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Current Affairs

A Magazine of Politics and Culture

How Serious Is The Inflation Situation?

Current Affairs economist-in-residence Rob Larson offers a primer on rising prices and an assessment of conservative inflation panic.

American conservatives spend most of the time hysterical about various developments, like private companies requiring workers to vaccinate against the coronavirus, or the law school analytical framework called critical race theory. But lately the right wing has returned to a classic bete noire of theirs—inflation. Breitbart writes that “Bidenflation” is burning “white hot,” while the Wall Street Journal complains that “Mr. Biden ought to be enjoying an economic boom from the ebbing pandemic as the government lockdowns end. Instead his policies have abetted a spike in inflation that is outstripping gains in wages. Telling people not to believe what they see with their own eyes is rarely a good political strategy.” 

Inflation is an important economic indicator, like the economic growth rate and unemployment rate. But it’s easy to get rusty on the math behind these measurements, so let’s first take a moment to review the basics. 

Pennies from Heaven: A Quick Reminder Of What Inflation Is, How It’s Measured, and Why It Matters

Inflation refers to the decrease over time in the buying power of currency. Or to put it another way, inflation describes an increase in the prices of goods and services across the full economy, or what economists call the “price level.” So inflation doesn’t usually refer to increases in prices for specific products, like housing, or services like education (both of which, by the way, are rising fast). Instead, inflation means that prices tend to increase across the board, usually when the economy is growing. 

Inflation can happen for a few related reasons. One reason is a side effect of capitalism’s famous growth—as production of goods and employment increases over time, employment tends to expand, which historically tends to raise worker incomes. This is usually accompanied by more lending, or “credit creation,” by private or public banks as people take out loans for cars and houses. This adds to the total money supply in the system, often referred to as “overheating.” As there is now more money chasing a slower-growing amount of goods, prices are driven upwards.   Since this accompanies economic growth, market observers sometimes call this “good inflation.” 

Another cause of inflation is cost-push inflation, where higher costs of production lead to price increases by firms—the classic case of this is the 1973 energy crisis caused by the OPEC oil cartel embargo, which was carried out in retaliation against the West for its support for Israel in the Yom Kippur War. The abrupt restriction of oil drove up the price of energy and every other product generated from fossil fuels, driving the big inflation waves of the 1970s.

A final factor driving broad price increases is “adaptive expectations”—the amount of inflation that people come to expect will occur, usually based on recent experience. The issue with this is that once inflation gets high, it can be hard to bring back down, because workers expect rising prices and then tend to demand more raises. These higher wages then add to the demand pushing up prices, causing a self-fulfilling “wage-price spiral.” But of course, workers these days can’t just demand higher wages the way they might have in the 1970s when inflation was last high, and when labor unions were far stronger and more common than today.

In the US, the most common inflation metric is measured by the Bureau of Labor Statistics in its regular Consumer Price Index (CPI). Essentially this is done by looking at the prices of various consumer goods, like food, housing, clothing, energy, and health care, and keeping track of the cost of this “basket” of goods.

A simplified version of the calculation looks like this: A basket of goods and services for urban consumers might cost $1000 in 2020 and $1040 this year. The BLS creates a price index, which may be based on a past year or just the first year in a data series. The index takes the current basket price and divides by the base year’s basket’s price, and multiplies by a hundred. So the 2020 index would be 

$1000 / $1000 x 100 = 100

And the 2021 index would be 

$1040 / $1000 x 100 = 104

Finally, the inflation rate for the year would take the difference in the index values and divide by the starting one: 

(104-100 / 100) x 100% = 0.04 x 100% = 4%

On the other hand, deflation is just the opposite, a decrease in prices over a period, most often seen during recessions. Lower prices—sounds great, right? But deflation is economic poison, because it kills demand—once people and companies realize that prices are falling, they tend to put off any purchase that can be delayed, so they can get a better price. This means a collapse in consumer demand, and like high inflation it can be very hard to get out of. The classic case of stubborn deflation today is Japan, which has battled deflation off and on since its great speculative bubble blew up back in 1991. With a declining population and limited private investment, the economy has barely grown and prices have hardly budged, despite the government and central bank using every trick in the book, including rock bottom interest rates, even negative rates, and giant fiscal stimulus. After years of flat prices, Japanese consumers now expect very low inflation, making it hard for companies to consider raising prices, which they can generally avoid anyway with cheap imports. The pandemic recession has worsened this trajectory.

