Inflationary Austerity

In January, U.S. inflation hit a 40-year high of 7.5%. Before the Ukraine war, my guess was that inflation from 2022-2024 would peak at 8.6%. Now I expect that peak to be around 10%. My suspicion is that the Fed will delay tightening until after the midterm elections, then become sharply contractionary in December or January, desperately hoping that the Misery Index will be low in time for the 2024 election.

What’s so bad about inflation, anyway? Economists have struggled to come up with a good answer. The best story, in my view, is that inflation causes recessions via politics: Voters hate inflation so much that politicians willingly endure severe recessions to get it under control. So while there’s a long-run trade-off between inflation and unemployment at low inflation rates, high inflation is a leading cause of high unemployment.

Recently, though, I noticed a novel and noteworthy benefit of inflation. Namely: Given current cost-of-living adjustments (COLAs), inflation is swiftly eroding the real salaries of federal workers. Biden’s official adjustment for 2022 is only 2.7%, almost 5 percentage-points less than current inflation.

If, like me, you believe in austerity for liberty, this is great news. We need to shrink the public sector at the expense of the private sector, and the simplest way to make this happen is to cut the real federal budget to bone.

If that seems overly libertarian, there are more ecumenical reasons to cheer low COLAs. Key fact: The Congressional Budget Office has found that almost all federal employees are paid far above market. Low COLAs are a simple way to drag their sky-high compensation back to Earth. Low COLAs help restore horizontal pay equity; why should federal employees get paid so much more than equally-qualified private-sector workers? Low COLAs help restore labor market efficiency; when the federal government overpays, this tends to fill jobs with overqualified workers.

If high inflation goes on long enough, I suspect that federal COLAs will start to catch up. For now, however, we’re in a strange situation where high inflation indirectly causes austerity. Let’s enjoy this side effect while it lasts.

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