Assume, for purposes of argument, that the American economy has adjusted to the impacts of the war and the pandemic. Supply chain issues are a thing of the past. Gas and food prices are no longer soaring. The traditional balance between spending on goods and services has been restored. As a result, inflation has declined to about 3 or 4 percent.
But that number is still uncomfortably high by the standards of the last 30 years. It is being driven by two phenomena. First, wage increases are still outpacing productivity gains as a result of labor shortages. Second, many companies have discovered that Americans will pay more for their products than they previously suspected. Profits are consequently increasing, the stock market is doing well, and consumer demand remains at a relatively high level.
What can be done to resolve these issues? The obvious response to labor shortages is to liberalize our immigration quotas. That, of course, is a political non-starter. American consumers can start refusing to tolerate unwarranted price increases as their pandemic savings dwindle. Finally, the Fed can try to destroy consumer confidence by raising rates to the point that stock, bond, and real estate prices are crushed. That’s the real danger in 2023.