Inflation, like other economic developments, creates winners and losers. Since it lowers the value of currency, it can reduce the burden of debt on those with mortgage or student loan debt (unless they have inflation-adjusted balances). But holders of great wealth hate inflation, as even modest rates can erode large amounts of buying power from their gigantic holdings. And different assets have different levels of vulnerability to inflation—owners of assets priced in currency, like houses or stocks, often feel they benefit from inflation, especially if they focus on the value of their specific asset rather than on overall prices. But assets denominated in currency, like cash or debt instruments like bonds, are actively hurt by inflation which directly cuts their exchange value.

Plus, inflation (especially erratic inflation) makes it hard to gauge what a good price is and thus messes up conservatives’ precious fondness for relative prices, which are supposed to make markets efficient. These “price signals” already leave out “externalities”, from secondhand smoke to climate change, which is bad enough, but when prices fluctuate it is legitimately harder for businesses to plan, which doesn’t make them any likelier to invest in growth, or to hire.

Because inflation hurts those with great wealth and can potentially help debtors, conservatives have opposed any hint of inflation for many years. Luckily for them, the high rates of inflation caused by the energy crisis and rising wages of the 1970s were decisively broken by the Reagan Revolution. At the time of Reagan’s 1980 election, Paul Volcker was the Chair of the Federal Reserve, the US central bank, among whose responsibilities include adjusting the money supply to influence interest rates, and through that the overall level of economic activity. Inflation in the US at the end of 1970s peaked at a rollicking 14.8% in 1980, utterly unacceptable to the American wealthy elite and their corporations. Volcker dramatically spiked interest rates, raising the important federal funds rate to a stunning 20%. This was high enough to cause a punishing recession, the sharpest one at that time since the Great Depression itself, with unemployment rising north of ten percent, causing major economic pain. But it also leveled off the CPI. 

Further, Reagan’s administration declared open season on organized labor, signaling to employers that labor law protections for union organizers would no longer be enforced, and Reagan fired 11,000 striking air traffic controllers himself. This period set off a decades-long decline in labor power. As a result, most economic growth since then has gone to the richest families who own corporate stock, not to the laborers who create the wealth.

But this ugly class warfare has also played a role in keeping inflation in check ever since, as economists broadly recognize the decline in union density has meant the loss of the “union premium” on wages and benefits over the last forty years. As incomes have stagnated for the majority of Americans since then, and especially as workers have lost the benefits of  collective bargaining, the various models of inflation described above that refer to widespread “demands for raises” are increasingly obsolete. The low inflation of the past forty years suggests that prices are less buoyant when the growth of purchasing power is locked up in a ruling class of people who already consume a huge amount and tend to only moderately increase it, as even wretched ruling-class scumbags like Larry Summers now openly acknowledge. Inflation has remained around an average of 2% since the early 1980s, a limited number that accommodates economic growth without much erosion of the wealth hordes and constant financial transactions of the great companies and owners of concentrated global wealth. 

This means that, ironically, the threat of inflation is highly inflated by the Right, who have somberly predicted spikes of inflation at every policy turn they dislike. They claimed inflation would take off after the 2008 finance crisis, when the Fed activated its controversial asset-buying campaign to depress interest rates, known as “quantitative easing.” The Fed ended the program in 2014 and restarted it in the face of the Covid recession, with conservatives claiming both times that this plan was similar to printing money and would bring about soaring Weimar Republic inflation numbers any day. One still waits. 

Splitting the Bill

But this summer, as the economy reopened after Covid shutdowns ended, the numbers actually popped. In June, the Consumer Price Index leapt up 5.4% compared to the night before, higher than the already surprising 5% year-over-year increase in May. The Right cried bloody murder, for two reasons: inflation is anathema to them, and it was an opportunity to bash the new Democratic administration’s recently-broadened public programs of social support, like the expanded unemployment benefits then running in many states.

But a look behind the headline number suggests a calmer outlook. First, the numbers are subject to a mathematical quirk called the “base effect,” since they are “year-over-year” metrics created by comparing the price of goods baskets in July 2021 with the same ones in July 2020. If one of the years in question is atypical (say, due to a pandemic), then the difference will be exaggerated. Of course, May and June 2020 was a highly unusual time, as the economy was in a stunningly sharp recession as the pandemic shutdowns suffocated consumer demand, bringing a short-lived deflationary price level fall. That means that the increase in prices from last June to June 2021 are exaggerated by the artificially low June 2020 base prices relative to today. A way to see through this passing quirk in the data is to recognize that this summer’s prices are up only 2.5% relative to summer 2019, before the pandemic disrupted the economy. 

