Is Inflation Really Transitory?
As inflation has been running hot for much of 2021, the American public has been told countless times that these price increases are only ‘transitory’.
Some of the high printouts can be attributed to low base effects from a locked-down economy in 2020, however, history and data both point to these higher prices sticking around for a while.
If we look back at the post-Great Financial Crisis (GFC) economy and compare it with the locked-down economy of 2020, we find a lot of similarities. Mortgage delinquencies and unemployment rates climbed while gross domestic product fell sharply.
While these are common occurrences during financial crises, a key distinction can be found when we compare the federal deficit of $1.4 trillion in 2009 to the much larger $3 trillion deficit in 2020.
This number has grown so large over the years because the economy has become addicted to government intervention, i.e., federal reserve money printing and government deficit spending.
Looking at a chart, we see that the balance sheet of the Federal Reserve has steadily grown since late 2008, with sharp increases during both the GFC and lockdown economies.
This massive amount of government intervention in the economy has artificially held interest rates near zero, which has subsequently led to a record amount of government, corporate, and household debt.
The economy is currently propped up on government spending and cheap debt. If interest rates were to rise, we could see another economic crash like either 2008-09 or 2020. Since we do not have any politicians or bureaucrats willing to let this happen under their watch, government spending will have to increase moving forward, which will be a catalyst for inflation.
Like we saw in 2020, much of this government spending will probably continue to go directly to individuals and businesses through transfer payments. Social security, welfare, Medicare, and possibly more stimulus check programs will all be beneficiaries of increased government deficit spending.
These payments will lead to an increase in the money supply and an increase in demand for goods and services. At the same time, consumers are already flush with cash from government payments during the lockdowns as well as a decrease in spending during the same period, further increasing the demand for goods and services in the future. This increased demand will allow producers to raise prices.
This pent-up demand for consumer spending may sound like a good thing as we come out of lockdowns that saw economic activity falter, but the opposite may be true if more dollars are chasing the same amount or fewer goods and services in the economy.
Some of these government payments, like welfare and stimulus checks, are a disincentive for people to work. If fewer people are working to produce goods and services, we will have fewer things to spend money on and prices will go up.
Along with these disincentives, regulations, taxes, and medical mandates are all likely to increase over the coming years. This would lead to a smaller labor supply and increased wages, which would be yet another catalyst for prices to go up over the long term.
Just as ex-Fed Chairman Arthur Burns was wrong about inflation being transitory in the 1970s, the current narrative that consumer price inflation is only transitory, will soon in itself, prove to be transitory. Today’s combination of increased government deficit spending, higher consumer demand, and a decrease in the supply of goods and services will prove too much for the already strung-out economy, and rising consumer prices rising can likely be expected for the foreseeable future.