The economics of inflation: simple yet complicated
Inflation! Over the last several months, as we continue to navigate the pandemic, we are also beset by rising prices. Inflation is when the average prices of goods go up. It has also been said to be too much money chasing too few goods. In essence, high consumer demand, low supply, and prices go up.
The Bureau of Labor Statistics reported that inflation hit a 40-year high of 8.5 percent last month. There are several reasons for the rise in inflation.
First, let’s look at how the inflation rate is calculated. There are three measures of inflation. The two most frequently cited indexes are the Consumer Price Index (CPI) and the Personal Consumption Expenditures Price Index (PCE). These two measures take different approaches to measuring inflation. There is also a third, known as the Gross Domestic Product (GDP) Deflator.
The United States Bureau of Labor Statistics (BLS) calculates CPI inflation by looking at the average weighted cost of a “basket”-- a large number of goods and services that consumers normally buy in a given month. The BLS does a survey to determine what people are buying.
Approximately 24,000 consumers from around the U.S. are surveyed by the BLS every quarter, and another 12,000 consumers maintain annual diaries of their purchases. The makeup of the basket of goods and services changes gradually over time, following the buying habits of consumers, but overall, CPI inflation is calculated from a pretty stable or fixed set of goods and services. The CPI is the most common measure of inflation. The PCE tracks the prices businesses report selling goods and services for. The GDP Price Deflator is much more comprehensive and measures the prices of all goods and services that people buy. It has an advantage over the CPI because it covers all goods. Its trends are similar to the CPI.
Now, why are prices rising? There are several reasons, all having to do with restricted supply and/ or higher demand. Almost all relate somehow to the pandemic.
The pandemic: Many producers shut down or produced less, restricting supply, so demand outstripped supply. Gasoline prices which impact the cost of almost everything we buy have risen exponentially over the last few months.
Supply Chain Issues restricting supply further: The fact that products are not getting to us in a timely fashion drives up their prices.
Trillions of stimulus dollars in consumers’ hands: As the economy began to shrink in early 2020, the federal government passed several stimulus packages. The more money people have, they more likely they are to spend. The more people spend, the more likely prices rise. Too much money, chasing too few goods.
Low Interest Rates: When interest rates are low, people borrow more, save less, and can spend more.
Labor shortages leading to rising wages: As a direct result of the pandemic, production is low, fewer people were working to drive and unload trucks, supply is lower, and people are willing to pay more. Also, companies are paying more for people to work. With more money in their hands, again, too much money, chasing too few goods.
War in Ukraine: This international crisis has also led to goods not flowing across the globe as freely. Again, a supply restriction, which drives prices up.
In order to control inflation, there needs to be a restriction on the amount of money flowing in the economy to lessen demand. One way to do that is to increase interest rates (the price of money), so people borrow less and spend less, thereby lowering demand and therefore the prices of goods and services.
The danger here is that if demand is lowered too much, we could end up with a recession. So, which do you prefer, recession or inflation? Full employment with higher prices or high unemployment with lower prices? Both unemployment and inflation are two evils, and when the two are combined they are known as the “misery index” I leave that up to you.
But as for me, I will try to live with the inflation, which cannot last forever, and be thankful for my employment.
Kojo A. Quartey is President of Monroe County Community College and former Professor of Economics. He can be reached at kquartey@monroeccc.edu.
This article originally appeared on The Monroe News: The economics of inflation: simple yet complicated
