BREAKING Analysis: Inflation Runs Red Hot

By at 13 July, 2021, 10:22 am


by Raymond J. Keating –

Inflation was running hot heading into June, and according to the latest Consumer Price Index report from the U.S. Bureau of Labor Statistics, it got even hotter in June. Indeed, the 0.9 percent increase in the CPI in June was red hot.

Over the past year, CPI inflation ran at 5.4 percent. Compare this 5.4 percent 12-month change to where it was in January, that is, 1.4 percent.

Indeed, if annualized, during the first six months of 2021, inflation has been running at better than 7 percent. Over the past four months, the annualized inflation rate ran at better than 8.5 percent.

Source: Federal Reserve Bank of St. Louis, FRED

Recovery constraints and the effect of government policy

In the recent SBE Council brief “The Inflation Question: Key Points to Ponder,” I walked through some of the basics on how to think about the causes and effects of inflation. The key point about our current situation was noted:

“With an economy coming out of pandemic-related shutdowns across most industries to varying degrees, the loss of millions of small businesses and jobs, a dramatic shift in how countless businesses operate, significant and ongoing supply chain issues, new expectations among many workers as to how they wish to work, and unprecedented government subsidies to those not working, increases in costs for businesses and in prices for consumers are not exactly surprising. There are tremendous changes and tumult occurring in the economy. But is this the start of a significant bout of inflation, or is it merely transitory given the challenges faced as the economy continues to claw back?”

Indeed, what often gets overlooked on the inflation front are constraints on or disincentives for undertaking productive economic activity. Such constraints, combined with extensive government subsidies to consumers, can fuel price increases. With a pandemic shutdown, much of our economy obviously has faced production constraints.

Constraints on production clearly are driving up prices. And it is taking time – longer than some expected – to work through these constraints. Market prices are serving as guides as to where investment and production are needed. That’s one of the great wonders of the pricing mechanism in a market economy. But the process can be – and in this case, is – painful.

What lies ahead? And, the policy impact.

But when talking inflation, reports on where inflation was is like driving a car by watching the rearview mirror. The question is: What lies ahead? The aforementioned process of working through pandemic constraints will proceed, and likely keep inflation running hot at least for a few more months.

However, as always, there are questions about public policies. Are policies in effect or being considered that would make this inflation situation even worse, and become something more than a transitory, market effort to work through production constraints?

Unfortunately, monetary policy has been pointed in the wrong direction for nearly 13 years now. Unprecedented loose money stands as a serious uncertainty when it comes to where inflation might be headed. The Fed’s focus should be on reining in the monetary base, and working to achieve price stability. But the Fed hasn’t been terribly interested in this core work in a very long time.

Meanwhile, the Biden administration and Congress are working to impose constraints on entrepreneurs, businesses, investors and workers via increased tax and regulatory burdens; industrial policies whereby politicians and bureaucrats make resource allocation decisions; the maintenance of protectionist trade measures; and government subsidies for not working.

It seems like just when the private sector works through pandemic constraints, President Biden and Congress will be ready with further governmental costs and restraints.

The right policy mix for strong growth and low inflation is monetary policy focused on price stability, and incentivizing the supply-side of the economy via tax and regulatory relief, free trade, and restrained government spending. Right now, however, the policy mix – or at least where part of it might be headed – is exactly wrong.

Raymond J. Keating is chief economist for the Small Business & Entrepreneurship Council.


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