The Whys of Inflation


“There are at several reasons why the US is experiencing inflation, and none of the can/will be fixed anytime soon if ever”— Paul Ebeling 

The underlying reason why prices rise is that total demand is greater than businesses’ ability to supply that demand.

On the supply side, the lack of willing workers and the resulting rising wages have restricted companies’ ability to increase output. Plus, the increased labor cost means business must raise prices in order to maintain a high enough profit margin to stay in business.

With 4.3-M workers quitting their job in September and with thousands of additional workers dropping out of the labor market, inflation is likely to last for a long time. The longer it lasts, the more likely the economy will experience a longer-term wage-price spiral.

This spiral occurs when labor cost rises, say, 5%, which forces business to raise prices.  Then if there is a 5% inflation, workers will demand a 7% raise next year, because they need 5% just to keep up with inflation and they want to really get 2% more. Then labor cost go up 7% which raises prices more. This results in the wage-price spiral.

Also, the Biden administration wants to transition away from fossil fuels. As a result, it cancelled the Keystone Pipeline, ended drilling on federal lands and stopping exploration off of the Alaska coast. These actions restrict supply which, in a growing economy, raises energy prices. That means consumers and business pay more for energy, which drives up the overall inflation rate.

Fiscal Policy is also contributing to inflation. The federal government has spent $6 trillion more than was raised in tax revenue for Ys 2020 and 2021. This excess demand on a $22-T economy will contribute yet further to rising prices. Not only won’t the federal government reduce spending to fix this, but they are proposing to spend $5-T more.

Finally, baffling to most objective economists, is the Monetary Policy set by the Fed. 

Historically, at the very hint of inflation, the Fed will act.  For instance at the end of Y 2016, there was a slight hint of inflation.  The Fed raised interest rates 8Xs from the end of Y 2016 to the end of Y 2018.  They also reduced their purchases of government bonds.

The Fed tries to defend themselves by citing Modern Monetary Theory (MMT), which says, under circumstances similar to what we are experiencing today, increases in the money supply will not be inflationary.

Because today’s inflation is mostly caused by those four reasons, inflation is here to stay. It is imperative that the Fed act immediately. The board of governors should gradually reduce their bond purchases and gradually raise interest rates.  The Biden administration should refrain from spending any more trillions, and Congress should not pass any additional spending bills until the inflation problem is resolved.

Failure to take these actions will result in much higher inflation, and eventually slower economic growth. The worst case, which is possible considering the size of the public debt and the resulting capital shortage combined with the current labor shortage will be stagflation similar to what the US experienced in the 1970s.

Have a prosperous day, Keep the Faith!