In yesterday’s (June 15) print edition of the Wall Street Journal, economists Mickey D. Levy and Charles I. Plosser, in “Inflation Demands Bold Fed Action,” write:
Strikingly, many [state and local governments] are now providing financial subsidies to offset higher gasoline costs, which may buy votes for local elected officials but also contributes to demand for energy and thus to inflation.
If the subsidies are given conditional on incremental usage of gasoline and other energies, then they’re correct. However, the one I’m most familiar with, the one that Governor Newsome has proposed for California, would give a $400 debit card or check to an owner of a registered vehicle. There is no requirement that it be spent on fuel.
Will this, if passed into law, add to generalized demand? Yes. Would that then cause a slight increase in the demand for fuel? Yes. But their sentence would have been more on target it they had written:
Strikingly, many are now providing financial subsidies to offset higher gasoline costs, which may buy votes for local elected officials but also contributes to overall demand.
READER COMMENTS
Andrew
Jun 16 2022 at 12:19pm
I don’t quite get this. Doesn’t California have to balance the budget every year (unlike the federal government)? If so wouldn’t the subsidies be offset by less state spending and hence be roughly neutral as far as overall demand? What am I missing?
David Henderson
Jun 16 2022 at 1:27pm
Good question.
Yes, it has to balance the budget every year, but in the sense that it can’t have a deficit.
So to answer your second question, “What am I missing?” you’re missing the fact that the California state government has a huge budget surplus. Of course, many of us would rather that it take that money and cut some tax rates and also make up for recent less-than-adequate transfers to the state government employees’ pension fund. But that’s probably not in the cards.
Andrew
Jun 16 2022 at 5:29pm
I definitely expect to see the headline “California Invests in Jump Starting New Porcine Aerospace Industry” before “California Rebates Excess Taxes”.
Jose Pablo
Jun 19 2022 at 11:20am
But cutting tax rates would increase demand, wouldn’t it?
So reduzing subsidies and increasing taxes would be the right fiscal policy to curb inflation, am I wrong?
Maybe, on top of that, cutting corporate taxes to increase supply?
How relevant is fiscal and monetary policies beign aligned? … quite a lot if you came to believe Cochrane (wich I do, most of the time) or not that much says Scott
nobody.really
Jun 16 2022 at 4:50pm
I read Henderson to draw a distinction between stimulating demand and stimulation inflation. But in the current environment, I don’t see how generically stimulating demand does not also stimulate inflation. After all, doesn’t the Fed’s tool for fighting inflation–selling bonds/securities to raise interest rates–work by generically reduce demand for all other goods? Have I misunderstood this?
nobody.really
Jun 16 2022 at 5:02pm
Wait–maybe Henderson is merely drawing a distinction between stimulating demand and stimulating demand for energy. And, yeah, I get that distinction.
David Henderson
Jun 16 2022 at 7:23pm
Yes, that latter is the distinction I’m making.
Matthias
Jun 17 2022 at 8:39am
People who have a car are more likely to drive than people who don’t. [Citation needed.]
So I would expect the subsidy you described to lead to slightly more driving. Though not as much as directly requiring purchases of petrol to be eligible for a subsidy.
Only paying a subsidy to people rich enough to afford a car is another example of welfare for the well-off.
nobody.really
Jun 17 2022 at 9:44am
To generalize: To what extent does government have cause to promote the stability of the status quo–that is, to insure against frustrated expectations?
I favor government-financed “social safety nets,” designed to keep people’s circumstances from falling too low. But those programs are supposed to be targeted to the relatively poor, not merely those who experience unexpected loss. A subsidy to car owners seems to fall into this latter category.
Perhaps the archetypical example of status quo policies would be unemployment insurance. Yes, I suspect that losing employment correlates with poverty. But does government have cause to require insurance against this risk rather than simply relying on the social safety net provided for all?
Maybe so. Perhaps promoting the status quo helps people make long-term investments, including investments in capital goods (houses, cars, educations), that people would otherwise under-invest in.
Or maybe these policies are simply a kind of middle- (and upper-) class welfare designed to curry favor with the more powerful segments of society, ignoring the plight of the weak segments of society. Cue the Public Choice discussion….
Thomas Lee Hutcheson
Jun 17 2022 at 10:26am
No. Only the Fed causes inflation
Now if you want to get super deep into the weeds, to get optimal shifts in resources in response to large suppl shocks like in petroleum and wheat markets DOES require large changes in relative prices and if some of those relative prices cannot adjust downward, the Fed might need to allow average prices to rise faster than their target otherwise. And local subsidies to gasoline use (are there any?) would slow the shift in resources and require the Fed to allow extraordinary price rises to go on longer than it would without the subsidies. So in THAT sense, yes, local subsidies will “cause inflation.”
Thomas Lee Hutcheson
Jun 17 2022 at 11:15am
Until reading the comments, I had not even considered that the question was if the subsidies affected aggregate demand. But answer is still no. Changes in aggregate demand do not require the Fed to allow more inflation.
Comments are closed.