
Obviously, we need to carefully monitor the IRS to ensure that it does not use its considerable powers to target political enemies. Nevertheless, our tax system is dependent on voluntary compliance and a robust audit capability helps to encourage that voluntary compliance.
Are the Tax Law Changes Good Public Policy?
In terms of taxation, I would have preferred a broad based carbon tax and tariff approach. Absent that, I would have preferred they leave in the carried interest provisions and accomplished the rest of the revenue gain with an across the board increase in all marginal tax rates both personal and corporate.
The best that can be said for the tax policies in the IRA is that these taxes finance the subsidies and tax credits in the act with some kind of tax revenue. That is at least better than the half hearted attempts to claim fiscal neutrality in the original Build Back Better plan.
The Bottom Line
If I had been presented with the IRA and told that I had a choice between it and nothing, I would have supported it. It is sad that it is our only choice.
Invitation for Comments
Finally, I have not had time to read the entire act and this analysis was prepared based on a number of summaries of the act. If the reader is aware of any inaccuracies, please let me know by commenting below. If there are any aspects of the IRA not mentioned here that you would like to address, please do so in the comment area below.
In the 1970’s Alfred Khan, an economist who was responsible for fighting inflation during the Carter administration, used the word “banana” as a substitute for “recession” when speaking to the press. His reasoning was that it made people nervous when he used the word “recession.” Apparently, he later switched to “kumquat” when a banana company complained. He was a funny guy.
We seem to be at a similar moment in history. First, let’s get the definitional argument out of the way. The National Bureau of Economic Research (NBER) uses a variety of factors to say whether the economy is in recession. Two consecutive quarters of negative GDP growth are among those criteria, but there are others. But to be honest, lots of people use the two quarter decline in GDP as a marker for a recession and you wont find many historical periods which had two such quarters that are not now considered to have been in a recession.
So what is the big deal?
Folks who root for the Democratic Party are reluctant to have the word “recession” associated with the Biden administration. Folks who cheer for the Republican Party are eager to tar the Biden administration with the term. The argument is pointless. The fact is the economy is slowing down and two quarters of negative GDP growth are a good marker for that.
Is a slow down bad thing?
In my opinion, a slow down is actually exactly what we need. More than a decade of loose monetary policy accompanied by aggressive fiscal stimulus, supply chain problems, and war have created the worst inflation in 40 years. The Federal Reserve needs to bring that inflation under control quickly before inflationary expectations become ingrained. That means higher interest rates with reduced demand for housing, cars, and capital investment. All of those mean a much cooler labor market. In the context of accelerating inflation these are good and necessary things. Ideally the slow down will be mild and brief, but make no mistake it is necessary.
What Should We Call the Current Phase in the Economy?
If it makes you happy you can call it a recession. If you prefer you can call it a temporary slow down (crossing your fingers and hoping for the best). Or you can follow Alfred Kahn’s lead and call it a “banana” or a “kumquat.” Whatever you call it remember it is not, necessarily, a bad thing.
Opportunities to Vote for the the Center and Against Extremists
There are a number of excellent opportunities to prune the political tree of extremists today, August 2, 2022.
On the Democratic Side
Representatives Cori Bush (D-Mo.) and Rashida Tlaib (D-Mich.), both members of the so-called Squad are being challenged by more centrist Democrats in their primaries today. Please vote for the centrists. Representative Andy Levin (D-Mich.), a member of the Congressional Progressive Caucus is being challenged by Representative Haley Stevens (D-Mich.), who belongs to the more centrist New Democrat Coalition in a new district created by redistricting. Please vote for the more centrist candidate, Haley Stevens.
On the Republican Side
Donald Trump has, helpfully, compiled a list of candidates to vote against. (A specific list of 25 candidates Trump endorses in today’s primaries is included in this link.) He calls it endorsements. Absent any other information simply voting against these candidates would help move American politics back to the center.
Please vote in the primaries. If we have no centrist candidates to vote for in the general election, we have only ourselves to blame.
If an Embargo of Russian Gas is a Good Idea, Why is Russia Cutting Off Supplies?
In earlier posts I have pressed for an embargo on Russian natural gas exports. I still think this makes sense, but I can also see the wisdom of a buyers’ cartel that would cap the price that Europe would pay for Russian gas (also explained here). What gave me pause in these thoughts was Putin’s decision (and I am assuming it was his idea) to reduce Russian gas exports through the Nord Stream pipeline. Why would he voluntarily forego this revenue? Does he really think it hurts the West more than it hurts him? Does he just think that Western leaders, particularly German leaders, are so weak-willed that even a small amount of pain will cause them to collapse like a house of cards? Is he just acting like a spoiled child, threatening to hold his breath until his parents give in?
