Monday, August 9, 2021

Transitory Inflation: Is It Sticky Notes or Cast Iron (Part 1)

 


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?”

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