Why are goods more expensive?
Chilling out the hot button issue of inflation.
There’s been a lot of talk about inflation and price level increases. And it seems simple right? The government is printing money and that leads to a larger money supply meaning a dollar is relatively weaker. But in the western world that is rarely the sole cause and rarely the biggest problem. The answer for our current crisis is also more complex.
Why do we want to print any money at all? Well first, we need to replace money that is lost or damaged and prevent deflation. A small amount of inflation can be good, pushing people to spend their money instead of horde it. And deflation is far more damaging than inflation, just look at Japan in the 2000s. So, to keep the “good” effects of inflation, governments keep the amount of money printed fairly low and consistent, and for the U.S. this has been true throughout the pandemic. If this is not the cause of our problems, then what is?
Well, some people blame the amount of money given out through stimulus. This is because prices can be caused by demand. Now this is “demand” in the economic sense, meaning consumers wanting and buying items. As an economy grows, people can earn more money, meaning they can buy more. But suppliers (people who make and sell stuff) catch on and raise prices somewhat. This means high price levels will happen when things are going well. But if you combine this with pent up demand from the pandemic, you may have gotten prices that outpace real income growth.
But this may not be the cause, or at least the sole cause of our current price increases.
Governments may affect price levels through other means as well, not just printing money. This comes from monetary policy, which is policy around the management of money and the banking system. This is a job so important, that in the U.S. this task was given to the Federal Reserve (the Fed) as we didn’t think we could trust politicians with it. This is because monetary policy has the power to speed up and slow an economy. But when used unwisely, this tool can be very damaging to the future of the economy.
Monetary policy is done in two main ways: changing interest rates and the buying/selling of bonds. The Fed can influence interest rates of the whole market. When it decides to lower interest rates, people have less reason to save and more reason to borrow. This makes the economy speed up, as there is more money being handed around. And when it raises interest rates, the opposite happens, as people save more and borrow less. The Fed does something similar through the buying and selling of bonds. It can make the banks buy or sell U.S. Treasury bonds, which are basically like very safe investments in the U.S. Government. When it makes them sell the bonds, the banks have more money that is not tied up in investments which means they will now put it in the economy and speed it up. And, of course, the U.S. Government can reverse this as well.
To use a recent example, the Fed desperately tried to speed up the economy during 2020 and it even set interest rates to zero. This may have helped the economy from crashing too hard during the pandemic, but now may be a cause of recent inflation. While this was good during the pandemic, it may be causing our price levels to increase as the economy goes to its natural state again.
So simple right? Just reverse it? Not so fast. If this is NOT the main cause, reversing this could slow down the economy for bad reasons and hurt a whole lot of people in the process.
Paul Krugman in the New York Times points out another factor and puts more of the blame of the price level increases on the supply side rather than the demand or monetary side. He states that the bottlenecks along certain kinds of goods is a big driver of this price level we are seeing. The pandemic has made people act and buy in different ways, helping lead to a bottleneck of goods and suppliers desperately behind. These price levels are determined by producers, not consumers, or the government. As supply is unable to keep up with demand, suppliers will be able to raise prices and if they did not, they will sell out quickly. Take the PS5 shortage for example - demand was very high but supply low, yet Sony cannot change prices easily, leading to a shortage. However, scalpers can, leading to a high priced market of limited goods.
So in reality, the picture of inflation is very muddy, what causes it at each point in time unclear, and the fixes even harder to discern. Right now the Biden administration is targeting the supply shortage, which looks to be a good thing. It seems like the most risk free way to target prices. Others think we need to cut spending, while those on the opposite camp say we should enact price controls. I am skeptical of both, either could end up leading a currently well performing economy to do far worse, even if it doesn’t feel like it’s performing well right now.
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