There has been a growing volume of discussion on “Transitory
Inflation” around the US’s COVID-Recovery. One might say: Almost an
inflationary amount of media coverage on the question of what will happen in
the US Economy. Some, like the Fed and the Treasury, are espousing the view
that the up-tick in prices/costs that have come with re-opening the US economy
are ‘temporary’ or ‘transitory’ and due to conditions related to the pandemic
and due in large part to the supply-chain disruptions occurring simultaneously
with rebounding consumer demands. Of course, there are those, like some
financial industry leaders or economists, who assert that these inflationary
price/cost increases will persist and will not be ‘transitory’.
Yes, I know; what a shock that there are different projections about inflation
and from those who’s views on the economy are supposed to be most informed. That
the ‘most informed’ are interpreting the same state of affairs differently would
seem illogical; but this is more common than one might think. This of course
raises the question: Who’s right? And that is where the answer is much like the
economy itself. The economy isn’t simple, it isn’t preordained to react in a
highly deterministic manner based on a numeric measure which is well understood
in the context of economic theory; but which is abysmally poorly defined in the
practical terms of reality.
Who doesn’t know that ‘Inflation’ is “a general increase in
prices and a decline in the purchasing value of money”? Some will say: “the
cost of goods increases”. Now as to who doesn’t know that, well it is not clear
but if you asked a systems analyst, they might say that these definitions are
not adequately defined in that they doesn’t tell you what happens because of
those conditions. Now, if we add the complicating notion of “transitory” to the
mix, the picture doesn’t get any clearer.
Let’s reset the discussion. First, let’s attempt to define
“Inflation” a little more specifically. This doesn’t mean that economists or
financial experts will agree, but they already don’t so what do we have to
lose?
A general and useful definition of “Inflation” is:
The price/cost of some item or
items (henceforth call ‘goods’) increases, while the following conditions are
also true.
Conditions:
·
The value of the money, capital, wages, assets,
or any other items unrelated to the goods, whose price has increased, have remained
unchanged.
·
The consumers/customers of the ‘inflated’ goods
continue to purchase these goods at the higher price/cost.
·
The level of supply of the goods and the level
of demand for the goods must be measurable/quantifiable as variables in
assessing the impact that this ‘Inflation’ will produce in the economy.
·
Open criteria: yet to be determined conditions
which are needed to produce the consequences of these goods’ inflationary impact.
This is a more useful definition of ‘Inflation’, at least
from a systems analyst’s perspective, because it allows for a more calculable
way to derive consequences.
I want to point out at this juncture, that this is the
simplest example of Inflation, and it may also shed some light upon what adding
a ‘transitory’ factor or dimension to Inflation would require.
So, what does this definition of Inflation tell us?
First, it tells us nothing about what caused the price/cost
of the goods to increase. Basic economic theory indicates that the price/cost
of an item will increase due to any number of factors:
1.
The Supply/Demand principle indicates that price
will increase if ‘supply’ is inadequate to meet ‘demand’. So, if supply
decrease then price will increase as long as demand remains that exceeds the
available supply quantity. Or, if demand increases but supply does not respond
to adequately meet it then price will rise.
2.
On the opposite side of the inflation coin, the
price/costs of good can decrease if ‘supply’ exceeds ‘demand’. This is the
counter-part to inflation; it is deflation.
3.
Price may also increase even if supply and
demand themselves are not actually relevant factors at play. If the ‘producer’
of the goods sees or thinks that they can increase their revenues and profits
by raising prices, then that would create an inflationary force. This decision
by the producer is a risk. As long as there is a reasonable level of
free-market competition then the assumptions is that competitors will gain
market share as long as they offer lower prices/cost. If the free-market
concept doesn’t operate efficiently then some level of inflation occurs.
4.
There are some bizarre or outlier situations
which create an inflation-like effect but have a dubious connection to the
economic principle of a “rational consumer” which renders explaining or
modeling the effect and projecting it somewhat difficult to achieve. An example
of such an economic event is a fad. If a good becomes a ‘fad’ item then its
price may well become detached at least for a period of time from a real supply-side
constraint.
Taking the conditions which define inflation together with
the factors that create the underlying price/cost changes provides a way to
assess and project impacts from inflation on an economy.
