Will inflation rear its ugly head?

In the past 50 years prices of goods and services have increased substantially. In 1972 a new home went for $25,200, a new car $3,560, a movie ticket for $1.50, and a dozen eggs for 45 cents.[1] Unfortunately, we all know those prices are no longer the case.

For many of us, we’ve become accustomed to inflation. Since the 1970’s, Americans have experienced an average inflation rate of 3.84%. To put that in perspective, what cost $1,000 in February 1971 for goods and services, cost $6,592 in February 2021.

At its core, inflation is largely driven by:

  • An increase in the cost of the raw materials and/or labor used to produce goods and services; and/or
  • A rapid increase in the demand for goods and services, without an equally rapid increase in productivity or supply.

While in 2020 the demand in certain service sectors declined precipitously, the demand for home consumption goods increased. The pandemic caused major slowdowns in the transport of goods which exacerbated supply shortages in all areas of several goods.

For example, oil and gasoline prices have trended higher recently, partly due to cuts in supply but also to increased demand as major economies around the world recover from the COVID-19 pandemic. Other imbalances between supply and demand exist. Currently, demand exceeds supply ranging in areas as diverse as housing, semi-conductors, steel, and packets of ketchup.

Additionally, there are the factors of monetary and fiscal stimulus.

Monetary stimulus are the actions taken to manage an economy’s money supply – this would be the U.S. Federal Reserve Bank (FED) for the United States. Think back to 2007-09. The FED began to inject massive monetary stimulus to the economy to fight deflationary pressures that began during the Great Financial Crisis. The FED lowered short-term interest rates, and purchased fixed income securities (bonds) in the open market. This action is designed to contain long-term rates from rising due to market pressures.

Fiscal stimulus are the actions to boost an economy through increased spending. To combat the economic impact of the pandemic, the U.S. government added $3.1 trillion in increased government spending and tax credits in 2020. Additionally, in mid-March 2021, the government added a second fiscal stimulus of $1.9 trillion in Covid relief, including a $3 trillion dollar infrastructure spending package under consideration.

Combined monetary and fiscal stimulus have raised fears among many economists that the U.S. economy will “overheat” and bring on inflation. Indications of that anticipated inflation have shown up in higher yields from intermediate- and long-term bonds.

Another concern among economists is a change in FED policy. The current policy is an inflation target to average 2% a year. This is a departure from the previous FED policy of “price stability” (zero inflation). This change in policy is suspect but it may allow the FED greater discretion to pump up money and credit which to some economists means the FED might permit inflation to run as high as 3% a year for an extended period.

So, will prices rise substantially?

With this monetary and fiscal stimulus, and as the recovery continues, business and consumer spending will likely increase, and more instances will occur where demand exceeds supply and leads to price increases.

In addition, concerns about labor shortages exist in many areas such as health care and information technology that require acquired skills where not enough trained workers exist.[2] This skills mismatch places pressure on employers to raise salaries and wages.

The combination of these developments has brought forth fears of higher inflation. Yet not all economists agree. Some argue the stimulus package will stimulate needed growth without undue inflation. World Bank chief economist Joseph Stiglist argues that the FED will be able to tamper inflation by returning to a more normal monetary policy.[3]

It’s uncertain whether demand-driven economic growth will in fact spur inflation to substantially higher levels. New economic developments (predictable or not) may occur – positive or negative – that further increase or decrease the demand for goods and services, or which may substantially affect the costs of raw materials and labor. The future of the U.S. and world economy is always uncertain.

So, will inflation rear its ugly head? Prospects for higher inflation are greater now than they were a year ago. There will certainly be instances of higher prices for some goods and services. Whether widespread and sustained inflation occurs will depend on the extent demand exceeds supply – imbalances created by COVID-19 and its after-effects, including government policies. Future inflation will also be affected by how quickly any imbalances that do occur are corrected though expanded production and the increased transport of materials, components, and completed goods.

[1] “Remember When” infographic for 1971, from Seek Publishing.

[2] See, e.g., https://hechingerreport.org/opinion-why-we-must-invest-in-new-innovative-workforce-training-to-fill-a-skills-gap/.

[3] Dan Rabouin, “1 big thing: Stiglitz says Biden’s spending could mean ‘a new world’,” Axios, March 30, 2021.

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