Inflation, Ugh.

Too much money chasing too few goods and services: inflation. Inflation is not a difficult concept to describe or to understand. Little Jill has an extra stick of gum that Jack would like to buy for a nickel. All looks good for Jack to enjoy a stick of gum until Billy, who also would like a stick of gum, arrives with a nickel and a penny he found on his walk over. Jill, ever the rational seller, agrees to sell Billy her last stick of gum for $0.06. Voilà, the Jill-Jack-Billy market for gum just experienced 20% price inflation.

The gum market balanced with just Jill and Jack involved, but Billy’s $0.06 – more money – unbalanced the market. If Jill’s mom happened to show up with another stick of gum – more supply – the market balances, providing both Jack and Billy still want a piece of gum. This balancing function that Jill’s mom provides in our very, very simple example represents what the US economy now sorely lacks, a balancing function.

This morning’s 8.6% annual increase in the U.S. Consumer Price Index (CPI) surprised – again – to the upside as compared to the consensus expectation for an 8.3% increase in year-over-year prices. The above figure from The New York Times offers a breakdown by major product and service category of the drivers of this 8.6% indexed figure. Unless you pulled a Rip Van Winkle and fell asleep for the past year, I’m sure you’re quite aware that gas prices at the pump, soft drink prices at the grocery, and clothing prices at the mall, all are higher along with the prices for just about everything else.

For any number of reasons, ranging from:

  • COVID shutdowns that limited production and transportation of goods and services,
  • Ukraine – Russia war that disrupted trade flows,
  • Insufficient workers to increase production of stuff and to serve consumers, and
  • Ineffectual government policies that further these economic imbalances,

the world cannot supply sufficient goods and services to satisfy demand given the magnitude of money available to purchase goods and services. This imbalance places outsized pressure on the US Federal Reserve, unfortunately, to reduce the amount of money available to purchase goods and services. Alternatively, consumers could choose to scale back their consumption of stuff. They could opt to save some of this excess money they currently chose to spend. Alas, it’s the job of government to do for the people what they cannot do for themselves and reduce consumption by decreasing the amount of money available to buy stuff. Enter all of the discussions about the Fed increasing interest rates and engaging in quantitative tightening, or reducing the amount of money flowing through the economy.

This is where it gets complicated, though. Everyone freaks out about the Fed raising rates too much and pulling too much money out of the economy. Exacerbating these fears concerning the Fed’s actions, the potential for consumers to come to their senses and start saving some of their money and not buying so much stuff. Doubling down on these problems:  provider of goods and services solve their issues and oversupply the market and have to fire some workers. What was a robust economy growing at an attractive rate with historically low unemployment goes off the rails and into a ditch. Ugh.

All of a sudden one begins to see why even the greatest economics PhDs screw this up. Solving inflation requires balancing an equation but with far, far too many variables of unknown interdependencies. In order to help these struggling, anxiety-riddled PhDs balance this inflation equation, a rational consumer – the main character of every economics textbook – might choose to walk more, drive less, go on a diet, turn off the A/C, open a window, and save some dough. Or not…