Inflation Concerns Rising With Goods and Services Prices

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Sing along if you know it: Feel like I’m running on an empty gage. Oh no, not again. It hurts so good. I don’t understand…Inflation, or something.

The Washington Post:

Most economists expect prices for many goods and services to show continued gains on Wednesday when the Labor Department releases its next monthly inflation report.

The Federal Reserve insists that today’s rising prices — up 2.6 percent over the past 12 months — will not blossom into anything like the economy-wide, double-digit inflationary spiral of the 1970s. Some economists, including Lawrence Summers, a former treasury secretary, however, warn that President Biden’s free spending could ignite inflation that would outstrip wage gains and leave consumers struggling to make ends meet.

The Fed, backed by most private-sector economists, says a temporary period of higher prices represents just the latest twist in the coronavirus pandemic’s unprecedented bust and boom. Fueled by government stimulus checks and pent-up consumer demand, the U.S. economy is galloping ahead. Yet many industries have not adjusted to the pandemic’s reshaping of demand, meaning that some factories cannot satisfy all potential customers.

“What we’re seeing right now is an economy struggling to recalibrate,” said Lindsey Piegza, chief economist for Stifel Financial in Chicago. “This is not a seamless process and it’s certainly not something that happens overnight.”

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Even as the Fed reassures investors, expectations of future inflation, which over time can contribute to sustained price increases, reached their highest mark since 2013. A market gauge called the U.S. Treasury 10-year break-even rate reached 2.5 percent on Friday, up sharply from 1.99 percent at the beginning of the year.

The fast-growing economy is battling shortages of labor and raw materials. Freight costs are soaring. And executives are scrambling to maintain profit margins by passing on the higher costs to customers or by developing less expensive production methods.

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Price gains are expected to peak in the second quarter, before easing later this year as production bottlenecks are cleared, according to economists surveyed by Bloomberg News.

But Friday’s disappointing jobs report — and the computer attack this weekend that idled Colonial Pipeline’s main East Coast fuel artery — underscored the daunting uncertainty surrounding the economy’s revival.

“What worries me the most is we don’t have any historical examples of how long bottlenecks persist or the damage they can do,” said Frances Donald, global chief economist for Manulife Investment Management. “This is one of the most complicated periods in modern economics.”

That last bit seems to be the import part here. We are off the page, economically speaking, coming off a year plus of pandemic-related shutdowns, draw downs, and closings. Plenty of attention has be paid to the effects of stimulus and increased unemployment benefits, while less has been paid to other effects such as school closings/going virtual affecting childcare requirements for families. Plus, the economy is more barge than speed boat; hot economic takes that are stuck in the moment miss out on years and sometimes decades of policy and economic factors that tend to converge in moments of crisis. Everything from the Fed keeping interest rates very low for long periods of time, to wages, to debt loads, to government spending affects the economy when it comes to inflation.

So, instead of trying to prognosticate about an economic situation we have already established is unique, perhaps a review of three examples in US history of inflation would be a more useful tool in what to watch for going forward.

The United States has gone through booms and busts, leading to periods of both prosperity and recession. In order to better understand the trajectory of the rising cost of living and prices of goods, it is important to study historical inflation rates in America.

The Great Depression. The Great Depression of the 1930s occurred due to a range of factors, including wild speculation and liberal lending that led to a bubble burst in 1929, when the stock market crashed. The unemployment rate and natural disaster also played a part. Economist and Chairman of the Fed Ben Bernanke later theorized that deflation during the Great Depression led to a reduction in value of people’s assets. Since people used those assets for collateral, the banks were faced with greater risk and therefore foreclosed on the loans. In Bernanke’s view, deflation results in a block in the cycle of lending and borrowing that is essential for moving the economy forward.

The 1970s. Although the Fed can increase the strength of the economy by printing money, that comes at the cost of a higher rate of inflation. Higher inflation causes real interest rates to rise again and the economy to slow. If the Fed is not careful, its actions can backfire and lead to an economy with high rates of inflation but not very high GDP growth. In the 1970s, the United States experienced precisely that outcome. Inflation rose throughout the 1970s while economic growth slowed. This “stagflation,” as it was called, experience left a mark on many Americans—so much so that there are people who believe that trying to increase GDP by printing money is so dangerous that it borders on evil.

The Great Recession. While printing money is a way for the Fed to help the economy, there are limits to this strategy. If the economy enters a liquidity trap, printing money will no longer be effective. A liquidity trap occurs when there is a lot of cash in circulation that is not spent or invested. Instead, people and institutions “hoard” their money. This is a problem because that hoarded money isn’t boosting the economy and creating jobs by being in circulation. When the Great Recession began in the United States in December 2017, Ben Bernanke, the Chairman of the Federal Reserve, responded by printing money aggressively. Economists and other commentators were worried that he would cause extreme inflation. However, because they were in a liquidity trap, most of the money sat in banks and did not circulate in the wider economy. As a result, there were huge increases in the money supply, but only a very small increase in prices. While the Great Recession was the worst economic downturn since the Great Depression, within several years (and after the Fed lowered interest rates and the government created an 800-million-dollar stimulus package), the economy was able to reach stability.