Increased demand and supply chain disruptions are hitting consumers’ wallets, but the current inflation may be temporary, a Tufts economist explains
The recent jump in prices for food, gas, cars, and other goods is due to increased demand and tangled global supply lines, according to a Tufts economist. And he thinks it’s temporary.
“For inflation to continue, prices must continue to rise at a rapid rate, and to me that doesn’t seem likely right now,” says Michael Klein, the William L. Clayton Professor of International Economic Affairs at The Fletcher School and executive editor of the nonpartisan online publication EconoFact. “Part of the government safety net has been withdrawn,” which will reduce demand in the months ahead, he says, and businesses are trying to solve supply slowdowns.
Inflation has clocked in at more than 5% for the past four months, a big jump over the 1.7% average for the decade before the COVID-19 pandemic, Klein says. In fact, the annual increase in the consumer price index is the highest it’s been since 2008.
Food and energy have seen some of the steepest hikes. The price of beef is up more than 17%, restaurant meals more than 5%, and natural gas more than 20%, while gasoline prices have soared by more than 42% over the last year, according to the U.S. Department of Labor.
Tufts Now spoke with Klein to understand how inflation starts—and when the current surge in prices might end.
Tufts Now: Why are consumer prices for everything from new cars to gas, food, furniture, and restaurant meals going up?
Michael Klein: Inflation is the rate of change of prices for what’s called the basket of goods. And that basket of goods is supposed to be representative of what an average, urban consumer purchases.
One source of inflation is that there’s a lot of demand for things, and that’s what’s going on right now. There’s a huge increase in demand for goods, which is causing prices to rise.
Another cause of inflation is a constrained supply. The current supply bottlenecks are contributing to that.
How is the COVID-19 pandemic affecting inflation?
One factor is that inflation is measured as what prices are now compared to a year ago. A year ago, we were in the depths of the downturn, but when you look two years ago for the comparison instead of a year ago, inflation doesn’t look as bad.
So the current inflation is because of low prices and reduced spending earlier in the pandemic?
Yes. Inflation doesn’t mean high prices, it means rising prices. If prices go down, as they did early in the pandemic, and then up, then you’re comparing current prices to that trough, which was an unusual time.
Is the current inflation temporary, then?
That’s the big question right now. Are we back in a situation like the 1970s, where we’re going to have to get used to endemic inflation, or is this temporary?
My guess is that this will be relatively temporary. We were successful at keeping a lot of people from falling into poverty, despite the fact that we had the worst downturn since the Great Depression as the economy was falling off the cliff in the spring and summer of 2020. Through government efforts, we were able to keep people from falling into desperate poverty, but that meant that they had more money to spend and they spent it on a lot of goods.
And then also the supply was constrained because of a lot of things related to COVID, so that has led to higher prices now.
But for inflation to continue, prices must continue to rise at a rapid rate, and to me that doesn’t seem likely right now. Part of the government safety net has been withdrawn. People are addressing the supply constraints.
Are you saying that the $1.9 trillion rescue package that the federal government enacted in March contributed to the current inflation?
Yes. But it also contributed to people not falling into desperate poverty. Given how bad the situation was, it was very important for the government to provide that kind of social safety net support.
The goal of government isn’t just to prevent inflation, but neither is the goal of government just to prevent unemployment. The Federal Reserve has what’s called the dual mandate of stable prices and low unemployment. That’s a tricky thing to manage and it’s especially tricky when you have of a once-in-a-century pandemic affecting the country.
How could the Federal Reserve help reduce inflation, if it wanted to?
They would raise interest rates.
How would that affect the economic recovery?
When the Federal Reserve raises interest rates, it makes borrowing more expensive, both for consumers and for businesses. It also would tend to strengthen the dollar. All of those things have a contractionary effect on the economy.
If you find it more expensive to borrow money, you might not buy a refrigerator or a car. If businesses find it more expensive to borrow money, they might not buy new equipment or build a new factory.
And then if the exchange rate strengthens, exports from the United States face greater price pressure, because that would increase the price of goods that they sold abroad. And the strengthening of the currency means imports are cheaper. All of those things tend to dampen economic growth.
The idea is when you rein in economic growth, you slow down inflation, because there’s less demand, so there’s less price pressure.
Having said that, the inflation rate had been sort of stubbornly flat for the seven or eight years up until COVID. It didn’t change much with economic conditions. Now, of course, we’re seeing it move up to rates that we haven’t seen in a while, but it’s at a time when we’ve had unprecedented movements in economic activity because of COVID.
You alluded to supply chain disruptions contributing to the current rising prices. What’s causing those and are there some areas where they are more of a problem than others?
It’s more of a problem for goods than for services. And one thing to note is that the world production is very integrated. It’s not just that we’re buying cars from abroad, but that parts of cars that might be assembled in, say, the United States or Mexico are coming from all over the world.
Likewise with iPhones, for example. An iPhone eventually comes from China, but all the component pieces have to get to China first. Very integrated world production makes the world more vulnerable to supply chain disruptions.
Part of what’s happening is that, as I said, there’s this bigger demand. Part of it also seems to be that there are labor shortages for truckers and for longshoremen to unload ships.
So it’s a perfect storm. It’s unprecedented, the kind of backups that we’re seeing, for example, at the Port of Los Angeles, and that’s contributing to price pressures.
What needs to happen to have the supply chain right itself, and how long do you think that might take?
Demand has risen and we need more people to help unload the ships. President Biden asked the Los Angeles port to stay open 24/7. A movement toward 24/7 work at that port and at businesses like Walmart and others working to alleviate this will help.
But what really matters is what happens with COVID, and not just in the United States, but worldwide. That’s because we’re sourcing from so many countries, but it’s also because the pandemic isn’t solved anywhere until it’s solved everywhere.
To learn more about inflation and other economic issues, visit EconoFact. Recent EconoFact podcast episodes include What Do A Billion Prices Tell Us About Inflation? featuring Alberto Cavallo of Harvard Business School; Understanding Current Inflation, with Jay Shambaugh, F95, of George Washington University; The Financial Sector and Rescuing the U.S. Economy, with Jeremy Stein of Harvard University; and The U.S. Economy: Financial Stability, Longer Term Risks and Reasons for Optimism, with Eric Rosengren, former president of the Federal Reserve Bank of Boston. EconoFact has also published the memos Rising Inflation? by Menzie Chinn of the University of Wisconsin and Pandemic Shortages and Inflation: From Empty Shelves to Higher Prices, co-authored by Cavallo.
Heather Stephenson can be reached at email@example.com.