Shrinking Output, Rising Prices
Why the Economy’s Broken and How to Fix It.
Hello Friends!
Check out my latest commentary on X on the latest GDP report highlighting what it means for growth and inflation. Thoughts?
The U.S. economy is stuck in a troubling pattern: Americans produce less and pay more. That’s the unmistakable message in the latest Bureau of Economic Analysis data.
In the first quarter of 2025, real GDP shrank by 0.3%, even as inflation increased. The PCE index jumped 3.6%, with core inflation rising 3.5%. That combination of lower output and rising prices is called stagflation, and it’s the clearest sign yet that our current economic playbook is broken.
But this doesn’t have to be permanent. While the problems are real, the solutions are within reach—if we’re willing to abandon failed policies and embrace proven free-market reforms.
Let’s start by understanding the numbers.
Real GDP measures the actual value of goods and services produced, adjusted for inflation. It’s how we track whether the economy is genuinely expanding. When it drops, as it did in Q1, it means the economy is producing less, not just moving money around, but truly slowing down.
Meanwhile, prices are rising. Inflation isn’t just “sticky”—it’s accelerating again. After some moderation last year, the Fed’s preferred inflation measure is back up to levels that erode wages and strain household budgets.
Rising prices without rising production means we’re all paying more for less.
Yet some observers might point to nominal GDP growth of 3.5% as a sign of health. That’s misleading. Nominal GDP tracks the dollar value of spending, unadjusted for inflation. Rising prices inflate nominal GDP. This is why nominal GDP targeting—a policy better than the current regime--is flawed. It gives equal weight to real output and inflation. But inflation doesn’t build prosperity. It distorts it. Real growth is what improves lives and livelihoods.
The Federal Reserve can influence inflation, but can’t create real output. It doesn’t build factories, invent products, or hire workers. What it controls is the size and structure of its balance sheet, which it has used to pump trillions of dollars into financial markets since 2008. This money flows first to financial institutions and asset markets before trickling into the real economy. That’s how we end up with too much money chasing too few goods, and prices rising ahead of real production.
Eventually, markets correct. That’s the bust after the Fed-fueled boom. These boom-bust cycles aren’t random—they’re policy-driven. And they hurt.
But the distortions don’t stop with the Fed. Washington’s broader economic policy—especially spending, trade, taxation, and regulation—has become a breeding ground for uncertainty and overreach, keeping the economy off balance.
A key example in last quarter’s GDP report is the surge in private inventories. On the surface, it looks like strong investment. In reality, it’s a red flag. Inventories are goods that were produced or imported but not sold. They’re leftovers, not growth. They’re also one of the most volatile parts of GDP. And they often rise when businesses feel unsure about the future.
That’s what’s likely happening now. With President Trump's renewed tariff hikes with a minimum rate of 10% on all countries and higher tariffs on some countries and some things, businesses are bracing for higher input costs and supply disruptions. When that happens, they stockpile goods. This behavior isn’t about optimism but protecting against policy-driven risks. And when inventory surges fade in future quarters, they’ll drag GDP down even further.
We also saw a rise in imports, which are subtracted from GDP in the accounting formula. That doesn’t mean imports are bad—it’s just how GDP is calculated. Since imports show up in consumption and investment but aren’t produced here, the amount is removed from the calculation to measure domestic production. So, a rise in imports could reflect strong demand or better global supply chains.
Meanwhile, government spending fell slightly—mainly from a drop in federal defense spending. But state and local governments increased spending, especially on salaries. This isn’t a shift toward leaner, more effective government. It’s just more bureaucracy at a time when we need real productivity.
Put all this together, and we’re looking at an economy where shrinking output and rising prices are being propped up by temporary, unstable forces—inventory build-ups, uncertain trade policy, and fiscal gimmicks. But again, the good news is that we don’t have to stay on this path.
Here’s how we fix it—with simple, proven, market-driven rules:
Monetary Rule: Shrink the Fed’s balance sheet back to about 5% of GDP, where it stood before the Great Financial Crisis. It’s now over 23%. This would mean a transparent path for the balance sheet to go from $6.7 trillion today to $1.5 trillion soon. This would provide a smaller Fed footprint, meaning less distortion in asset prices, interest rates, and credit markets.
Spending Rule: Cut federal spending by $2 trillion up front, then allow it to grow by no more than the rate of population growth plus inflation thereafter—what taxpayers can actually afford.
Regulatory Rule: Reduce federal final regulatory costs by 20% immediately, then apply the same pop + inflation cap going forward. Regulatory costs are a hidden tax, especially for small businesses and entrepreneurs.
These reforms would rein in government excess and help bring better market discipline, stability, and freedom back to the economy. They’d empower people to build, invest, and innovate without fear of constant shifts in interest rates, trade policy, or red tape. They would stop the bleeding of rising prices and falling productivity and replace it with a real path to growth.
So yes, today’s economy is underperforming. We’re paying more while producing less. But that doesn’t mean we’re stuck. We can reverse this trend—if we dare to step away from central planning and back toward economic freedom.
Shrinking output and rising prices don’t have to be our future. With the right policies, we can grow more and pay less. That’s the free-market path forward. That’s how we let people prosper.