Inflation remains a hot news topic and political issue. The Biden administration is taking increasing heat. Democrats fret about whether public dissatisfaction with rising prices will influence the 2022 election cycle. Republicans are ready to beat that drum.
In financial news, whom President Joe Biden should appoint as Federal Reserve Chair is front and center — with inflation as the backdrop. So practical issues counterbalance economic theory on causes and cures of the general price-level increases we’re seeing.
Last week in this column, we postulated on the underlying theoretical causes. Economists share a clear consensus. Milton Friedman was correct that, overall, inflation is “a monetary phenomenon.” Excessive growth of the money supply is the root problem.
The links between money growth as controlled by the Fed and price-level increases are not as clear as once thought. Libertarian Friedman hated any human discretion over the amount of money in the economy and fantasized on how a computer in the basement of the Fed could run things — not 12 people on some committee.
The 1970s inflation and then-Fed Chair Paul Volcker’s crushing it by restricting money growth bore Friedman out. But the history of massive money increases following the 2007-09 Great Recession not causing noticeable increases in general prices demonstrated deeper complexities.
The money supply-inflation link is a fundamental cause, but other factors matter in the shorter term. What economists call “exogenous shocks” — events from outside the economic system itself — can raise prices or lower them.
The San Francisco earthquake, the outbreak of World War I, the 1988 U.S. drought, the 1973 Arab oil embargo and the 9/11 attacks all were external shocks that pushed up consumer prices. Even an avian flu killing tens of millions of chickens in 2014 pushed up egg prices enough to affect the food-price component of the Consumer Price Index.
Historic pandemics like the one we’re currently in also are exogenous shocks. The Black Death that may have killed up to 200 million people in the mid-1300s changed European wages, land prices, food production and other variables for centuries. The 1918-1920 “Spanish” flu substantially reduced economic activity, though its specific effects are hard to separate from the ending of World War I. We didn’t try to measure gross domestic product in those days.
COVID certainly qualifies. It initially put millions of people out of work, closed millions of businesses, caused airlines and ocean shipping companies to cut capacity, upended commercial real estate and other land-use issues and much more. COVID, and the federal government stimulus payments in response, also undid long-forged social contracts around school and work that may never be repaired. It has changed people’s values.
People forget that at COVID’s beginnings in the U.S., between March to May of 2020, the CPI actually fell for three months. That was not because the Fed had suddenly curtailed the money supply. It came from people having less to spend and not going out to spend if they did. People hunkered down.
COVID certainly is the greatest peacetime external shock since the flu epidemic. And it is occurring in a world where major economies are more tightly interlinked than at any time in human history. So adjustments and readjustments caused by the disease cause turbulence in supply, demand, prices and employment.
Couple this with a severe drought in important food producing areas of North America. Resulting price spikes in wheat, corn, soybeans and any livestock fed any of these commodities are the primary cause of the food prices jumps that are highly visible and irksome to consumers. And OPEC, which cut its oil production as COVID slowed world demand, is not willing to increase it quickly to push energy prices back down, even as demand ramps up.
Most economists see these as important in the short term. Most minimize, if not dismiss, the anticipated effects of Biden’s spending plans that are still in the works. The federal deficit is narrowing. The enormous sums cited in the transportation bill include large amounts already programmed under existing legislation that would be spent in any case. And it is all over eight-to-10-year horizons. These facts led to statements this week by financial ratings firms Moodys and Fitch downplaying effects from the federal budget on inflation.
However, the general public is convinced that whoever is in the White House is responsible for inflation. Poor Gerald Ford, who had no effect on the 1970s inflation at all because he did not have occasion to appoint a Fed chair, nevertheless took much blame. Jimmy Carter does bear blame to the degree he appointed G. William Miller, the worst Fed chair ever, but gets no credit for soon putting Volcker; who ended price surges in Miller’s stead.
The GOP is beating up on Biden over inflation, but Democrats would be beating just as hard on any Republican who might be in the Oval Office right now. That’s how the game is played.
Moreover, while Biden’s long-delayed spending programs are not yet in play, the multi-faceted COVID-related spending and tax breaks that started in 2020 are having price effects — again, a monetary problem. Economists probably will argue about the overall effects of these measures for years, but they certainly kept the economy from much greater shrinking than might have occurred, albeit with inflation as the price. They put money in the hands of households when opportunities to spend it were limited. They’re spending it now, as the latest retail sales report from the Commerce Department shows.
That is very analogous to World War II, when wartime production burgeoned employment and manufacturing. Household incomes rose dramatically from Depression-era lows, but there was nothing to buy — cars, appliances, building materials and even gasoline or tires were hard or simply impossible to get. Everything went to the war effort. High pressure war bond campaigns sopped up some of this money. Price controls were a harsh ceiling.
Then the war ended in August 1945. Millions of servicemembers were discharged and price controls scheduled to end. However, re-tooling from bombers and radars to autos, refrigerators, radios or phonographs took time. Prices spiked, workers went on strike and consumers seethed. A GOP-majority Congress passed the anti-union Taft-Hartley Act. Supply and demand eventually balanced, and Democrat Harry Truman squeaked out a narrow win in 1948.
Biden could open the Strategic Petroleum Reserve to lower gas prices or end Donald Trump’s tariffs on imports from China, which were passed on to consumers. But these are palliatives. The Fed could move faster on tightening money and thus push up interest rates. But consumers, voters and financial markets would hate this even more than ongoing inflation bumps, and again likely blame Democrats.
St. Paul economist and writer Edward Lotterman can be reached at stpaul@edlotterman.com.
Real World Economics: Inflation’s roots go deeper than money - TwinCities.com-Pioneer Press
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