Prices are going up everywhere, and it’s causing a bit of a stir.
One of the top controversies in America is whether inflation is transitory and short-lasting or a longer term risk to the economy. The controversy is being battled out by politicians, in the press, and pretty much everywhere in the public sphere.
Except, surprisingly, among economists and financial analysts. For them, the matter is pretty decisively resolved.
First, let’s take the politicized arguments. You will hear, among other debates, that the Federal Reserve’s loose monetary policy has caused inflation due to rising money supply. You will also hear that Biden’s generous programs have caused too much complacency in the labor market, causing higher wages and thus inflation. You might also hear that foreign actors, in bad faith, are pulling strings to cause inflation.
None of this is really accurate, and the data makes it very clear what is actually going on.
Among economists, the orthodox view is that inflation is temporary, transitory, and unlikely to last into 2022. Furthermore, the orthodox view insists that several independent and unrelated phenomena are causing the inflationary trend, and these are likely to resolve over the long term.
To understand this, we need to go beyond the headline consumer price index number (6.2% year over year in October). That’s bad, but it is anniversaring a very low number. If we go back to 2019, we see annualized growth of about 3.4%. Much less, and much closer to the Fed’s target of 2%.
If we look at core CPI (excluding food and energy), we see a 4.6% year-over-year increase. Annualized from 2019 is 3%—even closer to the Fed’s target.
Thus, we can discredit much of the price growth as transitory, related to the disruption of the coronavirus and not much of a diversion from normal inflationary growth. However, both 3% and 3.4% are still well above the 2% target, indicating that the coronavirus might not be all that’s going on here.
Is labor a big part of inflation? To answer that question, we can first take a glance at the ISM Services PMI, which at 66.7 indicates relative strength for the sector, not what you’d expect from a labor shortage and wages spiraling out of control. The report did call out the difficulty to hire, but also saw price growth (at an index of 82.9) not much above the long-term trendline.
More concretely, we can look at average weekly earnings, which in October were up 4.6% from a year ago and up 5.3% annualized from 2019—suggesting that earnings growth is actually decelerating. While 4.6% is somewhat high, it is still not significant enough to account for the inflationary growth we are seeing across the economy.
To demonstrate that, we need to dig even deeper into the CPI data. Looking at October’s CPI-U data, freely available from the Bureau of Labor Statistics, we can dig into the specific contributors to inflation to a very fine detail. If we look just at services (excluding energy services), we see year-over-year growth of 3.3%—below other contributors to inflation and far from the biggest offender. Since services are most sensitive to wage increases, this more modest increase confirms that wages are not a big contributor to the big and scary headline inflation number we are seeing.
This unevenness also makes it quite clear that profligate Americans are not driving inflation—there just isn’t enough real wages to justify the hypothesis of over-indulgent Americans (consumer spending, tracked separately, also confirms this hypothesis is false). It also suggests that the Federal Reserve and U.S. government’s separate stimulus actions aren’t driving inflation; if it were, it would be more evenly spread out.
To explain what is happening to inflation, then, you would need to drill into each constituent. What is driving higher oil prices, higher pork prices, higher housing prices, etc. The answers there are diverse and complicated, but in almost all cases speak to disruptions in the supply chain, in delayed consumption, or in a market shifting en masse much faster and more violently than it normally does.
And that completely points to a transitory and short-term trend that is unlikely to last much longer—especially when we start to compare to 2021, when inflation numbers are likely to fall dramatically.
