As Congress considers a year-end spending bill, it faces a decision that will have a meaningful effect on inflation: whether or not to extend across-the-board Medicare reimbursement rates. This decision also has ramifications for Federal Reserve policy and the labor market.

It is a stark choice. Increasing Medicare reimbursement rates would increase inflation and the pressure on the Fed to pursue more aggressive interest hikes–whereas reducing reimbursement payments would decrease inflation and translate to lower healthcare costs in the private system, weakening the case for the Fed to break the labor market in its mission to reduce inflation.

Given the Federal government’s considerable price-setting power in this sector and the high costs of unemployment, Congress should alleviate pressure on the Fed to combat inflation by avoiding  unnecessary increases to Medicare reimbursement payments.

The Fed is Focused on Services Inflation

In recent months, core goods inflation has fallen while services inflation remains strong. The Fed has shifted accordingly, indicating that it is especially concerned about the level of measured inflation in one specific sub-index: core services ex housing.

[Core services other than housing] is the largest of our three categories, constituting more than half of the core PCE index. Thus, this may be the most important category for understanding the future evolution of core inflation.
Jay Powell, November 30, 2022

Worryingly, Powell has indicated that the Fed intends to reduce inflation in services by weakening the labor market— risking throwing Americans out of work and slowing the pace of wage growth. Fortunately, we need not rely solely on costly tools like interest rate hikes to slow inflation in this sector. Congress can help lower the prices of healthcare services by changing Medicare reimbursement rates.

Congress Has a Proven Opportunity to Relieve Healthcare Services Inflation

There is strong historical evidence that Medicare reimbursement policies can significantly reduce healthcare inflation and drive cost savings throughout the healthcare system. Fiscal policies reducing Medicare reimbursement rates during the Obama Administration kept inflation in these categories low over the last decade, with price increases reaching a near-historical low level in 2015. Low healthcare services inflation was a significant contributor to overall inflation staying below the Fed’s 2% target. Furthermore, private reimbursement often follows Medicare reimbursement as private insurers gain bargaining power against hospitals. As the year comes to an end and Congress continues negotiations over an omnibus package or continuing resolution, policymakers should take a page from the Obama-era playbook and pass disinflationary healthcare policies.

During the COVID-19 pandemic, Congress introduced two measures to provide relief to healthcare providers. First, in the CARES Act, Congress put the Budget Control Act sequester (a 2% across the board cut) on hiatus. Second, at the end of 2020, Congress provided an across-the-board 3.75% increase for all physician services. The former expired at the end of June this year, and the latter remains in place but is 3%.

Congress stepped up during the pandemic to provide much needed relief for the healthcare industry. But with the worst of the pandemic in our rearview, these measures make little sense. Physicians’ incomes have bounced back from the pandemic lows and continue to rise. Congress should not bring back the sequester hiatus, nor should it continue the temporary bonus payments. [1]

These two policy decisions would reduce PCE inflation in the healthcare sector, as well as overall core PCE inflation since healthcare services comprise a large portion of PCE. Healthcare services comprise 26% of core services ex housing and 18% of core personal consumption expenditures overall. The prices for a substantial portion of these services are set by Congress, and there would be knock-on effects in the form of reduced private insurance payments, since a large portion of private rates are linked to Medicare reimbursement rates. Last year, we estimated that these policies would each directly result in a decrease in core PCE readings of around 0.1%, for a total of 0.2%, in addition to any knock-on effects on private prices. All of these changes would help cool inflation without unduly harming the healthcare industry.

Conclusion

Congress faces considerable pressure from the hospital lobby and other healthcare interest groups. However, as a plurality of Americans still considers inflation and the economy to be the most important issue facing their lives, Congress should put weight on how its choices will affect inflation and the overall health of the economy. Slowing healthcare services inflation today will reduce the cost of medical care, but will also forestall the Fed from pursuing aggressive interest rate policies that risk a recession.

Footnotes

[1] Congress should continue to delay or waive the mandatory 4% reduction in Medicare payments triggered by the PAYGO sequester after the passage of the American Rescue Plan, as it has never been enacted before and could negatively impact healthcare services.