Covid-19 Related Inflation Surpasses 40 Year Record: How Long Will It Persist? – Forbes

Burning US five and one dollar bills, London, 8th August 2011. (Photo by Tom Stoddart/Getty Images)

The Bureau of Labor Statistics released its monthly inflation report this week showing a jump in year-over-year CPI at 8.56%. You must go back over 40 years to December 1981 to find a higher reading. Whats the cause? Whos to blame? Is it President Biden? Is it the Federal Reserve? Is it government spending? Is it Covid? More importantly, how can we get inflation down to a more normal level? Some expect inflation will normalize in the coming months. I believe inflation will persist for a while. Heres why.

Inflation is caused when demand exceeds supply. In other words, when there is too much money chasing too few goods and services, prices rise. Its really that simple. Lets go a bit deeper.

Supply: The pandemic caused the greatest supply-chain disruption of the modern era. Businesses rely on its workers to produce. When workers are in short supply, production falls, reducing supply. Thats precisely what happened. From acquiring the needed materials to processing them for production, to shipping them to distribution centers to transporting goods to the retail outlet, to staffing the retail outlet, the pandemic has caused a major disruption. Thus, supply has declined substantially due to Covid-19. Moreover, some locations are experiencing yet another wave of Covid cases. Remember, supply is not just a U.S. issue, its a world-wide issue.

Demand: At the onset of the pandemic, the U.S. government, in an effort to prop up the economy, passed several pieces of legislation, resulting in a great deal of money in the hands of consumers and businesses. Generous unemployment benefits paid low-wage workers more money than they earned when working. Congress also sent direct payments to families. For example, the child tax credit paid $300 per month for each child under age 6, and $250 per month for each child 6-17 years old. This expired at the end of 2021. Government support led to the shortest recession in U.S. history, lasting only two months.

Politicians learned a great lesson during this period. I noticed republicans adopted part of the democrats play book. Democrats are largely perceived as the party of the worker. In the past, democrats sought to put money in the hands of citizens through social programs. Republicans have been more focused on businesses. Why? If business is strong, theyll hire workers. This time, however, republicans put a great deal of money directly in the hands of consumers. Its likely politicians will continue to spend excessively, and record budget deficits will become the new normal.

As mentioned, inflation rose by 8.56% on a year-over-year basis. Energy prices rose a whopping 32% during the period with gasoline surging 48%. Prices for used cars and trucks rose 35.3% but showed signs of slowing in March. Food inflation was only slightly higher, rising 8.8%. Beef prices rose 16.0% and dairy products increased 7.0% over the previous 12 months.

Inflation in the Southern region of the U.S. rose 9.1%; compared to the West (8.7%); Midwest (8.6%); and the Northeast (7.3%). The Mountain region experienced the worst rise at 10.4%.

How do we get inflation back to 2.0% or less? This problem will not be fixed by a single entity. It will need coordination between the Federal Reserve and the federal government. Heres why.

The Federal Reserve is responsible for monetary policy. Its tools include changing short-term interest rates, the money supply, and bank reserve requirements. Thus, the Fed can reduce demand by raising its fed funds rate, reducing the money supply, and increasing bank reserve requirements. While these will reduce demand, the fed has often started too late and gone too far. In fact, the fed is considered a primary cause of many U.S. recessions. Some believe the fed is behind the curve today. The fed is only now beginning a series of rate hikes and will begin removing billions each month from the economy. Thus, the fed is changing its stance from an easy monetary policy to a tightening policy. While this will certainly reduce demand, will it reduce it too much? What about the federal governments role in this mission?

The U.S. government is responsible for fiscal policy, which includes spending, taxation, and transfer payments such as Social Security. Government spending is at an all-time high topping $6.8 trillion during fiscal year ending September 30, 2021. Federal receipts are also at an all-time high exceeding $4.0 trillion during the same period. Unfortunately, that leaves the second largest deficit in U.S. history at more than $2.7 trillion (the worst was a year earlier at over $3.1 trillion) and a public debt exceeding $29 trillion. Excessive spending is inflationary while raising taxes will slow demand. Yes, these conflict with each other as one serves to increase demand while the other reduces it. This is why I suggest coordination between the federal government and the Federal Reserve is needed, but I dont expect it. Why? Because the fed seeks to remove itself from politics and the federal government leads with politics. Therefore, the two opposing forces will not work together, and politicians will continue to spend as much as they can to secure their place in government.

So, whos to blame for the surge in inflation? While the federal government and the fed are culpable, Covid-19 is the unknown variable. We do not know when the pandemic will subside to the point where workers are no longer concerned with contracting the virus. In the meantime, the government will expand spending and raise taxes (at some point) while the fed will tighten. Both will have an effect on demand. Hence, it depends on Covid-19. And this unknown variable plus the lack of coordination between the Federal Reserve and the federal government makes it impossible to accurately predict when inflation will normalize.

Stay tuned.

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Covid-19 Related Inflation Surpasses 40 Year Record: How Long Will It Persist? - Forbes