Concerns over inflation really began in 2021 and they were driven by three main catalysts, with economists disagreeing on what was the biggest primary cause.
The first, which perhaps got the most attention in 2021, was due to shortages. This supply-side contributor to inflation can be damaging and worrisome, because they are the effect of real scarcity of wealth and productivity that means people will be worse off in real terms. These were largely due to the chaos created by COVID-19, with supply chain shocks due to workplace restrictions being a prime example—but by no means the only. Shortages of labor, goods, and commodities were all seen as big contributing factors to rising prices, as a lack of stuff to sell with persistent demand resulted in rising prices.
The second is a bit more hopeful and comes from the demand side. Major pivots in consumer behavior because of COVID-19 resulted in unexpected demand for some goods that drove their prices higher as firms couldn’t pivot fast enough to accommodate the demand. The biggest and most obvious example is housing in mid-sized cities. With work from home suddenly an option for many, demand for larger houses in cheaper areas around the nation drove up those prices to be less than cheap. This inflation is perhaps most easily and directly tackled by the Federal Reserve, whose interest rate hikes directly and immediately impact housing prices (which are already beginning to fall).
The third cause is also supply-side driven and is perhaps the most bleak and terrifying: geopolitical and global uncertainty. Both the war in Russia and China’s persistent Covid Zero policies have created disruptions in the global supply chain at a time when it was trying and struggling to adjust to the post-pandemic world. These have been cited by business leaders as major and particularly ruinous impacts to the global economy, driving scarcity and driving up prices at the same time. This in turn results in lower growth that produces the kind of stagflationary economy of the 1970s—where there is rising prices at the same time as no growth.
Indeed, GDP figures for the western world have been anemic despite their return to post-pandemic normalcy, the removing of most pandemic restrictions in most nations, and a pivot towards new consumer demand. The pivot is a difficult one, stymied by continuing uncertainty from the east, and the concern over firms’ inability to pivot resulting in a recession has risen. Add onto that the fear that the Federal Reserve will overshoot, and you have a true disaster possibly brewing.
That overshoot is a bit complicated, but intuitively it makes sense: higher borrowing costs result in less free flowing capital in the economy, less investment by firms, less spending by consumers, and ultimately less revenue and earnings for everyone. While there is uncertainty whether the Fed will overshoot or not, memories of the Fed’s aggressive rate hikes of the 1970s and the deep recession that followed have panicked investors and economists alike, fearing that the Fed is repeating history.
The stagflation of the 1970s was very much a shortage-driven one, with oil in particular driving the downturn. This is an important point, because if the stagflation of 2021 and 2022 has been because of shortages (the first and third causes above), there is good reason to believe a pivot towards a recession is likely. But if that interpretation is wrong and we’re seeing more the chaos of changes to demand that the supply side has been unable to adjust to in time, then we are likely seeing a very different situation that could surprise worriers in the coming months. Understanding the data is more crucial than ever.