Inflation is Here. Why? What Can We Do?

The latest CPI release today shows that real inflation is here. Headline inflation for consumer prices is up 6.2% compared to a year ago and a almost full percentage point in just the past month (seasonally adjusted, so compared to the normal monthly increase).

Back in June, we could reasonably say that 45% of the increase that month (and 27% over the prior year) had been due to just the price of new and used cars, in the past month only 17% can be attributed to vehicle prices. That’s still a lot, considering cars are only about 8 percent of the overall CPI, but inflation is clearly showing up in other areas.

Gasoline prices (also car related!) are always volatile, but they are up sharply in the past year. The over 50% increase for regular unleaded gasoline translates to $1.22 more per gallon than a year ago (and $1.50 more gallon than Spring 2020), which is the largest nominal price increase consumers have seen in a 12-month period (the data stretches back to 1977).

But gasoline is only about 4 percent of consumer spending. What if we look more broadly? Even excluding energy prices, inflation is 4.7% over the past year, the highest increase since 1991.

The natural related questions are Why? And what can we do about it?

The Why question is tricky. The Federal Reserve is very interested in whether the increase in prices is caused by monetary policy. It very much guides their action. Consumers don’t really care that much. They just want the pain to stop. Unfortunately, though, part of the pain may be induced by consumers themselves: spending on goods is extremely high right now, with the year so far 18% above the comparable period in 2019. Higher spending will increase prices in any environment, but the strain it is putting on supply chains only exacerbates the problem. This is not to “blame the victim,” but rather to understand what is going on.

What can be done? That’s an even harder question. It’s convenient to blame the President for things like gas prices. And certainly many voters and pundits will blame him. This charge is not completely without basis, as there are certainly things at the margin a president could do to ease gas prices in the short run (allow more drilling, gas tax hiatus), but we shouldn’t oversell this. And in other areas too, perhaps there are changes that could be made at the margin. But given the massive increases in consumer spending (at least for now), any changes won’t put a dent in the overall inflation rate.

But what about at the individual level? Milton Friedman was asked this question in 1980. That year inflation was 13.5%, the highest since World War II. Friedman’s answer: high living. He said there is no asset which you can expect to protect you against inflation, so you should spend what you have now on something nice. Buy a nice house, a nice suit, a picture to hang on the wall. This is what economists sometimes call “the flight to real values,” or as Phil Donahue put it “convert your money into material things.” While this advice may make sense at the individual level, it doesn’t have great implications for the current supply chain issues.

Friedman did have clear advice for the nation: the Federal Reserve should stop increasing the money supply. Whether that advice will work in the current environment, or whether it will stall the economic recovery, is the hard question the Fed is wrestling with at this very moment.

One thought on “Inflation is Here. Why? What Can We Do?

  1. Scott Buchanan November 10, 2021 / 7:20 pm

    Nice article, thanks. However, I submit that it is fiscal policy more than monetary policy that has driven this inflation. All the massive QE (bond purchases) done by the Fed since 2009 has mainly gone into boosting the prices of financial assets, mainly benefitting the wealthy. There just is not a clear, strong path for that QE money to flow from Wall Street to Main Street.

    The federal government has dumped trillions and trillions of dollars into the wallets of citizens, who have saved some and (by basic arithmetic) are in the process of massively spending the rest, and at a time when the supply chain has various bottlenecks.
    If trillions more in deficit spending are forthcoming, so will be inflation. (Not saying that is morally right or wrong, it’s just plain math).

    The Fed of the 1980’s was independent enough to crank up interest rates to astronomical levels, knowing that a recession would ensue, with the belief that the resulting pain of unemployment (with only modest unemployment insurance payments back then) would break the back of inflation. And it did. But I doubt that could happen today. Any Fed board that deliberately brought on a big recession “just” to halt inflation would be toast(ed), and the federal response to recession is now to massively hand out money.

    Like

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