More on the current inflation
Economics Without The B.S.**:
[**
Double entendre intended.]
The world
community experienced a shock to the economy when the pandemic hit in
March/April of 2020 – a major contraction of economic activity. Had central banks, around the world along
with our Fed, not intervened, there would have been a large deflation across
the international economy, to include the United States. That would have affected asset prices,
probably on a broad category – physical and financial assets. One can only speculate what that impact would
have been, remembering that asset prices underlie the foundation for credit, as
collateral, and the importance of credit to keep liquidity flowing to support
economic activity/behavior. Not to
mention that a prolonged deflation could result in cuts to income – derived
from wages and salaries – something Americans have not experienced in many
generations.
Instead of dealing
with a deflation, and the possibility of a deflationary spiral, central banks
did intervene; and, in the case of the United States, where we also had a very
large fiscal intervention, we were able to stabilize the price level to some
extent where we are dealing with some degree of inflation at present without
knowing its severity. The broad category
of asset prices has held firm or have even risen substantially. Credit markets were disrupted, but the Fed
has intervened to support specific sectors of the credit market.
Only to that
extent can this inflation be considered a monetary phenomenon. When the international economy shutdown, that
caused physical harm to the economy – unemployment, a substantial reduction in
the output of goods and services, and business closures. In other words, greatly reduced economic
activity of actual physical/real people and structures (businesses, equipment),
and the flow of goods through the vast distribution system.
The injection of
monetary and fiscal stimulus bolstered segments of the economy. But it has been uneven. This has resulted in imbalances among the
sectors of the economy and especially between the demand for goods and services
and the ability of the broad economy to respond, to fulfill that demand. The supply is lagging the demand.
That gap between supply
and demand is affecting prices. You see
this gap in the uneven recovery by comparing Personal Consumption Expenditures
(PCE) with the broad Industrial Output.
And you see the
effect on price when you compare the Consumer Price Index (CPI) to the Producer
Price Index (PPI) – it is the PPI with the wild swings that tells the story. In the post-2008 Financial Crisis years, the
PPI took wild swings while the CPI remained steady; the price increases in the
wholesale system were absorbed within the economy and not passed on to
consumer, as reflected in the gradual increases in the CPI. This time the price increases in the PPI are
not being absorbed within the economy, they are being passed on to consumers,
as reflected in the CPI. The PPI leads
the CPI and is driving the CPI.
https://fred.stlouisfed.org/graph/?g=JvxR
PPI and CPI
The inflation
behavior now is due to the PPI swings and the behavior in the productive
sectors and the supply chain/distribution system that services the productive
sectors.
That we are in an
inflationary time period, and not a deflationary time period, is a monetary
phenomenon. But that is a one-time
event. The inflation we are now
experiencing is due to imbalances within the physical economy – namely the
recovery of the production and distribution sectors lagging, failing to satisfy,
the demand for goods and services.
In this current
inflation Aggregate Demand is leading Aggregate Supply, and the lag in
production and distribution results in the PPI leading the CPI. This inflationary cycle is not due to
monetary factors, but due to the real, physical economic structure and process
– the flow of goods and services have been disrupted. There is little the Fed can do about that;
and probably little Central Planning by the government can do.
Take care of the Big Picture – dealing with the pandemic and
restoring an operational framework – and let the individual agents (big
businesses and small businesses, and the folks who make up the labor force)
figure things out for themselves. Sooner
or later order shall be restored, and we will probably be operating at a higher
price level, but without the inflationary pressures and back to some sense of
stability.
