Inflated narratives

The subject of inflation is on lots of minds these days, but is not always understood with clarity and cogency. The heated political atmosphere makes for agenda-laced commentary that is sometimes not even intentionally lacking in objectivity. The entire matter requires calm voices, diligent analysis, and an understanding of the issues—not pre-set conclusions.

Inflation produces a rare economic conversation that invites participation from almost everyone. Only a small part of the population understands monetary policy and only a rarified group has opinions on how fiscal tools impact GDP growth, but everybody buys groceries and fills up the gas tank. Inflation is more politically sensitive than other economic problems because its impact is felt most intensely by such a broad base of citizens (lower income and middle class, to be precise). Whereas stock market volatility or real estate values impact those who have a financial position that affords them the accumulation of assets, a move higher in the price of low-cost goods impacts lower income workers more, for the simple reason that a gas bill or a restaurant visit are a far bigger portion of a lower income than a higher income. The top quintile of wage-earners spend 8 percent of their incomes on food, whereas the bottom quintile spend 31 percent of their income on food (source: USDA). The impact of inflation is not spread evenly.

Inflation in the United States was a significant problem in the 1970s and early 1980s, and then we went through a period economists refer to as “the great moderation” for nearly 40 years. In the 1970s, money supply growth was extreme, and tax, regulation, and energy policy were all highly biased against what we call “the supply side” of the economy—that is, robust production of goods and services. The late economist Milton Friedman taught us that inflation is “too much money chasing too few goods,” and the 1970s had both problems on full display—unwise monetary policy and way too few goods being produced to “absorb” that monetary liquidity.

Inflation did not go away in the 1980s and ’90s, but a 20-year boom in economic growth curtailed it as new goods and services (economic output) put the money being created to good use, and price levels moderated substantially. Even as prices grew 2 percent or so per year, wages grew above that level, and inflation largely left the national conversation as a couple of decades of solid economic growth, impressive job creation, and needed wage growth became the dominant economic stories.

Inflation may have been in the conversation from 2007 to 2021, but not because we were struggling with too much of it. After the global financial crisis, America feared falling into a deflationary spiral, much like the debacle that plagued Japan since the late 1990s. Central bankers actually tried to create more inflation but were unable to do so, as interventionist fiscal and monetary policy felt like “pushing on a string” (that is, more government spending and more easy monetary policies had less and less of an impact). The central bank during this period went “berserk” (with zero percent interest rates for almost 15 years and trillions of dollars of “quantitative easing,” whereby the Federal Reserve bought bonds with money that did not exist to ease financial conditions).

Inflation became a more negative conversation again in the aftermath of the COVID lockdowns. By the second half of 2021 most of the country was reopened, and the impact of having the global supply chain nearly shut down for a year and a half became clear. American consumers were ready to resume consumption of goods and services, but production of those goods and services was not ready for the task. Shipping costs had exploded, semiconductors were not available, and of course, the Biden administration’s decision to extend COVID support payments to workers for an extravagant period of time exacerbated the limited supply of available workers. Prices skyrocketed as this disconnect between supply and demand intensified, and inflation was back in our national lexicon.

After peaking at 9.1 percent in the middle of 2022, inflation started coming down, due to normalization of the supply chain, higher interest rates, and the normal cure for high prices (which is, well, high prices). Prices were not resuming pre-COVID levels, but the rate of growth came down from roughly 9 percent to roughly 3 percent. As a significant part of that 3 percent was made up of a “shelter” calculation that assumed rents were still growing 7-8 percent per year when most market indicators pointed to flat rental growth, the assumption entering 2024 was that the inflation growth level would show 2 percent in short order. That assumption was largely behind the Fed’s declarations in November that it anticipated cutting interest rates three times this year.

The inflation rate has stayed above 3 percent so far in 2024, with the most recent reading showing a huge spike in auto insurance costs as an outlier that significantly impacted the numbers. Rent and Housing estimates have not yet caught up to real-time market indicators, and the mathematical impact has kept the inflation rate above 3 percent even as rental cars, toys, appliances, travel, and furniture have all “deflated” year-over-year (i.e. a negative rate of growth in prices).

The primary point I would make to the current discussion around inflation is my objection to any suggestion that the economy is “too hot,” and that such low levels of unemployment create inflation. Inflation is not caused by growth; rather, growth is hindered by inflation! What causes inflation is too much money chasing too few goods. We can blame the federal government for excessive spending and debt, something it has been doing in spades for 20 years now. But excessive government spending hardly makes the economy run “too hot”—it hinders future economic growth immensely as future resources are pulled into the present and not available for future growth. What causes inflation is too much money chasing too few goods, and the greatest way to get the goods and services one needs for the economy to run in equilibrium is more workers. More productivity means more goods and services, and that is anti-inflationary, as the 1980s and 1990s made clear.

Each political party has its own narrative about inflation for the months ahead, this being an election year. Those of us who want a just economy rooted in growth and productivity ought to root for a strong and stable dollar, a price level that does not see food prices jump, and the end of expectations that a central bank can wave a magic wand and make all desirable economic outcomes come true at once. Inflation may be headed lower, but no one will celebrate that if years and years of economic irresponsibility leave us with impaired growth for a decade to come.