Complexity of Understanding Inflation
Understanding Inflation can either be simple or complex. A simple look just compares prices over time periods. An example is the Inflation Check Challenge covering the last 12 months. Complexity arises when we search for the whys and how comes. Today we will take a look at both.
Inflation Check Challenge
Early last year I became concerned with the possibility of inflation. Interruptions in the supply chain were becoming a problem. So, I issued the Inflation Check Challenge to the readers of Econogal. I shared an example of a market basket and began tracking prices. Throughout the year, I posted quarterly comparisons. To review previous graphs, click on the month that interests you; January 2021, April 2021, July 2021, October 2021. Below is a year- end comparison with additional comments.
Consumer Price Index (CPI)
Listing the CPI throughout 2021 would have been less work, but personally not as meaningful. This figure is closely watched and often influences everything from the stock market to government entities and individuals. Cost-of-Living Adjustments (COLAs) are based on the CPI. But the CPI has some shortcomings. Especially for those of us living in rural areas. The index is weighted heavily toward urban life.
A second argument concerning the CPI is whether or not to include items whose prices are volatile. Food and energy costs fall into this category. These two categories are represented in the below table by the highest increases. Thus, arguments such as this Wall Street Journal opinion piece on transitory inflation by Alan S. Blinder need to be considered.
Thirdly, the CPI does not reflect the impact of substitute goods. Without a close substitute, inelasticity of a particular good or service is great, so prices shoot up. Conversely an elastic good will not show much of a price increase. (See Elasticity of Demand and Supply in Regards to Covid-19.)
Over the last six months or so the term transitory inflation has been bandied about. There are nuances to the definition. Short-term, temporary, and not permanent are all a bit vague, but certainly apropos. Recently, Federal Reserve Chairman Powell dropped the description “transitory” when discussing inflation. Why?
Economists are split (Still!) on what the future holds. Individuals like Mr. Blinder above, defend the current rates of inflation as transitory. This school of thought believes prices will self-adjust in the coming months. And that Fed action will be harmful. This is very much the Classical School approach.
The argument for transitory inflation also reflects a belief that deflation is a possibility in the near future. Both with and without governmental interference in the economy. Understanding inflation means grasping disinflation and deflation. Disinflation occurs when the inflation rate slows down. We are currently not in a period of disinflation.
Nor are we in a period of deflation. However, if you look at the table below one item represents deflation. Why did toothpaste decrease in price? Was this an anomaly? Most likely. If the price check were to continue, I would expect this item to also increase.
Those studying the market understand not everything moves in the same direction. But to have a deflationary period, the majority of goods would be offered at lower and lower prices. Deflation and recession often go hand in hand. The United States has not experienced prolonged periods of recession in almost three decades. Nor have we faced high inflation. Instead we experienced a steady low inflation rate interrupted by a handful of short-lived recessionary periods. Most notably the financial crisis of ’08 and ’09.
Understanding Inflation: Demand-Pull and Cost-Push
How high will inflation go? Will we experience hyperinflation, stagflation (high inflation accompanied by a recession) or will the current increase lead to deflation? All are possibilities.
The supply chain disruptions triggered the economic change. Shortages of goods play into demand-pull inflation. Regardless of whether the demand is a need or a want, too few goods leads to higher prices as the market tries to reach an equilibrium. So, even though the shortages were thought to be temporary, an upward price movement took place.
Unfortunately for present day consumers, demand-pull inflation is concurrent with cost-push inflation. The Covid-19 pandemic is greatly impacting labor. And labor is a key cost in production.
Cost of Labor
Even before the pandemic hit, there was pressure to raise the minimum wage rate. Urban areas in particular had an imbalance between wages and the cost of living. Add onto that the aging of the Baby Boomers into retirement status and a squeeze begins in the labor market.
Then Covid-19 struck. Early on the focus was on the elderly and those with underlying health problems. Thus the impact on the labor market should have been negligent. But, other factors came into play. Health care workers and other essential workers remained on the job during the early waves. Many were repeatedly exposed. Non-retirees began to become severely ill. Deaths occurred across all demographics. Long-Covid disabilities popped up randomly. If you are near retirement age or a non-essential second income, do you want to take such a health risk? For many the answer was no.
So, early retirements are occurring. Non-retirees are also leaving the workforce. Replacement labor is costly. Salaries are pushed up by fewer individuals available to work. The hardest positions to fill require specialized training. Employers compete by offering higher wages. Cost-push inflation is here.
Government Intervention-Fiscal and Monetary
Understanding inflation can be quite complex. The current situation reflects this. Shutting down the economy in 2020 as a response to the novel coronavirus will have long term implications. In addition to national defense, governments have a responsibility for the social wellness of citizens. So, the shutdown was an effort to control viral spread.
To offset economic losses, a number of fiscal policies were put in place. Congress passed trillions of dollars in aid. The various stimulus packages injected dollars into the money supply. Economic growth was not occurring-indeed production was inhibited by worker illnesses. Thus more demand-pull pressure occurred.
Meanwhile, the Federal Reserve Board of Governors attempts a juggling act. In theory, the Federal Reserve is an independent entity charged with the stability of the economy. The goal is one of high employment with a low level of inflation.
But in recent years, “The Fed” has been pushed by both sides of the political aisle. Most recently as mentioned in the Random Thoughts of Mid-January 2022, the entity has been tasked to include non- monetary functions such as Climate Change in its decision making.
