Every day another article, pundit, economist, politician or expert warns darkly about the current rate of inflation and what it portends for our economic future. So I thought, why shouldn’t I join in, providing an alternate view of the subject? I think there is decent evidence to offer a deflationary puncture to the expanding alarm.
The headlines tout the year-over-year inflation change as “the highest increase in 30 years”. Sounds frightening, doesn’t it? But let’s remember that the inflation rate in 2020 was 1.25%. This year, the Federal Reserve projection is that, for the full year, the inflation rate will be about 4.2%. So the two-year average will be 3.13%, rounded up.
The qualitative description of this inflation trend is that it is “high”. As for all adjectives, “high” is relative and subjective. “High”, as compared to what? And in who’s view? Being the age I am, I remember the late 1970s when inflation reached 13.3%, and averaged 6.8% in that decade. Interest rates were raised in response, which created a subsequent recession, cooling price increases and wage growth.
The inflation rate in the United States averaged 3.24% from 1914 until 1921, which of course included World War I, reaching an all time high of 23.70% in June of 1920 and a record low of -15.80% in June of 1921, just one year later, largely caused by a dramatic rise in interest rates and a subsequent recession that year. Viewed across a longer time span, the average inflation rate over the sixty year period between 1960 and 2020 was 3.7%, higher than the two-year average expected for 2020-2021. Considered in this light, current inflation rates are less concerning.
Much of the debate about inflation is pegged around the Federal Reserve’s desire to achieve a steady trend of about 2% inflation, plus or minus a bit. Why did they pick that rate? Part of it stems from an enduring desire to avoid the double-digit inflation of the late 1970s, which created economic disruption in almost every part of the American economy. Also, when inflation gets “too high”, that is, high enough to devalue the dollar as compared to other currencies, the dollar becomes less attractive as a reserve currency around the world. This erodes the economic influence and power that the U.S. has in global markets, affecting political influence as well. If inflation is “too low”, it prevents the reduction of our national debt through an “acceptable” rate of currency devaluation. The Federal Reserve is trying to hit the sweet spot between lowering long-term national debt through inflation (because we can’t pay it down through tax revenue above expenditures alone, or ever for that matter), and keeping interest rates low enough to stimulate investment in business and other assets, therefore creating jobs. No jobs, no tax revenue. No jobs, no consumption, causing less jobs. That’s a bad downward spiral.
Interest rates also affect debt service on the national obligations, taking more money out of spending for government activities and putting it towards paying back all of us investors who own that national debt. That dynamic also cuts jobs, adding to the downward plummet.
I’m sure there’s a complicated model in use that includes all the interacting factors to arrive at the target of about 2% inflation. But we have reality to compare to as well, to see what happens if we hit that rate over a longer period of time. After the Great Recession, for more than ten years, the inflation rate was stable around 2%, interest rates stayed lower in tandem, and we made steady economic progress through to the end of 2019, reaching essentially full employment and a healthy economy. The dollar was strong, and our global position as the economic (as well as military) leader of the world was more secure.
Some people think that the budgetary decision to go further into national debt to provide financial support to the American people and its businesses was a cause of the problem, or at least it was too high. They have a point. The stimulus provided this year was likely too much, in my opinion. That’s hard to get right, and is only apparently right or wrong after the fact. But the pandemic recession would have happened with or without the interventions of government to close businesses and restrict the contagion. If we had stayed wide open, the death rate would have been astronomical, creating social and economic chaos. People would have elected to isolate without being told. Without the financial support in place, foreclosures, bankruptcies and bad debt would have gone through the roof. Retirement assets would have plummeted in value.
By the actions taken, we not only sustained the economy, we saved countless lives. Where we are today is that, as a nation wrangling with itself, we’ve arrived at an “acceptable” hospitalization and death rate to allow most business activities to resume. The pent up demand and record savings from not being able to spend the stimulus money or the income earned from employment has created a massive consumption spree, which has outstripped supply. Pricing thus goes up. Pressure on supply chains and demand for materials is at a steep level. Developing countries’ continued limitations on activity due to their lower accessibility to vaccines has contributed to the problem. So has the fact that many people in the U.S. are fundamentally rethinking what work means to them and how they want to spend the time of their lives, leaving jobs unfilled.
All of these factors are contributing to the current state of the economy, and to the inflation rate we are seeing. But the rate over 2020-2021 is less than the sixty year average.
So, once again, let’s step back from the ledge, get a grip and take these trends in the context we find ourselves in. When prices get “too high” people will defer purchases. I know I’ve made that decision several times of late. Others are too. That will reduce demand, taken as a population, naturally limiting inflationary pressures. My guess is that producers will over-produce expecting the demand to stay high for longer than it will. We’ll see some great bargains sometime in the not too distant future.
If we measure the impacts over a longer term and resist the desire to over-correct, we’ll come out fine. We all know what we’re supposed to do if our car hits a spot of black ice. The right response is modest adjustment, turning into the skid, not trying to make a u-turn.