Since the end of 2020, consumer prices for gasoline, food, housing and most everything else have surged and there is growing concern about inflation. Individual price increases are not inflation; by definition, inflation is a sustained pace of decline in the value of money. It occurs when all prices are generally rising, causing the value of money to fall.
This was a major problem during what is called the Great Inflation, 1965 to 1982. During the subsequent Great Moderation, inflation — using the Federal Reserve’s preferred measure of prices, the Personal Consumption Expenditure deflator, excluding food and energy — fell to about 4 percent annually from 1984 to 1990, then declined further to about 2 percent from 1994 to 2008, and has averaged below 2 percent since. Over the past year, however, these prices have risen 3.5 percent — a pace not seen in 30 years.
The most popular measure of prices, the consumer price index (CPI-U), rose 5.4 percent in July from a year earlier. Since December, the CPI has accelerated to a 7.1 percent annual rate.
Some analysts and ordinary Americans blame President Biden for these developments, but inflation began rising in April 2020, well before he entered office. The Biden administration’s actions over the past five months, however, already have had significant energy price effects and will have more effects on prices, though it is likely too early to expect to see many of them.
The administration took broad action to repeal many of the Trump administration’s deregulation efforts, especially in the energy sector. Not surprisingly, the producer price for fuels and related products and power, which had fallen 30.4 percent in the year ending May 2020, rose at 57.5 percent in the year ending this May — a real shock to the general level of output and prices, but one that largely will come in the next year. This includes oil, gasoline, natural gas and coal, areas where the administration’s stiff new regulations reduced drilling, closed pipelines, withdrew oil drilling rights and curtailed use of coal, as well as providing an incentive for OPEC to raise world oil prices.
Other regulatory efforts that boost labor costs and medical care costs will lower productivity growth and raise prices. Supply chain bottlenecks associated with COVID-19, such as the chip shortage for the computer and auto industries, and the reluctant slow pace of return to work by many workers, will also raise prices for several more months. The latter, of course, can hardly be blamed on the Biden administration. These are simply mini-supply shocks that temporarily lower the growth of productivity and output and raise prices.
A final concern for many analysts regarding the Biden administration is the explosion of federal expenditures, passed and in the pipeline, that will balloon budget deficits and the nation’s debt. These new expenditures will misallocate the nation’s resources, reducing efficiency, and will slow real GDP growth. Associated debt will crowd out new investment, and new tax proposals would raise the cost of capital to businesses, further reducing capital formation and productivity and real wage growth. Taken together, the Biden administration’s policies portend a set of supply shocks that will slow the economic expansion and raise inflation.
The late economist Milton Friedman said that “inflation is always and everywhere a monetary problem.” Faster monetary growth is the cause of faster inflation. A corollary is that an adverse supply shock to output, given the money supply, can raise prices, temporarily causing the inflation rate to rise as the economy adjusts to “the same money chasing fewer goods.”
When the pandemic and recession began in February 2020, the Federal Reserve took unprecedented actions to stimulate the economy and ease potential disruptions. From Feb. 29, 2020, to July 28, 2021 — roughly 17 months — the Fed essentially doubled their balance sheet assets by $4.1 trillion. These actions were supplemented by a plan, implemented since December, to buy $120 billion of Treasury securities ($80 billion) and agency mortgage-backed securities ($40 billion) each month. At this pace, through the end of this year, the Fed would add about $0.7 trillion more to its balance sheet; extended through the end of 2022, it would add another $1.4 trillion to its holding of securities. Even if it does, however, the Fed will be stuck with having created a major surge in inflation, the likes of which has just begun.
Such a path for Fed assets is unsustainable. Rumbling within the Fed suggests this rapid expansion in balance sheet assets will have to end soon. Yet, as recently as July 28, Chairman Jerome Powell said: “We’re clearly a ways away from considering raising interest rates. It’s not something that is on our radar screen right now.” Others are not so sanguine.
The money stock measure M2 has grown rapidly because of Fed stimulus. During the recession and first month of recovery, from February to May 2020, M2 exploded at a 78.8 percent annual rate, far above its previous 6.8 percent increase in the previous year. Subsequently, from May to December 2020, M2 slowed to a still inflationary 12.1 percent annual rate. In the first six months of this year, it accelerated slightly to a 13.6 percent annual rate, a little faster than the pace in the previous seven months of the economic recovery. M2 growth since the first month of the recovery is exceptionally high, growing at a pace not seen since the Great Inflation.
The outlook for inflation has deteriorated sharply since the pandemic began and the Fed took inflationary monetary policy actions. Because of the lagged effects of monetary growth on inflation, it is likely that this new episode of inflation will continue for quite some time — even with a speedy response by the Fed, which grows more likely by the day. The Biden administration’s policies will worsen the outlook for inflation. Increased regulations have created an energy price shock, and introduced other supply shocks that will slow productivity and output growth and boost inflation.
John A. Tatom is a fellow at the Institute for Applied Economics, Global Health and the Study of Business Enterprise at Johns Hopkins University, and a former research official at the Federal Reserve Bank of St. Louis.