Is inflation our new normal in the post-pandemic economy?

© Courtesy photo Dean Bosco

In recent weeks we’ve experienced the increased prices of commodities in the United States. The rising costs of lumber, computer chips, cars, houses and more could be a sign of a further troubling trend. Inflation is the highest it’s been in more than a decade, and some economists worry it could spin out of control. So, what’s behind the current rise in inflation?

When the COVID-19 wrecking ball hit the economy last year, no one was thinking about inflation. It was clear the economic shock of social distancing and other restrictions was going to cause a major recession — and it did. What was surprising was that it was so short lived.

Now, the U.S. economy is growing fast. But this growth comes with a side effect: inflation. Prices for everyday items are rising rapidly, but wages are not keeping pace — so the money Americans earn isn’t stretching as far. But inflation isn’t inherently a problem.

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Inflation is actually a very normal part of the economic cycle and is imbedded in all economies at all times. The Federal Reserve, which is in charge of keeping the economy stable, doesn’t mind inflation as long as it’s low and steady. The Fed tries to maintain a 2% inflation rate, which most economists agree is reasonable. As long as it’s consistent from one year to another, people can base their financial plans around it.

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Inflation becomes a problem when we start losing track of where it’s going, and consequently makes it  a lot harder to navigate the economy. Economists’ concerns heated up earlier this year when we suddenly saw microchip shortages for cars, lumber prices going through the roof, and other commodity prices rapidly increasing.

At the same time, we started seeing real-world implications of these changes. We got a big wake-up call when the Consumer Price Index (CPI) report showed that consumer prices rose 4.2% in April — the biggest year-over-year since 2008. At the same time, the May Jobs Report was significantly off its target of 1 million jobs, and only came in at 266,000.

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In real-world terms, the 4.2% inflation rate means that costs of daily goods and services have more than doubled from what they were a year ago — and corresponding wages have stayed flat, so our money isn’t going as far as it used to.

There are three main reasons why the “bad kind” of inflation happens:

Supply issues

Salad prices are going up. Restaurants were shut down during the pandemic, so lettuce growers started sending all their produce to supermarkets. Now restaurants are opening, but they don’t have any lettuce because the supply chain was disrupted. So, they’ve increased salad prices to make up for the reduced quantities.

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Demand issues

With restrictions ending, people are going out and spending money all at the same time. This leads to a huge spike in demand for goods and services, which in turn leads to inflation.

Compounding the pent-up demand is because people have a lot of money to spend right now, partly due to the government’s three economic stimulus bills. This additional discretionary money is allowing people to get out there and spend, spend, spend — more than they might have done otherwise!

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Money supply

When the Federal Reserve creates “new” money and pumps so much of it into the economy that the money itself begins to lose its value, it forces people to use more of it to buy the goods and services that sustain their daily lives. Some economists believe this is beginning to happen. The Fed is pumping billions of dollars into the financial system by buying treasury bonds and mortgage-backed securities from banks and financial institutions.

The Fed has said repeatedly that these trends are transitory and are in direct correlation with the impact of the pandemic. But should we be worried?

If inflation becomes intrenched, then the Fed has to cool things off by raising interest rates, thereby slowing economic activity. This could then cause a recession and increase unemployment. If the Fed has to clamp down on economic activity to fight off inflation, it’s likely to hurt the very people who need it.

So, the Fed and the Biden administration have to walk a fine line. Not enough stimulus means people may not have enough money to buy food. Too much stimulus means the price of food goes up and the stimulus money isn’t worth as much. The question then becomes: Is the stimulus really for individuals and families with lower income, or is it just a transfer mechanism to the businesses that sell them their goods and services?

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One possible blind spot is that policy makers, including the Fed, often look to the last economic crisis for how to respond to the current one. The lesson learned from the 2008 – 2009 financial crisis was that — after pumping trillions of dollars into the economy — the inflation everyone was worried about never happened. So perhaps the government could have been even more proactive. The Biden administration seems to have taken this lesson to heart and has said all along that it’s better to do too much than not enough.

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It could be we’re seeing a new breed of economic activity that may prove to be more difficult than the same old monetary policy remedies can manage. But right now, the signals of whether there is a real inflation problem are mixed at best. We have to watch how things unfold to know what we are getting — and to know what the right response ultimately needs to be.

For more information, contact Dean Bosco at dean.bosco@CLAconnect.com or 407-802-1225. For more information on CliftonLarsonAllen LLP, visit CLAconnect.com.

This article originally appeared on The Patriot Ledger: Is inflation our new normal in the post-pandemic economy?

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