The Role of Contracts
One clue as to what is behind the choking off of gas supplies is the excuse offered: technical problems with the generators that push the gas through the pipeline. The company responsible for maintaining the compressors says that it is unaware of any problems. Why offer this excuse? Presumably the gas flowing through the Nord Stream pipeline is sold under a long-term contract with a fixed price (or some complicated formula that limits the extent of fluctuation in the price). What this means is that even though natural gas prices in Europe are exceptionally high, Russia is receiving a price for the gas that is substantially lower.
Isn’t Russia Contractually Obligated to Supply the Gas?
There is, probably, an out in the contract, for technical problems or “acts of god” that make it difficult to supply the gas. My guess is that Putin is using this ruse to limit Europe’s ability to stockpile gas for this coming winter.
What Should the West Do?
If there are contracts that govern the sale of gas through Nord Stream and other pipelines, the West ought to seize the opportunity created by Russia’s abrogation of its responsibilities under those contracts. The West should “renegotiate” the terms of purchase under those contracts at a lower fixed price determined by a Western buyers’ cartel. By the way, there is no reason why this arrangement should not survive the end of Russia’s war against Ukraine. It is important to remember that this is at least the second time that Russia has, probably, violated the terms of its contracts. The first was when they insisted on payment in rubles.
Would this Work?
I am assuming a lot of facts in this argument and would welcome others, who know the details of the Nord Stream agreement, to weigh in. However, if I am right, a buyers’ cartel for gas delivered by pipeline from Russia to Western Europe could accomplish two important objectives. One, it would deny Putin an important source of funds for carrying out his unprovoked war against Ukraine. Two, it would mitigate the harm to Western Europe from continuing to impose sanctions on Russia.
What Would Putin Do?
In response, Putin could do any of the following. First, he could realize that, in the long run, his situation is hopeless and withdraw his forces from all of Ukraine and cease all hostile acts against Ukraine. (I know this isn’t likely, but one can only hope that at some point Putin will come to his senses.) Or second, he could double down on the spoiled child model and refuse to sell gas at the cartel price, in which case we have a de facto embargo. Or third, he could accept that, once again, he has overplayed his hand and accept what he is offered for his gas.
Inflation appears to be at the top of everyone’s mind lately. That is understandable given that current inflation rates are at 40 year highs. It is likely to play a major role in determining the outcome of the 2022 mid-term elections, despite the fact that there is much bi-partisan blame to be parceled out for the current high rates of inflation. There are, also, a lot of silly proposals on the table for combating it, e.g. price controls and gas tax holidays. There are also some ideas that may be reasonable policy suggestions, in their own right, but have nothing to do with inflation, e.g. lowering tariffs, allowing Medicare to negotiate some drug prices, or facilitating more domestic energy production.
Milton Friedman, a Noble prize winning economist famous for his work on monetary theory and policy, said that “inflation is always and everywhere a monetary phenomenon.” Things like supply chain problems, higher oil and gas prices, Russia’s invasion of Ukraine, the rapid snap back from the Covid 19 induced recession, and aggressive fiscal policy did play a role. They helped to kick start the current inflation, but in the absence of accommodating monetary policy they would not have caused persistent inflation.
In theory, all of the above would have resulted in some things becoming more expensive. Absent monetary accommodation, these price increases would have been accompanied by declining prices for other goods and services. If those price declines did not materialize, because of “sticky wages and prices” we would have seen a recession until the under-employment of labor and other resources forced a relative price adjustment.
Evidence Backing the Theory
Those who think this is just theory should take a look at the inflation rates in Switzerland. The inflation rate in Switzerland (3.4%) is about half that of the rest of Europe (8.6%), yet virtually all of the litany of other factors listed above were present for Switzerland. What is different? Switzerland does not use the Euro and Switzerland’s monetary policy is not controlled by the European Central Bank (the European version of the Fed). Also of note is Turkey, which runs its own, extremely loose, monetary policy and has an inflation rate of 78.6%.
The History: The Fed, The Energy Crisis, and Monetary Policy in the 1970’s
In the 1970’s the Federal Reserve Board attempted to avert a recession, in the aftermath of that decade’s oil price shocks, by expanding the money supply. The idea was to produce just enough inflation so that wages and prices for non-energy intensive goods could decline in real terms (but stay constant in nominal terms) while prices in energy intensive industries could increase in real and nominal terms. Done just right this results in mild inflation and no recession. Sadly, the strategy is nearly impossible to execute properly. The problem is that inflation, once started is devilishly difficult to stop. The result was the “stagflation” of the 1970’s, high inflation and low growth. It was not until Paul Volcker really put the screws to the system, in the early 1980’s, and drove interest rates over 20%, that inflation was finally crushed.
What Should the Fed Do Now?
