The ABCs of Inflation

The ABCs of Inflation
by John Frost

Everyone has experienced inflation.  It is most notable in gasoline prices, food prices, entertainment, recreational prices and, in general, the cost of living.  We live in a capitalistic economic system wherein prices are affected by supply and demand issues, supply chain bottlenecks and, unfortunately, the behavior of providers who react out of greed and opportunity, not just necessity.  Some lay the blame entirely on Government policy, others point to the added costs brought on dealing with the COVID pandemic.  It might be a good idea to reflect on the issue and its repercussions.  Think of the costs of the myriad of charitable organizations who often provide goods and services to their respective audiences:  not only is demand up but resources are ever more expensive.  Consider the costs to our Rotary Club for overhead, meals, salaries and other demands from charitable organizations for contributions.  Certainly, these issues will be a challenge to the newly elected Board of Directors and President.

Let’s start at the beginning.  “Inflation” is defined as “the rate at which the value of a currency is falling and, consequently, the general level of prices for goods and services is rising.  The two most commonly used indexes are Consumer Price Index (CPI) and the Wholesale Price Index (WPI).  Keep in mind there are two issues:  the cost of production (materials and wages within the dynamics of production efficiency) and the demand for products and services.  Again the human factor and events can cause inflation.  Consider the hoarding of goods, mainly durables, as is evidenced by the empty paper towel shelves, toilet paper and even staples like canned peas, corn, and other vegetables and meats.  Prices often soar during the panic buying and hoarding events.

Keep in mind that inflation measures the change year over year.  Chairman Powell of the Federal Open Market Committee proclaimed that inflation would moderate over time.  In fact, if prices remained stable for a year there would be no inflation.  For instance, if gasoline had remained the same for a year the part of inflation based on fuel would be zero, or no increase, even though the price was high at the beginning of the year.  The same is true for most goods and services.  Recently, however, the month-over-month numbers seem to negate Powell’s stability prediction and, in fact, the current forecast does not call for stability but rather an increase in prices prompting changes in policy.

The role of Government plays a big part in the “demand pull” aspect of inflation.  This takes into account increased spending related to consumer habits as their pocketbook would allow more spending for necessities as well as added costs of non-essentials such as travel and entertainment.  In common language, consumers will order steak instead of hamburger despite the added costs even though the price of a steak may have been the same for over a year.  People will drive more, buy higher priced cars and even upscale their housing arrangements.  The controversy over President Biden’s Build Back Better Bill and the increased size of the Federal deficit relates to this very issue.  Too much money in the hands of consumers provided by the Government leads to demand-pull inflation.

Government regulation also plays a factor in inflation.  In Oklahoma, the production of new oil and natural gas is adversely affected by the delays complying with the Environmental Protection Agency.  Other producing states are also affected by embargoing Federal lands from exploration (ANWAR, New Mexico and offshore).  Existing production costs are affected by regulation of pipelines and other methods of transportation.  (Even tanker cars on trains are mandated to provide stronger bulkheads in order to reduce the environmental impact of accidental derailment of tanker cars and/or collisions, even though these occurrences are rare and quickly mitigated).  Perhaps the “Green New Deal” needs to be implemented gradually over time.

Scarcity of qualified workers and increased wages due to union demands, Government benefits for remaining unemployed and the increased costs of actually keeping a job, all contribute the adverse effects of the old familiar “wage-price spiral”. Prices go up forcing wages to go up which in turn contribute to increased prices.  That phenomenon contributes to the general inflation.  “Help wanted” signs are often accompanied by hourly wage and benefits notes when looking for workers.

Consider the ancillary effects of COVID other than the tragic loss of life and suffering caused by the Pandemic.  Labor shortages caused by “stay at home” policies, child care costs for working parents when schools are closed, treatment, testing, transportation costs related to dealing with the virus.  In many ways, it is unmeasurable but the effect on inflation is indisputable.

I am confident that The Club will respond just as each individual in The Club will with respect to the needs of our charitable clients, our friends and families as well as providers of goods and services who attempt to survive in this inflationary cycle.

Let me close for now with the hope and promise that saner policies will prevail and inflation will moderate but not go into a period of stagflation or depression.  That’s a topic for another time.