Before we go further, it is important to recognize a
relevant aspect of the economic concept. There is an assumption which needs to
be acknowledge that often goes unstated. In discussing any economic concept
there is a finite amount of funds that exists within the consumer population.
This finite amount has a meta-reality to it, because while it is finite it is
not fixed. This may seem a contradiction, but it has to do with what constitutes
the underlying ‘value’ of things in the economy (or the world). Resources are
constantly changing and with those changes their value may change. This aspect
of value doesn’t usually change for individual consumers that frequently or rapidly;
however, it can change in broader contexts. Take as an example: corn. The cost/price
of corn doesn’t usually change that drastically unless some event causes a very
extensive change in the entire market for corn or on something that corn
production relies upon. An individual consumer’s decision about corn, to buy or
not, has no real effect; whereas if a significant number of consumers alter
their buying decisions their collective impact could change the ‘value’ of corn
and thereby have an impact upon whether inflation or deflation happens.
What then is creating the current Inflation during this
initial period of the US’s COVID Economic Recovery? Well, there are many of the
factors mentioned above that are at play.
A.
Supply:
There are innumerable goods that are not available in quantities to meet
consumer demand. So, the producers raise their prices because there is a
willingness and tolerance among enough consumers to pay higher prices for the
same goods at the inflated prices. Consider just a few of the goods that have
made the news while there are likely multitudes more with less media attention:
a.
New Cars/Trucks
b.
Used Cars/Trucks
c.
Lumber
d.
Energy: Oil, Gasoline, natural gas
e.
Housing – new, used, rental
f.
Food: especially fruits and vegetables
g.
Food: restaurants, fast-food / take-out, away
from home
h.
Airline tickets
i.
Medical expenses
j.
Something you know of perhaps
Then there is the Resources
dimension of Supply that are associated with the production or procurement of
the goods. The COVID pandemic also impacts and continues to distort this part
of the Supply side. This facet of Supply includes things like:
a.
Workers. Perhaps the most dynamic and diverse
resource. One of the reasons there are Supply problems in goods is that to get
the goods into the market/economy you must have workers that are a key component
in producing the Supply. Someone must make the parts and assemble them to have
a new car. Someone must harvest material: food, lumber, petroleum, minerals, …
. Someone is needed to take your order and deliver it to your table; or issue
your boarding pass, and of course fly the airplane. You even need someone to
sell you what you buy at a store or have delivered to your home.
b.
Materials. Along with workers there are the substances/materials
that those workers are needed for acquiring, producing, and distributing. That
new car needs the materials which all of its various constituent parts require.
c.
Capacity. When the need for supply increases for
whatever reason, there are constraints imposed by how ‘responsive’ the production
process is or can be in reacting to that need. How much production capacity
exists limits how much can be produced no matter if you have more than enough
workers, more than enough materials, and more than enough money. The time
required to produce ‘X’ units may not be within your ability to change or
control. The number of units that you can push through the manufacturing
process at some number can not be increased. The amount of things that you can
move from where they are to where they need to be is dependent upon literally
how much space there is for the processes that move things.
B.
Demand:
This ought to be the easiest part of the Economy to both relate to and to
understand. Demand is what everyone buys. Every purchase that you make from the
smallest five-cent piece of candy at the check-out register (for those of you
who have every been in a physical store), to signing the mortgage papers when
you buy a home, to buying a seat on one of the commercial space-flight ventures;
and everything in between. Demand is transferring some of your financial
resources to someone else in exchange for those ‘Goods’ that they offer in that
exchange.
So,
what does all this mean for Inflation?
It is actually quite simple, if you are comfortable with the
concepts of Supply and of Demand and how they interact then Inflation is just a
process consequence that works to find a point of economic (monetary value) stability.
Hopefully, you have seen a Supply vs Demand chart that relates the cost/price
of goods rising or falling as these two factors change.
Inflation is just a response due to consumer
behavior. The ‘transitory’ aspect of inflation thus is exceedingly dependent
upon the same Supply / Demand relationship
in economic theory and thus upon the same consumer behavior. How to understand the
Consumer-behavior aspect of Inflation and the ‘transitory’ question around the
COVID-Recovery Inflation will be discussed in Part 2 of “Transitory Inflation –
Is It Sticky Notes or Cast Iron?”
