Why the inflation picture remains clouded and what business leaders need to know

Inflation is on everyone’s mind these days: what causes the surge, how high it will go, and when it will be under control. Will it be a short-term phenomenon, as the Federal Reserve has suggested, or more longer lasting? Unfortunately, no one can answer these questions as of yet, although many have tried.

Supply chain disruptions have been getting a lot of attention lately for causing current inflation; however, there are many other potential causes of inflation, such as profiteering, labor shortages, rising consumer demand, expansionary monetary policy, rising government debt levels, and more.

It’s impossible to get a clear picture of inflation because there are so many intermingled factors. An obvious trigger has been the pandemic, at first generating big shock waves that have cascaded into smaller waves — and they keep coming.

The prices of goods and services have been on the rise, as evidenced by a 5.4% increase in the consumer price index (CPI) over the past 12 months. Consider the rise in food prices, which overall were up 4.6% over the past 12 months and 0.9% in September alone. More specifically, the CPI index for meats, poultry, fish, and eggs rose 10.4% in the last year and 2.2% just in the month of September, with beef rising 17.6% over the previous year and 4.8% in September alone. As an example, the average price of ground beef was roughly $3.89 per pound last September and now it is $4.50 per pound, an increase of 15.7%.

Consumers Step Up Spending

Supply shortages and inflation fears have not curbed consumer spending, rather the opposite. Consumption expenditures rose by 11.6% in August over a year earlier, down from an annual peak rise of 29.9% in August. Retail sales rose an unexpected 0.7% just in September, following a 0.9% gain in August, despite higher prices for goods.

These facts point to another set of determining factors of inflation: producer and consumer behaviors that are turning inflation fears into a self-fulfilling reality. Households are accelerating purchases to get ahead of inflation, and producers are responding to the increased demand by raising prices. This is why we see consumers hoarding goods, rather than reducing their demand, which is causing producers to raise prices even further.

Government Policies

Some economic theories, such as monetarism, focus on the Federal Reserve’s expansionary monetary policy as driving inflation. To that end, the M2 money supply (which is cash and checking deposits) has grown by 34% since the beginning of the pandemic, while the monetary base (the amount of currency in circulation) has increased 83%.

While some claim that this results in too much money chasing too few goods — the classic inflationary setup — the issue is that monetarism does not explain the historical data. For example, from August 2008 to September 2014, the monetary base grew by 378% and M2 grew by 48%, but there was no inflation. The Federal Reserve has indicated, however, that it will slow expansion of the money supply starting in November.

Other economic theories link the level of government debt and inflation. Since February 2020, the US government’s debt level has grown by 31% to $28.4 trillion today, 1.25 times GDP and substantially above the historical average rate of around 0.60. While some claim this contributes to inflation, that may not be the case. We need to remember that the Treasury Department and the Federal Reserve operate differently. When the Treasury spends more, it must borrow more to pay for that spending. But, when the Fed spends more, it only needs to release new cash into the economy.

What about Supply Chain Disruptions?

Higher prices for a wide array of goods have been linked to supply chain disruptions, including a huge shipping backlog at major ports. While the number of ships waiting to move into the Ports of Los Angeles and Long Beach has been about the same for the last year, averaging 65 ships per month, their time at anchor has risen by almost 850% over the last year, now standing at 12.3 days.

These shipping disruptions are not the root cause, but a symptom. Supply chain issues started at the beginning of the pandemic when factories around the world had to close because of Covid-19 infections, causing shipping companies to cut back. It has taken time for factories to finally increase product, and for shipping companies to respond.

Another underlying problem with port backlogs may be the lack of available truck drivers to pick up and transport cargo, as evidenced by an estimated 80,000 driver shortfall in the U.S., with actual truck tonnage shipped declining by 5% over the last year.

The need for more truck drivers reflects an overall tight labor market, as a record 4.3 million people voluntarily quit their jobs in August and a further 5 million people have left the labor force since the beginning of the pandemic. The labor participation rate has fallen to only 61.6% in September, the lowest it has been since 1977. Not only could labor shortages exacerbate the supply chain disruption, but the need to attract workers with higher wages is also inflationary.

Inflation Outlook

Will prices rise and stay at elevated levels? Or will prices keep spiraling upward in a cycle of inflation?

For its part, the Federal Reserve has predicted an annual inflation rate for the year of 4.2%, higher than the 3.4% rate that was forecasted in June. Next year, the Fed has said, it expects inflation to moderate to about 2.2%, which is on par with its target. In a recent speech, Fed Governor Christopher Waller stated, “I continue to believe that the escalation of inflation will be transitory,” but added, “I am still greatly concerned about the upside risk that elevated inflation will not prove temporary.”

For economists, policymakers, and business leaders alike, we can only stand by and see what develops next.

 

This article was written by Phillip Braun from Forbes and was legally licensed through the Industry Dive publisher network. Please direct all licensing questions to legal@industrydive.com.