What Causes Inflation? -- August 29, 2020

Despite Jay Powell's speech this week ("inflation is not our main worry"), a recurrent theme on CNBC this past week, and in the business pages, has been talk about inflation.

The first thing that appeared in my 'in-box" this morning, from SeekingAlpha:  "the US is going into hyperinflation."

We won't know for many years, I suppose. But whether that article has validity or not, it lost all credibility for me when near the end it turned out to be nothing more than another "gold" article. The contributor noted Warren Buffett added "gold" to his portfolio. Did Buffett add "gold" to his portfolio or did he add miners or did he add both? It makes a huge difference.

What causes inflation?

Years ago I bought into that argument that high national debt causes inflation. About two years ago, I "converted." I no longer bought into that argument. 

I was converted when I started reading articles suggesting that increasing debt would cut into GDP growth but even under worse-case scenarios (at that time) the impact would be marginal. 

I don't follow macroeconomics very closely; I certainly haven't paid attention to the US history of the inflation rate. So let's take a look (see this link). 

To put that table in perspective, remember: the Fed is shooting for a 2% inflation rate. 

During my morning swim I thought about inflation and what drives it. For me, it comes down to this: a shortage of "things." 

A shortage of "things." A shortage of essentials. A shortage of commodities. A shortage of workers. 

I googled "what causes inflation shortage of goods debt."

This was the first hit, from economicshelp.org. 

From that site, definition:

Inflation means there is a sustained increase in the price level. The main causes of inflation are either excess aggregate demand (AD) (economic growth too fast) or cost push factors (supply-side factors).

From that linked site:

• Summary of main causes of inflation
• demand-pull inflation – aggregate demand growing faster than aggregate supply (growth too rapid) 
• cost-push inflation – For example, higher oil prices feeding through into higher costs. 
• devaluation – increasing cost of imported goods, and also the boost to domestic demand. 
• rising wages – higher wages increase firms costs and increase consumers’ disposable income to spend more. 
• expectations of inflation – causes workers to demand wage increases and firms to push up prices. 

Comments:

• interestingly, I don't see national debt as one of the five major causes of inflation; one might argue that "devaluation" would fit but then one looks at the definition of "devaluation: increasing cost of imported goods"; anyone seeing that?
• cost-push inflation as the #2 cause is not interesting; it would be expected. But using higher oil prices as an example is interesting; it raises two issues, which I will get back to later (maybe); for now, all I will say is that oil prices are the least of my worries when it comes to inflation;
• wage increases, regardless how it happens; sure, that's gonna happen (eventually) but it appears any increase mandated by government will be marginal at best; 
• right now, by the way, the discussion has changed from "my wages need to be increased" to "I need a job"; and, many of those needing a job, also need child care (most child care centers are either closed, or enrollment has been curtailed, by mandates);
  
• I may be completely wrong; I may be thinking too simplistically, but Jay Powell (the "Fed") sees deflation as a much bigger risk than inflation. And as hard as the Fed works on hitting its inflation target, they are now focused on jobs -- which, I think is a euphemism for "lower rates for longer;" bully pulpit to get Congress to pass another huge "stimulus" bill to help stop companies from laying off employees;
  

Getting back to the price of oil and inflation.

When I look at the graphic at this page, the relationship between the price of oil and inflation raises a "chicken and egg" question.

But let's buy into the argument that the price of oil can cause inflation. Two immediate questions come to mind:

• what's the boundary at which the price of oil meaningfully impacts inflation; is it the actual price or is it the velocity in the change of price? Is a surge in the price of oil from $40 to $80 over a short period worse than a melt-up from $40 to $80?
• the second question: for the average American, where does the price of oil impact most? travel expenses (airlines, gasoline) or Walmart products? I think that's a bigger factor than the price of oil, per se.
  

I'll quit here now. Lots to digest. 

But one last thought. I agree with Jay Powell. Right now the biggest problem is the number of Americans not working; that number will jump in September. I expect the major story in September will be the number of Americans being laid off. Linked above; here it is again.