The 5.4% increase in prices since last June is the highest increase in over a decade, causing fears about widespread and sustained inflation. Prolonged inflation is certainly possible, but we should not expect the kind of runaway inflation often seen in other countries such as Venezuela, where prices are rising by over 25% per month.
Nobel-prize winning economist Milton Friedman taught us that high and persistent inflation that affects most or all industries at once is a result of bad monetary policy. In short, when growth in the money supply outpaces growth in goods and services, prices go up since there are more dollars chasing relatively fewer goods. Too much money in the economy increases prices across the board, and prices do not come down until the money supply is aligned with economic output. This is the type of inflation that occurred in Germany in the early 1920s, Zimbabwe in 2008, and America in the 1970s.
The U.S. money supply has grown a lot since March of 2020, and while this could lead to prolonged inflation down the road, it does not seem to be the main factor behind the recent price increases. Instead, these price increases appear to be the result of supply chain issues, post-pandemic increases in demand for some goods and services, and poor public policies that prevent supply from responding to demand.
These price increases are bad for consumers, but too much money in the economy is not the underlying cause. The pandemic shifted demand for housing: People left apartments in cities for single-family homes in surrounding suburban communities. In many cities, such as San Francisco, rents plummeted as a result. Some of the increase in rents noted by the Times is due to measuring the increase in rents from the low base of last summer when rents were down.
Of course, changes in housing demand would not result in huge price increases if supply could grow accordingly. Unfortunately, strict zoning and land-use regulations implemented by local governments get in the way. Minimum lot sizes, height restrictions, permitting delays, and density limits in communities around the country add tens of thousands of dollars to the cost of housing.
These regulations also prevent the built environment from adapting as circumstances change. Abandoned factories and malls can be turned into mixed-use developments that provide new housing and retail space. Such adaptation can revive neighborhoods, but only if zoning rules allow it.
Outdated local public policies that prevent new construction, not bad monetary policy, are the causes of high housing prices and rents.
Energy is another example. In the latest CPI data, the price of energy is up 25% since last summer. Some of this is again due to a low base—oil and gas prices dropped during the pandemic as people curtailed travel—but high energy prices are also a result of bad public policy.
America has essentially outlawed nuclear power by making the permitting and construction process so onerous. Getting approval for a reactor site can cost close to $20 million and it is estimated that the regulatory burden per plant is at least $8.6 million.
The shale revolution drastically increased America’s output of oil and natural gas, helping America undercut OPEC’s oil cartel and bringing down natural gas prices from around $8 per million BTUs in 2008 to less than $4 today. Yet despite these consumer benefits, New York and Maryland banned fracking. These bans mean less supply and higher prices.
Environmentalists insist America needs to transition to renewable energy to save the planet, but again, regulation gets in the way. The hardware costs of solar panel systems have come down significantly since 2000, but soft costs such as getting a permit and complying with local ordinances add $6,000 to $7,000, or about one third of the total cost of a rooftop solar system. At the federal level, the Biden administration has maintained tariffs on imported solar panels. One study estimates that these tariffs led to a loss of 62,000 jobs and $19 billion of investment due to the higher costs.
Regulations that obstruct innovation and tariffs that raise costs and reduce international competition—not monetary policy—keep U.S. energy prices high by limiting our ability to increase supply.
Health care is another industry where regulation and government intervention drive higher prices. State certificate of need laws (CON) that prohibit new medical facilities and prevent existing facilities from expanding reduce competition, limit access, and increase health care costs.
State scope of practice (SOP) laws prevent nurse practitioners and other health care experts from fully utilizing their skills. There is no evidence that restrictive SOP laws improve patient outcomes, but they do increase prices: Child well-care visits are 3% to 16% cheaper in states where nurse practitioners can work independently. Allowing more trained medical professionals to treat patients would expand access to care and help bring health care costs down.
The pandemic forced policymakers to adjust some of their restrictive policies. CON and SOP laws were suspended in many states, which gave states more flexibility to deal with Covid-19 and empowered skilled nurses to provide much needed help when cases spiked. It is unfortunate that it took a pandemic to get policymakers to make these common-sense changes.
Telemedicine rules that prevented patients from seeing doctors remotely via video were also relaxed during the pandemic. Fears that this would compromise care were unfounded: New research shows that the relaxation of telemedicine regulations led to lower costs without diminishing the quality of care.
The video technology that makes telemedicine possible has been widely available for more than a decade, yet again it took a generational pandemic to get policymakers to act. This is the kind of policy sclerosis that keeps costs high and prevents much needed innovation.
FDA reform would help, too. FDA approval for drugs and medical devices often costs tens of millions of dollars and can take years to complete. These costs must be recovered via higher prices for new drugs or devices to make financial sense.
The FDA approval process is also fraught with uncertainty, which reduces the incentive to experiment with new technologies. It is faster and cheaper to get products approved by the FDA that are similar to current products than it is to get truly novel products approved. This incentivizes innovators to make small improvements rather than truly disruptive advances, and Americans’ health suffers as a result.
In January of 2021, economist Mark Perry of the American Enterprise Institute published a chart (shown below) that shows how the prices of different goods and services changed over time. The prices of goods and services in red increased faster than inflation while those in blue increased more slowly or even fell in price due to productivity increases that lowered costs.
Regarding the economy, the most important question to answer is how can we get the prices of the goods and services in red to mimic those in blue? Or in other words, how can we get more innovation and productivity growth in housing, higher education, and health care?
Nothing in the proposed infrastructure plan or the $3.5 trillion budget reconciliation package will do it. All these proposals do is throw more taxpayer money at the problems: More subsidies to higher education that undermine competition and get captured by universities via tuition and fee increases; more subsidies and government regulations in health care that keep costs high and slow innovation (hello FDA); and more federal intervention into infrastructure planning and construction that reduces the flexibility of local governments and the private sector, which together own and operate 97% of all infrastructure and are more familiar with the infrastructure needs of communities than lawmakers in Washington.
Neither proposal strengthens people’s incentives to innovate, either. In fact, if Senator Bernie Sanders gets his way the incentive to innovate will be reduced via higher taxes on investment and corporate earnings. It is tempting to think that higher taxes on the rich and corporations do not affect the rest of us, but research shows that higher corporate taxes affect us all by reducing wages and investment while increasing prices. Despite Senator Sanders’s claim, we cannot tax our way to productivity increases that lower prices.
To really drive prices down we need more productivity growth. To get more productivity growth we need to reduce government red-tape, create a simpler and more stable tax code with broader bases and lower rates, increase international trade, and foster a level economic playing field that precludes public officials from picking winners and losers.
Widespread and prolonged inflation seems unlikely right now, but the high prices caused by government policies will remain until we unshackle our innovators.