New York (CNN Business)Inflation isn’t just an economic headache — it’s become a political blame game that will almost certainly define this year’s midterm election campaigns.
But the cause of inflation doesn’t lie with any single government action or lack of action. And fixing it — that is, bringing current inflation of 7% back down to the more comfortable 2% level — is similarly well beyond the scope of any one lawmaker, central bank or economist.
Many of the increases are the result of global market forces, such as higher energy prices, or global supply chain problems limiting the availability of parts needed to make consumer goods. The limited supply of both new and used cars, largely stemming from a computer chip shortage, has resulted in record car prices — a major factor pushing overall prices up.
Demand remains strong
Of course, there are worse things than paying higher prices.
With strong consumer demand, prices on goods and services that have gone up during the pandemic are unlikely to come down to pre-pandemic levels unless there is a painful recession or a new round of stay-at-home orders caused by a surge in the pandemic. Either of those would result in job losses slamming the brakes on consumer demand, but both would be worse than the price increases they would reverse.
“Give people the choice between losing their jobs or paying more at the pump, people will take higher gas prices,” said Mark Zandi, chief economist with Moody’s Analytics. “You could kill the economy to get demand down, but you end up with a dead economy. It doesn’t make much sense.”
President Joe Biden is trying to tame prices where he can. But these steps are mostly Band-Aids, and they illustrate the limits of government power to regulate prices determined by market forces. And Biden conceded this week that the latest inflation reading “underscores that we still have more work to do, with price increases still too high and squeezing family budgets.”
“The options are pretty limited,” said Zandi. “There are things on the margin, releasing oil from the petroleum reserve, jawboning meat packers on prices. But they won’t have much impact on inflation.”
The high prices pose a significant problem for Biden, given the lack of steps the administration can take to fix a growing issue for US households.
“I don’t have a crystal ball to say exactly when it will peak,” a senior White House official told CNN this week. “But I can tell you we are doing all the things we need to do to keep prices in check.”
The role of the Fed
Tempering inflation is traditionally the purview of the Federal Reserve, which has a dual mandate to promote both employment and price stability.
When the pandemic hit, the Fed rushed to stave off financial Armageddon by slashing interest rates nearly to zero and pumping tens of billions into markets every month through its bond-buying program.
That helped to lift the value of assets, including stocks and homes. The low interest rates and high home prices also led to a refinancing boom that put billions more into the hands of consumers.
But the central bank can’t exactly flip a switch to right the global economy. The Fed is using the tools it has to tame prices — namely, rolling back its pandemic-era emergency stimulus measures and signaling it plans to raise interest rates to limit the amount of money coursing through the economy.
Raising interest rates should take the heat off prices, but those changes will likely be gradual. Markets expect the Fed to raise rates three or four times over the course of the year, to about 1% by the end of 2021. That’s a much gentler approach than the Fed took in the early 1980s, when the central bank jacked up rates 22.4% to battle inflation — helping spark two painful back-to-back recessions.
The Covid factor
Some prices have started to retreat as production increases, spurred on by higher prices and a normalizing of the supply chain.
Gas and other energy prices fell in December from November. Meat prices at the grocery store are also easing. As supply chain snags and labor shortages start to work themselves out, more declines in those volatile food and energy prices are likely.
“The only solution to inflation pressures is getting the pandemic under control,” said Zandi.
While politicians frequently trade accusations about who’s to blame for price surges, most economists point to multiple causes, mostly tied directly or indirectly to the pandemic. And thus there’s not much that can be done to counteract those price pressures.
Multiple rounds of government relief measures, which put trillions of dollars into the hands of consumers, did create more demand for goods — demand that many producers were unable to meet. Strong demand plus limited supply is the Econ 101 definition of what leads to higher prices.
Most of the Covid relief measures that raised government spending passed with broad bipartisan support. And most of that money has already gone out to consumers, with little additional money still left in the pipeline. That means there’s nothing for the Biden administration to shut off to reduce demand and price pressures.
The pandemic also sparked a shift in spending. Rather than traveling or going out to eat or for entertainment, people spend on goods, and that has further strained the supply chain.
Energy costs — a classic American political lightning rod — are also significantly higher than a year ago, even with December’s easing. But much of those price surges are dictated by OPEC and other oil-producing nations. On top of that, the US now has less oil-refining capacity because several refineries permanently closed during the pandemic, and the US oil sector was hit by widespread bankruptcies after crude prices bottomed out during the pandemic recession.
At the same time, the pandemic upended the labor market, pushing some out of the workforce completely.
The shortage of workers is pushing wages up, which could fuel demand and push prices up further, economists say. However, wages have so far not kept up with inflation.
— CNN’s Matt Egan contributed to this report
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