Furthermore, the specific economic sectors driving the current inflation appear to be experiencing temporary effects, often associated with last year’s unprecedented shutdowns and this year’s hasty drive to reopen. This kind of massive disruption always comes with sticking points, and the current price rises seem to owe a lot to them, but other issues are playing surprising roles. For example, price increases in the market for used cars and trucks accounted for a full one-third of June’s inflation spike. Why? The reopening has meant renewed demand for vehicles for workers returning to in-person work. At the same time, production has been constrained due to supply chain problems, primarily around the computer chips that are now ubiquitous in so many products. 

This global chip shortage itself tells us a lot about how the economy works these days. The sophisticated computer chips we rely on to run everything from our phones to our car transmissions are made by a small oligopoly of firms, like Broadcomm and Intel, with some making hyper-specialized chips that manage wi-fi connections or graphics, and others producing the processor “brains” of machines using them. The most cutting-edge chips today are produced by the Taiwan Semiconductor Manufacturing Company (TMSC), making “Most of the roughly 1.4 billion smartphone processors world-wide,” according to the conservative Wall Street Journal. But TSMC has been struggling to maintain production amid Covid disruption and a terrible drought in Taiwan, which has hurt farming and the water-intensive chip making industry. Taiwan’s central bank openly recognizes the responsibility of climate change for the historic drought, and the insanely powerful rains and flooding that followed.

Notably, despite the feverish insistence of conservative economists, the market gap can’t be filled by other firms—the Journal reports that “Semiconductors have become so complex and capital-intensive that once a producer falls behind, it’s hard to catch up. Companies can spend billions of dollars and years trying, only to see the technological horizon recede further.” This near-monopolistic industry is hoping to get production numbers up and to relieve its backlog, but until then it will continue contributing to inflation. The limited supply of fancy chips has caused delays in manufacturing new cars, which has in turn driven up demand in the used car market, which has made up a large chunk of the price increases recorded in the recent high inflation numbers. Unintended consequences are common in markets, despite conservative tendencies to  associate them primarily with government and government policies.

The Price Is Fright

Looking forward, managing inflation remains mainly the job of the Federal Reserve, a partially private and partially public body with regional presidents elected by private banks and national leadership nominated by the President, with a great deal of independence. Technically the Fed is expected to both limit inflation to an average of 2% and maintain “full employment” (usually meaning unemployment in the area of 3-4%), but as shown by the historic role it played in the rise of neoliberalism and austerity in the early 1980s, its banker leadership has always been more inflation-hawkish than eager to see tight job markets that could put more negotiating power in the hands of workers. 

That means that the Fed’s leadership is closely following the current inflation spike, with current chair and former Carlyle Group partner Jerome Powell defending the central bank’s ultra-low interest rates and its programs of buying bonds to keep long-term interest rates low (called “quantitative easing”). So far the Fed has stuck by the analysis that the inflation is sector-specific and likely temporary, and that the recovery still needs support since 5.7 million fewer jobs exist now compared to pre-epidemic. At the same time, the Fed’s Board of Governors are now debating how soon to cut back the asset purchases and lift rates from the floor, depending on how the recovery goes. But make no mistake, if the choice comes to keeping inflation in its box or aiding recovery in the job market, the Fed has a long history of choosing the former, most dramatically in Volcker’s recession of the early 1980s.

But the consensus view for now is that inflation will remain higher than its lows of the last few neoliberal decades but far from 1970s crisis levels. July’s price increase numbers were still elevated but down, and remained high through August, which, in light of decreased support from public policy raises the fearsome possibility of stagflation—weak economic growth with high inflation. However, people’s expectations of higher inflation have moderated from their highs in the winter and spring—while surveys and market-based metrics show that while consumers expect inflation to be north of 5% for this year, a relatively high number, their expectations for five to ten years out are below 3%, a much more moderate number and consistent with the low US inflation numbers of the neoliberal period. And because the public’s expectations for inflation affects their own behavior, from buying products to requesting raises, their self-fulfilling nature suggests limits on long-term price hikes.

Recent history should show us that social observers, certainly including economists, are not great at predicting the future. But the range of trends we’re seeing now suggest a return to our limited inflation status quo as the recovery haltingly continues in the face of new Covid variants. Regardless of the specifics, the political Right will continue to use the fear of inflation as a political tool to smear popular progressive policies like the Green New Deal. A basic familiarity with these economic concepts is critical for the Left in its struggle to rescue humanity from the fiery climate hell of capitalism, and aid us in building a socialist future, too. Bet your bottom dollar on that shit.

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