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To many people, “inflation” is a dirty word.
It means higher prices at the store and higher interest rates at the bank or auto dealer. The basic rule of inflation is that prices rise when too much money chases too few goods.
Yet the Federal Reserve, which can control the nation’s money supply, likes 2 percent inflation. That rate shows a growing economy in which business is trying to keep up with demand. Along the way, that effort can create more jobs and, as a result, more demand.
The neat trick is to keep inflation from getting out of hand. If prices and interest rates increase too rapidly, the economy can slow down. The mismatch between supply and demand becomes too great until the slowdown helps restore a more manageable balance.
For several years, the inflation rate has been at or below the Fed’s target. But it has climbed in recent months and some market experts believe it will stay high. They watch to see what moves the Fed will make to raise interest rates and when. It will act sooner than planned.
Why is inflation increasing? Its climb is yet another symptom of the COVID-19 pandemic.
When the coronavirus hit, the U.S. and much of the rest of the world hunkered down. Some businesses closed, travel almost collapsed and many people began living on reduced incomes. Less money was chasing fewer goods at the store — notably in the strange case of the run on toilet paper. The federal government moved aggressively to prop up household incomes.
As the economy recovered from the depths of the pandemic, prices began to rise. That created inflation well above the target 2 percent, though the Fed concluded that the level is both natural, given the low 2020 base, and temporary. The effect of the inflation surge can be seen in the big boost to Social Security payments for 2022.
While the Fed has been expected to allow small increases in interest rates as the economy returns to something like the 2019 level, what looked like temporary inflation now may extend as a changed economy begins to emerge. The virus won’t go away and neither will its effect.
One of the biggest changes has come in labor. Government policy assumed that almost all workers would want to come back to their own jobs just as soon as they could. Trucking companies, offices and restaurants were poised to open. But something funny has happened on the way to recovery.
During the slowdown, workers had the time to learn something about their place in the market economy. Employers have traditionally paid them at levels linked to the cost built into the prices they charge.
The COVID-19 quarantines allowed workers to better understand that their value to their employers was more than they were being paid. Places of business closed for lack of workers. If you withheld your labor, you might get paid more. It began to feel like a giant national labor union.
Only a few months ago, debate raged over a $15 minimum wage. Companies claimed that prices would have to increase, cutting sales and causing unemployment. When workers did not return as expected, major employers boosted wages in an attempt to lure them back. The minimum wage is now being set by the market and it could end up higher than $15.
Higher pay can translate into either higher prices, cuts to executive pay, or a reduction in booming investment gains. Right now, it’s higher prices. That yields higher inflation than originally expected.
The prospect of better pay should bring more workers back to the job. But what has been called the “Great Resignation” is also taking place. The COVID break led some people to decide on a more simple, family-oriented life, even if that means less income. When people start thinking “money isn’t everything,” the economy can change.
The impact of COVID-19 has been big enough to raise questions about the American economy itself. The free enterprise system is alive and well, but the supply chain from some sources, especially China, has been disrupted. Add to that the changed relationship of workers to their jobs and employers.
President Joe Biden believes the historic opportunity now exists for increased government efforts to develop new economic and environmental rules and social policies. The next 12 months should reveal if he is right. If so, sooner or later, somebody’s taxes will have to increase.
Economic change is occurring. Operating private enterprises is becoming more costly, possibly promoting labor-saving efficiency. In any case, people are likely to pay more and probably buy less.
That could look like inflation. But it may turn out to be paying something closer to the real cost of what we need or want.