So, rate hikes to discourage inflation were put on hold. The signal is for an increase in March of 2022. In my opinion the rate hike is overdue. Zero percent interest rates sound good on paper, but in reality may have done great damage to the economy. Time will tell. But, easy money through monetary policy coupled with tremendous amounts of stimulus signal inflation. Combine that with both demand-pull and cost-push market influences and you have a recipe for a perfect storm.
Is hyper-inflation next? A possibility exists albeit slight. Keys to hyper-inflation, which is defined as a 50% increase in prices month-over-month, are demand-pull inflation and a large money supply. Both are in place. Usually, developed countries escape hyper-inflation. Production can be ramped up which results in enough supply to defeat demand-pull stressors.
But, the Covid-19 pandemic is interfering. Wave after wave of variants undulate across the world. Production is impacted. Supply chains are broken. The labor market is skewed. Easy money amplifies the problem. How much will the March rate hike be? Will it be in time?
Last year at this time I felt confident we were in store for inflation. The prediction was accurate. This coming year? I have no idea. More inflation in the short term is likely. But after that? Cases are being made for both deflation and hyper-inflation. Compelling arguments for each. Unfortunately, anecdotal evidence supports the latter. Less than 48 hours after compiling the Inflation Check Challenge List, gasoline prices hiked another four cents. Three increases in a week do not make hyper-inflation, but the trend is ugly. However, I will not panic unless the price of a gallon of gas is locally $4.50 at the end of February. The important word is local as I have heard this amount is already charged in parts of the United States.
Politics and pandemic waves are interfering with the supply and demand mechanism. Thus, economic theory, difficult to apply in the best of times, might not be relevant in 2022. Now is a tough time for understanding inflation. The only certainty is uncertainty in the near future.
Year End Price Comparison
Change in Price
|% Change + Inflation |
|Planet Oat Extra Creamy Original Oat Milk||52 OZ.||$3.49||$3.99||$3.99/$2.99||$3.99||$3.99/$3.79||$0.50/$0.80||14%/27%||Double digit price increase for both regular and sale price.|
|Small bag Signature Select Sugar||4 LBS.||$2.99||$2.99/$1.99||$2.99||$2.99/$2.49||$3.29||$0.30/$0.50||10%/25%||The sales price inflation is calculated over a six month period.|
|Signature Select Cream Style Corn||14.75 OZ.||$0.69||$0.79||$0.79||$0.79/$0.65||$0.89||$0.20||29%||Sold Out in January of 2022. Unable to calculate inflation impact on sales price, only on sale once.|
|Fleischmanns Active Dry Yeast||4 OZ.||$6.99||$6.99||$7.19||$7.49||$7.49||$0.50||7%||Surprised at the single digit inflation rate as item often sold out.|
|Bananas||1 LB.||$0.59||$0.55||$0.59||$0.59||$0.69||$0.10||17%||This is a January over January comparison and did not take into account the lower April 2021 price.|
|Kraft Real Mayo||30 OZ.||$4.99/$3.79||$4.99/$3.99||$4.99/$3.79||$5.29/$3.99||$5.29/$3.99||$0.30/$0.20||6%/5%||Sale price bounced around a bit. Regular price steady upward movement.|
|Meow Mix||6.3 LBS.||$7.78||$7.78||$7.78||$8.22||$8.22||$0.44||6%||Steady Increase|
|Morton Salt||26 OZ.||$1.19/$0.94||$1.19/$0.99||$1.19/$0.99||$1.29/$0.99||$1.29/$0.99||$0.10/$0.05||8%/5%||I have never seen salt NOT on sale. Glad both indicators are in the single digits, otherwise one would have to take the stats with a grain of…salt.|
|Crest Pro Health Toothpaste||4.6 OZ.||$5.99/$4.99||$5.49/$3.99||$3.99/$3.49||$3.99/$2.99||$3.99/$1.99||(2.00)/(3.00)||-33%/-60%||Definitely flies in the face of inflation to have this large of a decrease.|
|Align Probiotics||28 Count||$26.58||$26.58||$26.58||$26.58||$26.58||0||0||Price Control? The lack of change defies common thought on prices and inflation.|
|Tide Botanical Rain Detergent||92 OZ.||$11.97||$11.97||$11.97||$11.97/$11.39||$11.97||0||0||No change to regular price and only on sale once.|
|Kerr Regular Mouth Canning Lids||12 Count||$3.18||$2.88||$2.88||$3.38||$2.28||($0.90)||-28%||Decrease in price perhaps reflects seasonal demand? Plenty of product in stock.|
|3M Ad. Allergy Furnace Filter||1 Count||$15.88||$15.88||$15.88||$16.38||$17.47||$1.59||10%||Even with the additional increase in price, product was sold out in January 2022.|
|Dunkin Donut Boston Cream||1 Count||$0.99||$1.09||$1.17||$1.09||$1.17||$0.18||18%||Return to July pricing. Newness of competition has worn off.|
|Regular Unleaded Gasoline||1 Gallon||$2.36||$2.79||$2.79||$2.79||$3.05||$0.69||29%||Ties for the largest percentage increase on list. Price is still way below what a gallon costs in other areas. Local market leader changed hands so more increases would not be surprising.|
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