The Public Policy

Regulatory Inflation

Turns out bad regulations have a rather large side effect.

By 7.9.13

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When federal agencies issue more than 3,700 new rules a year with total compliance costs exceeding $1.8 trillion, the case for regulatory reform practically makes itself. But there is another argument for lightening the burdens: Regulations cause inflation. Here’s how.

Money is not wealth. Wealth is stuff -- goods and services. You can’t eat a dollar, or drive it, or get legal advice from it. A dollar has value because it can be exchanged for actual wealth.

Suppose you double the amount of money, but without changing the amount of real-world wealth. The result is more dollars chasing the same amount of goods, so you would then have to spend twice as much money to buy the exact same sandwich or car or computer as before. Prices would double across the board. Inflation happens when the ratio of money to wealth goes up. This is what economists call the quantity theory of money.

Now here is why regulatory agencies, quite apart from the Federal Reserve, cause inflation.

In their book Democracy in Deficit, Nobel-winning economist James Buchanan and co-author Richard Wagner observed that government spending can create inflation “[t]o the extent that resources utilized by government are less productive than resources utilized by the private sector…” The same principle applies to regulation.

Many regulations reduce the amount of wealth that people can create. Other rules prevent wealth from being created in the first place. In general, regulatory spending creates less wealth than private spending. That means the nation’s supply of dollars is chasing less wealth than it otherwise would, so the prices are unnaturally high.

What is the total magnitude of this regulatory inflation? While a precise answer is impossible, we can come up with a ballpark figure, by a simple calculation.

Imagine a simplified economy that consists of just two things: 100 dollars and 100 apples, with the price of an apple being one dollar each. If new regulations pass that make it harder to produce apples, the next year there are only 90 apples produced. Their price goes up from $1 to $1.11.

Applying that analysis to the economy at large can give us an estimate of regulatory inflation. America’s GDP is currently about $16 trillion, according to the St. Louis Fed’s FRED database. Regulatory costs of about $1.8 trillion per year artificially raise prices by about 12.7 percent -- our $1.00 apples actually cost $1.13 because of regulations.

Now, some of those costs may be offset by benefits provided by those regulations, but the problem is that knowing the extent of those benefits is nigh impossible. A lot of cost-benefit analysis relies on self-reporting by agencies, which have an interest in, yes, inflating those benefits to justify their authority and budgets. And some rules are entirely wasteful.

Here’s an example. Last year, the U.S. Environmental Protection Agency (EPA) issued a rule concerning coal power plant emissions that it estimated would cost about $9.6 billion per year. The only demographic that would receive any potential health benefits from this regulation is truly niche: the unborn children of subsistence-level fisherwomen who consume more than 225 pounds per year of self-caught fish exclusively from 90th percentile most-polluted bodies of inland freshwater. And by the EPA’s own analysis, the biggest benefit is an additional 0.00209 IQ point per fisherwoman’s child. This is literally too small to be measured.

The EPA has never identified any such person, so the rule is almost purely wasteful (its unstated purpose is to give fossil fuels an artificial competitive disadvantage). Since the money supply isn’t reduced to match this wealth reduction, the result is an EPA-induced $9.6 billion reduction in purchasing power among everybody who uses fossil fuels -- that is, the entire U.S. economy.

However they are calculated, federal regulations cause an inflationary tax between one and ten cents on the dollar, over and above out-of-pocket compliance costs.

Perhaps some regulatory deflation is in order.

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About the Author

Ryan Young is Fellow in Regulatory Studies at the Competitive Enterprise Institute.