Why have prices been rising lately? Last week the Bureau of Labor Statistics reported that consumer prices have increased by 7 percent over the last year. The last time inflation was this high was 39 years ago. What are the causes for the increase in consumer prices? There are several factors that might be behind the increasing prices. These factors include profiteering and greed, supply chains disruptions, and the monetary and fiscal stimulus.
Recently President Biden stated that the higher meat prices might be the result of meatpackers using their market power to raise the price of meat. Senator Elizabeth Warren also expressed concerns that CEOs were a contributing factor for inflation. Recently, Senator Warren stated, “We can’t overlook the role that concentrated corporate power has played in creating the conditions for price gouging.” While it is true that CEOs and companies executives are concerned with profits it is not clear that these CEOs and executives have become more greedy during the pandemic; thus, it seems unlikely that this is the main driver of inflation.
Supply chain disruptions and bottlenecks have received a fair amount of attention. Computer chips, autos, cream cheese, furniture, and many other goods have been impacted by disruptions and bottlenecks which have impacted the availability and prices of some of these goods. A future post will explore supply chains and how they may, in conjunction, with other factors result in higher prices. If supply chains are the cause of rising prices, these effects are likely to be transitory and we might expect lower inflation rates in 2022.
Inflation, however, might be more persistent. One leading indicator of inflation is the growth rate of the money supply as measured by M2. The figure below depicts the growth of M2 since 2000. From 2000 to 2020, M2 growth averaged about 6 percent per year – even during the Great Recession when there was ample discussion of how the Federal Reserve increased the money supply. Over this time period, inflation was relatively low and relatively stable. During the pandemic, the growth rate of M2 increased dramatically. Over the first couple months of the pandemic, M2 grew by nearly 50% at an annual rate and since that time the annualized growth rate of M2 has been about 12 percent.
What is the cause of the increase? Fiscal and monetary stimulus. The fiscal stimulus provided households and firms with financial support and relief during the pandemic. Milton Friedman once stated that if you want inflation the Federal Reserve could simply drop money from a helicopter. The fiscal and monetary stimulus is similar to Friedman’s helicopter’s drop. After the stimulus payments were deposited in the households’ checking account, the households likely thought they were holding too much cash relative to other things. They were likely to use some of the funds to pay down some of their debt, purchase stocks, bonds, other financial assets, and/or buy goods and services. The increased demand for goods and services, without a large response in the quantity of goods and services supplied, was likely to be inflationary. If the growth rate of the money supply is the main drive, inflation may remain high, relative to recent history, as households continue to spend their excess cash balances. The Federal Reserve can raise its targeted interest rate and reduce the money supply would reduce inflation, but this may result in slower economic growth.
