The Inflation Question

There has been more and more talk about the fear of rising inflation. That is, a fear of prices increasing because of an increase of the money supply. This topic is fueled by recent decisions from entities like Jerome Powell’s Federal Reserve and their policy of increasing the money supply through buybacks on US Treasuries and “alternative” means.

Here, I will pitch my view on modern inflation and why you needn’t fear talks of soaring prices.

DISCLAIMER: This article is not an academic piece, it is an opinion piece. Nonetheless, I would not share my opinion if I thought it was valueless. I simply have a undergraduate in economics

1. The money supply is not the primary reason inflation

Articles in the media and popular memes have associated the rise of prices with the printing of money. Yet, prices have been rising, but not at the same rate.

What does this mean? It is correct that, in several markets, prices have been soaring (particularly housing, construction goods, and automotive). This has little to do with the rise of the money supply (although cheap interests rates may be having a strong impact). On the contrary, these sectors have been experiencing spiraling inflation due to multiple conditions.

• Real estate has been affected by pre-existing housing shortages, cheap lending, and new COVID-19 driven migratory patterns (Source: WSJ)
• Construction materials have been affected by the reduced labor supply, the increasing demand from new housing, and COVID-19 “home renovations” (Source: WSJ, WSJ)
• The car industry is being affected by a shortage of silicon chips needed to power the processors that make up modern vehicles, factory shutdowns, and cheap lending. The reduced supply of new vehicles has made demand spill-over into the used-car market, increasing prices for both markets (Source: WSJ)

If inflation were growing due to the money supply, every item in every market would be experiencing comparable price hikes.

Yes, inflation is occurring. But for consumers buying consumer goods, the inflation resulting directly from the Federal Reserve’s policy of “printing money” is pennies.

2. Inflation can be a good thing, especially in developed economies

The federal reserve has a targeted inflation rate of 2%. Why 2%? There is a meandering economic conversation about why this is a good number— It is supposed to incentivize consumers to spend, while not penalizing borrowers. To summarize, 2% is just an established consensus. That’s right. A bunch of very smart, very influential economists agreed that this was the best target (more accurately, the least harmful target).

Does this mean the economy experiences 2% inflation every year? No. not even close. The US economy (and most developed countries) has been experiencing near 0 inflation: a stall of inflation. Inflation has hovered around 0% for most developed countries for about a decade.

Reduced inflation is a challenging economic problem because it reduces the incentive to invest or spend money. It also gives governmental organizations less room to maneuver (i.e., interest rates, swap rates), and it means that there has not been enough demand for goods to raise prices. There is a great many case study about Japan’s near 40-year bout with near-0 inflation (I will not link any here. It is a fascinating topic to research) (Source: macrotrends).

The frightening economic story is when there is deflation. The classic deflationary event was the Great Depression. Imagine being paid 3 to 10 percent of your money’s value every year to hide it in your mattress. Sounds great? Yes. Ok, but when everyone is being paid to do the same, it is terrible because no one will want to spend money (Those with money will effectively have more money doing nothing)!

Being paid to hide your money is a deflationary economic environment. As prices go down, the value of money increases. Again, the result is consumers will want to save more, consuming less, lenders lend less, and investors invest less.

We NEED a slightly inflationary environment to keep the economic engine going.

3. Long awaited good news: wage growth

My final point is that, after a decade of no real wage growth for Americans, we are finally beginning to see wages outpace the inflation rate for the first time since the 2000s! Wage growth is fantastic news. I must caution that I have not seen any proof that the Fed’s policies are causing the increase of wages. I mention it because the point of this article is to alleviate cries of “Inflation bad! Economy bad!”

As wages grow, consumers will have more money in their pockets. More money means that there is more room to spend and fuel the economy!

Conclusion

After reading this opinion article, you should come away knowing that anyone who tells you to fear the current inflationary environment is just trying to drive panic or clicks. The current inflationary environment is good for the economy, not threatening. The shocks occurring now in particular sectors (housing) are NOT entirely because of the Federal Reserve’s policies! They are a result of too many buyers in markets with not enough products!

I will leave you with this. 1980’s America had an inflation rate of above 10%! Today we have an average inflation rate of under 2% (Source:FRED).

– Alex