Will US Inflation Reduction Act Impact The Economy? – A Brief Analysis

“Will US Inflation Reduction Act Impact The Economy? In this article, we examine the most recent interesting article titled “How the US Inflation Reduction Act will impact the economy”, which was published in the WEO forum on 2^nd November 2022 and analysis to provide a comprehensive overview on likely impact due to changes in policy and their effects on the US economy

Article on US Inflation Reduction Act

First, let us see what the article on talks about before going into our view on will US Inflation Reduction Act impact the economy or not.

The article “How the US Inflation Reduction Act will impact the economy” starts with the following key points

• New US legislation will dramatically change the economics of industrial decarbonization.
• Critics of the Inflation Reduction Act claim that it will increase inflation by pushing up energy prices.
• In fact, the new laws do not exacerbate inflation now, and are likely to have a deflationary impact in the long term.

The Major highlights of the article stated are as follows

…… But can its incentive-based policies work in the context of a looming recession, spiking inflation, and oil shortage?

Between the IRA and the Infrastructure Investment and Jobs Act, which was adopted in late 2021, the US government has committed to $479 billion in new climate and energy spending across the board. This will materially change the economics of industrial decarbonization. These investments are focused on four key areas: carbon-free energy, manufacturing, transportation, and clean technology.

Large corporate buyers of heavy industry materials and transportation are keen to benefit from the various provisions that will drive industrial decarbonization. A variety of tax credit schemes amounting to $35 billion have been set up to spur investment in breakthrough clean technologies such as hydrogen, direct air capture, and sustainable aviation fuels. According to a report by Boston Consulting Group, these incentives have levelled the cost competitiveness of traditional hydrogen production with green hydrogen (renewable energy with water electrolysis) and blue hydrogen (fossil-derived hydrogen with carbon capture). With these incentives, clean energy sources such as green and blue hydrogen will be even cheaper than traditional hydrogen by 2030.

In the transportation sector, US government will give up to $7,500 for the new purchase of a passenger electric vehicle and up to $400 for a used electric vehicle. This brings up the purchase price parity between electric vehicles and vehicles with internal combustion engines by 5 years. The IRA mandates sourcing battery minerals from the United States or a country with free-trade agreement, which disqualifies vehicles manufactured by China and Russia…………

The Inflation Reduction Act is a forward-looking, incentive-based policy that will spur investments into clean energy technologies by 2030 Image: CRFB.org

The impact on inflation

The Inflation Reduction Act is a forward-looking, incentive-based policy that will spur investments into clean energy technologies, and increase the demand for clean energy sources, by 2030. But will it succeed in reining in inflation? There is no simple answer. Conservative think-tanks such as the Heritage Foundation believe that the IRA will increase the prices that Americans pay for energy, as an increase in demand of clean energy sources will increase the price of those products. This is especially true in the context of growing demand for energy.

………….. A research report by University of Massachusetts predicts that “over a 10-year period, the IRA will generate an average of about 912,000 jobs per year through combined annual public and private investments at $98 billion.”

Some politicians on the left have criticized the IRA for funding the construction of a natural gas pipeline. If it were possible to create a fully renewable grid now, there would be no doubt that the IRA would immediately be massively deflationary. However, we know that the energy sources necessary to replace fossil fuels are not available immediately, and the IRA does not deter the government from investing in fossil fuel today to bring the energy prices down. On the contrary, it requires the Department of the Interior to offer 2 million acres of onshore and 60 million acres of offshore annual oil and gas lease sales. It also reinstates the lease sales in Gulf of Mexico and Cook Inlet in Alaska for oil and gas exploration. These provisions are a notable divergence from the climate goals, but will have a deflationary impact in the short- to medium-term.

Will US Inflation Reduction Act Impact The Economy?

The US Inflation Reduction Act might boost the economy in a variety of ways if it is successful in bringing down inflation. For instance, lower inflation may result in more stable prices, which will make it simpler for companies to plan ahead and for consumers to make purchases. Because firms are more willing to invest and hire when they have a clearer vision of what the future holds, this may result in increased economic activity. Because their money will continue to have purchasing power over time, households may find it easier to save and invest when inflation is low.

However, there may be drawbacks to lowering inflation. For instance, if the law were to be effective in lowering inflation, it might also result in a slower rate of economic expansion. This is due to the fact that attempts to lower inflation may also slow down economic growth and that high inflation rates can signal a robust and expanding economy. Furthermore, if the law were to be effective in lowering inflation, it would also result in higher unemployment since companies might be less inclined to grow and hire while prices are steady or declining.

When discussing the probable effects of the US Inflation Reduction Act on the economy, the following issues should be taken into account:

Effect on salaries: Slower pay growth might occasionally be caused by lower inflation since businesses could be less inclined to raise wages while prices are falling. However, if the legislation promotes greater economic stability and growth, this effect might be mitigated since companies might be more ready to pay higher wages to recruit and keep talented workers.

Impact on financial markets: When inflation is low, investors may be less willing to accept lower returns on financial assets like stocks and bonds, which can sometimes result in lower returns on those assets. However, if the action boosts economic stability and expansion, it might also boost investor confidence and financial asset returns.

Impact on enterprises: Lower inflation has various advantages for businesses, including making it simpler to plan for the future and protect against price hikes. For companies that depend on high inflation rates to remain successful, such as those that have taken on a lot of debt or have pricing power in their industries, it might be difficult.

Impact on inequality: Because rising inflation can narrow the wealth gap between the rich and the poor, it can occasionally result in less income inequality. However, if it results in slower wage growth or increased unemployment for specific categories of workers, it could also have the reverse impact.

Impact on monetary policy: The Federal Reserve, the nation’s central bank, may be hampered in its capacity to utilise interest rates as a tool for managing the economy as a result of the act. The Fed might have less room to cut interest rates in response to recessions if the legislation were to successfully lower inflation because lower rates could theoretically result in even lower inflation.

Impact on international trade: If the act results in a stronger US currency, it may affect US exporters by reducing their exports’ competitiveness on the world market. However, a higher currency can also make imports more affordable for American consumers, increasing demand for imported items.

Impact on the budget: Because tax collections are frequently correlated with economic activity, decreased inflation can occasionally result in lower government income. The act might also impair the government’s capacity to pay for services and programmes if it were to result in weaker economic growth or more unemployment.

Impact on consumer confidence: Lower inflation might occasionally result in higher levels of customer assurance regarding the purchasing power of their money. But if the action resulted in slower economic expansion or increased unemployment, it might also undermine consumer confidence and cause them to spend less.

Changes in policy and their effects on the US economy

When certain policy changes are made there is always a time lag for the outcome.  This policy change may increase investments, demand and Job opportunities but at what costs is the real question. Inflation will increase along with this change – though not for a long period. At present, a nominal increase in inflation will have a huge impact on the economy. How this policy change will have an impact on the economy – that only time can tell. Though there may be some deflationary impact for a brief period, there is a lot more to do on the policy side along with this policy change to keep inflation in check or under the tolerance level. 

Conclusion

The US Inflation Reduction Act has the potential to greatly impact the economy by reducing inflation & stabilizing prices. However, it may also have unintended consequences, such as slowing economic growth or increasing unemployment. Its success is dependent on a combination of factors such as the actions taken by policymakers, businesses, consumers, the Federal Reserve & the broader international economy. It is important for policymakers & analysts to carefully consider the potential effects of the Act and make any necessary adjustments to ensure that it achieves its intended goals while minimizing any negative impacts. Overall, it will be crucial to monitor the Act’s implementation and its effects on the economy in the coming months & years.

FAQs