Equitable Demand Management to Reduce Inflation


On January 7th, 2022, US President Joe Biden stated that to reduce prices, there are two primary options. You can either increase the amount of goods available for purchase, or you can make people so poor that they don't attempt to purchase the goods, meaning there are fewer people bidding up prices. This is an oversimplification of how bargaining power affects relative prices, but it raises an interesting question: can we fight inflation by reducing demand in a way that doesn't leave most people worse off than before? Demand management is difficult and unpopular, but there are several ways we should equitably reduce effective demand right now to combat inflation.


Voluntary Savings

The first thing we should do to reduce effective demand is to strengthen incentives for households to defer purchases. Traditionally, bond sales are thought of as being an anti-inflationary counter to government spending. The idea is that by removing money from private hands, the sale of bonds creates fiscal space for the government. However, Treasury bonds do not serve this function effectively for several reasons. First, they are highly liquid and can be sold as soon as the bondholder wants additional purchasing power. Second, they can be used as collateral to borrow money, restoring the bondholder’s lost purchasing power. Third, they are mainly purchased by financial institutions who would not have spent that money on consumer goods. Fourth, because they are a liquid benchmark asset, high rates on Treasury bonds increase rates across the board, increasing the cost of doing business, which firms pass onto their customers, raising relative prices, or if they cannot pass on the cost of increased rates, firms simply fold, reducing aggregate supply, causing further upward pressure on relative prices. US Savings Bonds are slightly better from an inflation-fighting standpoint. They cannot be sold or used as collateral for loans and can only be held by individuals. However, they can be redeemed early if bondholders want access to their money, and they currently do not offer an interest rate that is attractive to most individuals. Treasury Inflation-Protected Securities (TIPS) offer a slightly more attractive interest rate, but this is limited to the period shortly after their purchase, and these, like Treasury Bonds, can be sold on the secondary market.

I propose the Treasury create a new series of US Savings Bonds called the Deferred Consumption Bond, or DCB. DCBs, like other savings bonds, would not be transferable or capable of being used as collateral, and they would only be held by individuals. However, DCBs would not be redeemable before maturity for any reason, nor could they legally be classified as an asset when calculating a person’s net worth. DCBs would have a term of 5 years and would accrue interest annually at a rate equal to twice the current rate of inflation as measured on the date of purchase, or 5%, whichever is greater. Upon maturity, DCBs pay out the principal and accrued interest over twenty-four equal, monthly payments. Finally, individuals would only be able to purchase $50,000 of DCBs each year. Because DCBs cannot be sold, collateralized, or redeemed before maturity, once the bondholder bought a DCB, their purchasing power would be irrevocably deferred. Because the interest on DCBs would be tied to inflation, they would defer consumption when inflation was high without stifling aggregate demand when inflation was low. However, unlike TIPs, whose interest payout falls as inflation falls, the rate on DCBs would be locked in at the date of purchase and would never fall. For this reason, DCBs would be a more attractive and effective device to reduce consumer spending. Because DCBs would pay out the course of two years, if large numbers of people bought DCBs during a particular bout of high inflation, there would not be a sudden spending surge when their DCBs were redeemed. Finally, because DCBs are only held by individuals with a limit on annual purchases, they would not stifle ordinary business investment.


Federal Spending Cuts

Reductions in federal spending must be geared to reduce the use of real resources, and the most resource intensive agency in the federal government is the military. The US consistently spends more than 3% of GDP on defense, in excess of the NATO requirement of 2%. Maintaining such a large military budget involves consuming more energy than most countries, doubtlessly contributing to energy costs and increasing relative prices downstream of energy costs. Also, the countless skilled engineers, welders, electricians, and other tradesmen in the US military are using their talents towards maintaining bases, vehicles, and weapons rather than businesses and homes. The skilled labor shortage would be dramatically improved if tens of thousands of these service members were instead working in the consumer economy. To that end, I propose cutting military spending to the NATO requirement of 2% of GDP, a reduction of $200 billion per year.

Another large user of real resources in the United States is the criminal justice system, which spends billions of dollars and devotes time, resources, and energy to arresting and incarcerating hundreds of thousands of nonviolent individuals for possession and sale of minor drugs. Legalizing and taxing cannabis would reduce federal government spending by $7.7 billion and state spending by billions more. Legalizing cannabis would also alleviate the problem of overcrowded prisons, allowing fewer to be built and some to be closed, which would free up electricity and real estate towards more productive uses. Additionally, fewer incarcerated individuals would mean more individuals who are able to work, which would reduce wage pressure and increase aggregate supply without any additional spending. Consequently, I propose legalizing cannabis on the federal level and on the state level and releasing all nonviolent drug offenders.


Taxation

Tax increases to reduce inflation must be designed to equitably reduce the consumption of scarce resources. Energy is the scarce resource that most contributed to inflation in 2021, so any tax aimed at inflation reduction must begin with energy. The tax needs to be progressive, which requires only taxing excess energy use, which in turn necessitates accurately tracking total energy use each year. Because we don't keep tabs on how much any given individual spends on gasoline and vehicle fuel, it would not be feasible to tax vehicle fuel consumption progressively. However, it is feasible to track metered energy usage at individual addresses, including electricity and natural gas, so we must focus on residential energy consumption. My proposal is to introduce a progressive consumption tax on each watt of electricity or cubic foot of natural gas used (see Note below). It would start at $0 for all electricity or gas use below the typical amount of electricity or gas used by a home in a given zip code and progressively become higher. Most people—including virtually all poor people—would pay $0 under this tax scheme, but particularly wasteful consumers would be heavily penalized.


Conclusion

When designing demand management programs to fight inflation, we must be careful to avoid placing the burden for reduced consumption on the poor and middle class. I believe my proposals have struck this balance. The Deferred Consumption Bond program does not increase business costs that firms will pass onto their customers. The spending cuts I propose reduce consumption of real resources without reducing public services. Finally, the progressive electricity consumption tax penalizes only households that use energy frivolously. While it is important to avoid increasing inequality, demand management can be done without making everyone poorer, despite what President Biden seems to believe.


Note

A literal, direct tax on electricity consumption might be unconstitutional, so it may be necessary to structure it as a form of tax credit for non-consumption. For details on such constitutional arguments, I suggest researching the jurisprudence behind the Supreme Court's decision to interpret the penalty for not buying health insurance under Obamacare as a tax.