More on the current inflation

 

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. 

https://fred.stlouisfed.org/graph/?g=JACK

Industrial Production and PCE

https://fred.stlouisfed.org/graph/?g=Jm29

Capacity Utilization

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.