Why Inflation Is So Onerous To Catch Rid Of

Everything is moreexpensive. Prices overall are about 13% higherthan they were in April 2021, with the cost ofgroceries rising by nearly 20% over thattime and the cost of gas up 22%. It's even expensive tostay home. For example, the cost ofelectricity has surged 21%. Reducing inflation is thenumber one long term.

Objective of centralbanking right now. And that's true in theUS as well as globally. Sometimes inflation islike a shock because it destroys the consumer'sreal income. We look back in the earlydays of inflation, the Fed was using this term”transitory” to describe inflation because theythought a lot of the things that were causingprices to go up in the near term were relatedto the pandemic.

They thought eventuallythat stuff would just dissipate. Well, itreally hasn't. The Federal Reserve isusing the most powerful tool it has to slow downthe inflation creep, interest rate hikes. It is a very effectiveway. The problem is it's asmuch an art as a science. Different parts of theeconomy respond differently to changesin interest rates.

One of the things thatpeople don't understand is that inflation reallymight be benefiting them in ways they don't fullyacknowledge. There are winners andlosers. There are certainly people in theeconomy for whom this is the major challenge andthere are people in the economy for whom this isa big opportunity. So why does inflationstick around? Is anyone benefitingfrom it?.

And how do we get rid ofit? Inflation is simply therate of increase in prices in the economy. Inflation can occur for anumber of reasons. One is supply and demandissues, meaning there's too much money to goaround or not enough things to go around. Another catalyst: thecost of doing business increases, which leadsto companies raising.

Their prices. All ofthose things happened at scale in the past threeyears. Prices skyrocketed in avery volatile environment. But nowthat we're past the worst of the pandemic inducedstressors, prices are still struggling tostabilize. It's difficult forbusinesses to figure out how to set exactly theright price. When do the prices ofthings change?.

Some goods change pricesfrequently. If you go to the gasstation, it's different every time. If you thinkof other things that we pay for like collegetuition or rents or even something simple likethe cost of a movie ticket, those thingshave lower frequency resets. Also it's difficult forconsumers to do their shopping. If you putsomething in your.

Shopping basket and youcome back the next morning and it's adifferent price, you might feel not goodabout that and not like the firm that's doingthat to you. And because of thesereasons, the firms often leave their pricesstable for a period of time. Inflation also hasa funny component that's expectations driven,meaning if we expect prices to go up in thefuture, that's probably.

Going to happen. If we think, for example,that inflation is going to stay higher forlonger, I will be inclined to price thatin because I only get to reset my prices once ortwice a year. So I'm building in anexpectation that inflation may stayhigher for longer. Actually doing that maymean inflation stays higher for longer.

But if I expect forprices to be stable, if I'm convinced theFederal Reserve is going to do their job and getrid of inflation and stabilize prices, well,I should stabilize my prices as well. So partof the battle that we're fighting when we fightinflation is the battle of expectations. When inflationexpectations are high, it tends to influencebehavior.

It will make peoplethink, well, I'm paying more for goods, so Ineed more money. And then in turn,business owners will say, my employers are goingto come to me for raises, so therefore I need toraise prices so you can see where this goes. Itjust creates kind of this vicious cycle. Economists would call ita “wage-price spiral” whereas prices gohigher, wages will go.

Higher and then priceswill continue to go higher. And those thingsjust start to chase each other. And itperpetuates this kind of vicious cycle ofinflation that we've seen. A very strong labormarket or an overheated labor market can be onefactor in pushing inflation higher. There's a tension here.

Workers have beensteadily losing out for decades while firms aregaining more and more profit share. But theother problem is that the primary driver ofinflation right now is not stuck supply chains. It's really the wagepiece. A worker shortagecontributed to pushing wages and prices higher. Workers have seen bigpay increases since early.

2021, which led torecord job openings, high turnover and theunemployment rate at historic lows. But there are signs thatwage growth is cooling, with layoffsskyrocketing in 2023 across differentindustries. People care aboutinflation because of the low unemployment. Theability to change jobs for higher pay is aresult of low.

Unemployment. And so wemay increase their base salaries to say pleasestay. The only way to correctfor overpaying on base salary is reductions inforce: layoffs. It's a challenge forbusinesses because it's mostly coming from wagesand they have to find ways to be profitabledespite the rising cost of labor. But that's nota challenge for the workers that are gettingthose higher wages.

So there are some peoplewho are benefiting because they're gettingpaid more and they're getting paid morerelative to the profits of business that havebeen high for a long time. Typically ininflationary periods, wages don't keep up, andit's the price of goods that are going up morethan the cost of labor. But this is an unusualepisode where it seems like right now the maindriver of inflation is.