The policy solution is straight forward, if somewhat distasteful. The Fed needs to reduce the rate of growth of the money supply and quickly raise real interest rates with all of the tools it has at its disposal.
Calculation of Real Interest Rates
Real interest rates are the difference between the nominal interest rate and the expected rate of inflation.
The 10 Year Real Interest Rate
In calculating real interest rates it is important to subtract an estimate of inflationary expectations rather than a historical inflation rate, like the CPI, from current interest rates. The problem with using calculated measures of inflation, like the Consumer Price Index (CPI), is that they are backward looking and the current interest rate is forward looking. If we use the current nominal yield on 10 year Treasuries of 2.9% and the Federal Reserve Bank of St. Louis’ estimate of average inflationary expectations over 10 years of 2.34%, the real 10 year interest rate is 0.56% (2.9 minus 2.34), or nearly zero.
However you look at it, real interest rates, despite recent Fed action, are still either extremely low or significantly negative.
What Should the Target Be?
How high should the Fed push real interest rates? Reasonable people can disagree about the target and the speed for getting there. My own preference would be to see real short-term (1 year) interest rates at about 1-2% and long term (10-30 year) real rates of 3-4%. Getting there will require nominal interest rates in the high single digits or possibly higher. I am not sure what the appropriate speed should be to reach this target but I am sure that it is faster than the Fed is currently moving.
Will this Mean a Recession?
Maybe, but the longer we wait before trying to bring inflation down, the deeper and longer lasting the recession will be. We have already waited too long.
There is a proposal, backed by the U.S., to cap the price of oil and gas purchased from Russia. Janet Yellen, the U.S. Treasury Secretary, is apparently attempting to find international support for this plan. I am skeptical that this proposal will work, but it is not impossible.
The first thing to remember is that even if it does work, the objective is to deny Russia some of the revenues from its energy exports. Even if it worked perfectly, it would not lower world oil and gas prices. Why? Because world oil and gas prices are determined by global supply and demand. Capping the price that Russia can receive for its exports will not affect either supply or demand, unless it causes Russia to export less.
That is not to say that a price cap is a bad idea. There are two ways in which it might work.
The first way recognizes that the West has a degree of market power over Russian exports that must arrive by pipeline. If there is no feasible way for Russia to redirect these exports to other markets, Western countries can exercise that power by collectively refusing to pay more than the cap. If Russia wants any revenue from these exports it must accept the price cap. The oil and gas purchased through this buyer’s cartel can then be resold at market prices. The best way of doing this is for the oil and gas to be auctioned off by the buyer’s cartel with the difference between the price cap and the market price being shared by the participants in the buyer’s cartel.
The second way that the price cap might work, that is often mentioned in the press, is for the West to use its control over finance, shipping and insurance markets to coerce Russia to sell its oil and gas exports at the price cap. The problem with this mechanism is that it would be difficult to prevent purchasers from separately compensating Russia for the sale. If China or India, for example, receive the discounted oil and gas they can have a side deal to pay Russia the difference between the price cap and the market price or some portion of it. It is not at all clear to me how we intend to prevent these side deals. It is also not clear to me why Russia would sell its exports to anyone unwilling to provide the side payment.
My feeling is that the first of these two plans is plausible and worth trying. The second proposal strikes me as very difficult to execute effectively. It would leak faster than a ruptured tanker.
The California primary for the U.S. Senate seat will be held June 7, 2022. It is an open primary with 20 candidates including Democrats, Republicans, Greens, Socialists, and independents. The top two vote getters, regardless of party, will go on to a general election. You would think that in a field that large the Centrist Independent Voter could find a truly attractive choice. Well, actually, it is not as easy as we had thought. Many of the candidates are running just to focus attention on a pet issue. While some of these issues are worthy, these candidates are not even trying to present themselves as viable general election candidates.
Gov. Gavin Newsom selected Alex Padilla (D) to replace Kamala Harris when she became Vice President. California law requires an election to fill the seat at the next available election cycle. There are, therefore, two U.S. Senate elections going on in California this week: one to finish out Harris’ Senate term and one to succeed her.
Padilla is heavily favored to win enough votes in the primary to put him into the general election for both terms.
Among the challengers there is one candidate who, in our mind, should also be there. That is Jon Elist. A Republican, he characterizes himself as a pragmatic conservative. There is a small amount of overlap between his positions on issues and those of the Centrist Independent Voter. On those issues he does address, he takes advantage of his newcomer status to remain vague on what he actually would support. I am sure that during the general election he will be forced to be more explicit about his policy preferences. Nevertheless, we find his attempt to seek the crossover vote rather than cater to the hard right as refreshing, and would like to see him on the ballot in the general election.
We, therefore, endorse Jon Elist in the June 7, 2022 California primary for the U.S. Senate.