Our nations leaders misunderstanding of the nature of deficits, inflation, and money is slowly killing us. Their understanding of how the system works leads them to set unrealistic policy goals that not only don't solve the real problem, but often will exacerbate the problem. One example of this is in energy policy.
Here's what is happening, or at least, is going to happen. The price of oil is going up. Since so many things depend on oil, it eventually causes the price of everything else to go up. Our policy leaders identify this as inflation. To fight this inflation they do two things. The monetary policy is to raise interest rates. The fiscal policy reaction will be to reduce budget deficits. In both cases, the policy will likely reduce inflation in the short term, but at the cost of raising unemployment. In the long term it will do nothing to reduce the real culprit of the inflation, and may even make the problem worse.
Most of the traditional tools used to control inflation have everything to do with demand-pull inflation. That is when aggregate demand in the economy heats up and everybody is working and spending. The central bank can raise interest rates to discourage further spending and investment. This causes a slow-down in the economy and inflation is held in-check. Alternatively, the government can spend less or tax more. This removes money from people's pockets and they in turn demand fewer goods. This also causes a slow-down in the economy. Both of these tools can be argued to be a reasonable response to demand-pull inflation.
The problem comes from when there is a cost-push type of inflation. When the price of a commodity goes up, normally the open market will regulate it by finding alternatives - no government interference needed. However, there are some commodities that are so important and unique that either there are no alternatives or very poor alternatives. Oil is the best example of this. So many products depend on it and such a huge infrastructure is built on it, that there are few cost-effective alternatives. There are others, but oil is by far the biggest, baddest example. When the price of oil goes up, the market just absorbs it because the alternatives aren't there to regulate the price. This causes the price of everything to go up.
The monetarist economists, founded by Milton Friedman, have captured our government and thinking. They don't recognize a difference between demand-pull and cost-push inflation. Instead their credo is "inflation is always and everywhere a monetary phenomenon". So, their solution is the same as in demand-pull: Higher interest rates and smaller budget deficits. Both of which, will cause increased unemployment and likely, recession. This will fight the inflation short-term, but does nothing to solve the root of the problem.
The reasonable response to cost-push inflation would be to pursue alternatives to the commodity. Whether that's researching new technology or building an infrastructure to support existing alternatives. That way the market can start regulating the price, naturally.
Unfortunately, that is not what happens. In fact the short-term inflation fighting solutions make the long-term solution worse. As the government starts cutting back spending to fight the inflation, they may CUT spending that could lead to long-term solutions that find new alternatives or build-up infrastructure to support existing alternatives. Also, raised interest rates may discourage the private sector from investing in alternatives because they'll not want to borrow at such high rates.
Pretty soon, the cost of oil and gas is going to cause a spike in the CPI. At that point all the conservatives are going to start crowing about how it's caused by the budget deficit. We need to make sure that we're armed with the facts to fight this nonsense. It'll be hard, but it's the only way we can ever hope to get the economy going again without having to always worry about being chocked by oil prices.
I'm posting this in the Money and Public Purpose group which is the Modern Monetary Theory group here at daily kos. I realize this post isn't necessarily about Modern Monetary Theory. Most of the analysis is based on only the most fundamental aspects of classic Keynesian economics. However, I figured it was appropriate since MMT is an extension of the work down by "The Master". So if you're already a follower of the group, thanks for indulging me, and if you're new to it, I hope you'll follow it to learn more about Modern Monetary Theory.