Actually labor costs. And what that meansactually is that workers are gaining. There's a balancing actwhen it comes to tackling inflation because wegenerally don't want to stop prices from risingcompletely. The Fed considers aninflation rate of about 2% to be signs of agrowing economy. If you have noinflation, that implies.

That things are justgenerally flat. And if you look at timesthrough history when we've had extremely lowinflation rates, it has coincided with very slowgrowth. The goal is to make pricechanges so minimal on average over time thatthe average household and the average firm doesn'tthink about it when they're making theirspending and investments and hiring decisions.

The primary tool ismonetary policy. And here we're talkingabout the Federal Reserve raising short terminterest rates to slow down economic activityand slow down demand. When the Federal Reserveraises rates that quickly, it changes theimpetus to borrow if you're a US consumer andit changes the impetus to lend if you're a bank. It sort of slows nominaldemand and with the.

Slowing of nominaldemand, if we think about a steady state ofsupply, with that steady state of supply, withlower demand, brings in the generalized pricelevel. The Fed's goal is to slowdown the increase in prices, not to makeprices go down below where they wereoriginally, which economists call”deflation.” Deflation is prettyharmful because if prices.

Are going down, then alot of consumers will say, 'Well, why do Iwant to buy something today that will becheaper tomorrow?' And so it's usually associatedwith very low demand and a recessionary state. But interest rate hikescan also lead to some pain for consumers. Sometimes slowinginflation down, reducing demand means the labormarket weakens, and that.

Could mean consumptionslows, activity falls, and you do get arecession. It's not a pleasant trade off forpolicymakers to run that risk of saying, well, weneed to slow the economy down to bring inflationdown. Yes, it means we'rerisking a recession. But the long runhistory – here I'm talking across decades –suggests the best outcome for the US economy orany other economy in.

General is wheninflation is low and stable and we're nottalking about it. So at times that doesmean you have to risk a recession, but evidencesuggests that's the right thing to do if it meansthat inflation will be low and stable overtime. There's also a consumerbehavior component to slowing down inflation. There is that quote:”Nothing like high prices.

Cures high prices.” Andit's in some ways reflective of the factthat the consumer solves a lot of the problem,even without the help of the Federal Reserve oranything else on their own by restrictingdemand to come in line with supply. Eventually prices willhit a point where consumers will just say,okay, enough, I'm not going to buy this goodanymore. And that will.

Result in some otherthings: Either consumers just won't buy anything. They'll just say, we'renot going to buy cars anymore because carprices are too high. What consumers willsometimes do then is that they'll substitute. Instead of buying thosehigher priced goods, they'll buy lower pricedgoods and that in turn will help kind of pullprices down.

Obviously, if your goodsaren't selling, what are you going to do? You'regoing to cut prices. It's been a little over ayear since the Fed first started hiking interestrates in March 2022. There are signs thateconomic growth is slowing, which is whatthe Fed thinks the economy needs. But thecurrent rise in prices is still above the Fed'sgoal of 2%. The Fed uses thePersonal Consumption.

Expenditures PriceIndex, or PCE, as its inflation indicator. The year over yearchanges in PCE peaked in April 2021 at 30%. That number was down toaround 6% year over year change in March 2023. We're looking at morenormalized levels of inflation for the firsttime really in history without a recession.

Consumers still have alot of money. They're still able tobuy things. And I think anybody whohas tried to get a restaurant reservationlately can see that anybody who's tried tobook a vacation can see that people are stillout there spending money. And that, of course, isin itself inflationary. There are also globalfactors at play. The US actually importssome inflation from the.

Rest of the world andthat's because we import some of our goods andservices that we consume. If you get a good thatwas produced in Mexico and the price of goodsin Mexico is rising, well then probably thatimport from Mexico is more expensive here aswell. And that shows up ashigher goods prices in the United States. I think the big questionnow is will it remain.

Sticky and have we seensomething that's necessarily going tochange the outcome over the next decade versusour prior decade? And I'd say the jury'sstill out on that. Markets are kind ofsaying we can get down to 2% even by the end of2023, early 2024. We think it'll happen bythe end of 2024. The Fed thinks sometimein 2025. I think that's feasible.

Yes, we will be riskinga recession in the process, but if we getone, it would likely be shallower than theaverage recession. Obviously not desirable,but might be the right trade off for for thelong run. The goal is for you andI to never really need to have a conversationabout inflation. So how will we know whenwe're winning and when policy is working?.

It's when conversationslike this will shift back to other things.

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