The Bureau of Labor Statistics just released the Consumer Price Index (CPI) for the month of July. The .5% increase in consumer prices shows that even with the economy mostly fully re-opened, inflation continues to be a problem. Since last July prices have increased by 5.4%.
The Biden Administration and the Federal Reserve continue to incorrectly conclude that the inflation we are experiencing is temporary or as they say, transitory. They believe the inflation is due to supply chain disruptions. That’s because many factories and other suppliers were forced to temporarily shut down during the early days of the pandemic.
They also note that severe weather last winter caused supplier shutdowns. As a result, there are supply shortages which have driven up prices. They conclude that once the economy fully re-opens, the inflation problem will disappear.
They are flat-out wrong.
Right now, the economy is operating at the same level as before the pandemic. Right now nearly all suppliers are fully re-opened. Right now, if the Fed and Biden are correct, the monthly CPI number should be in the .2% range, a number we haven’t seen since the end of last year.
They are wrong because they are misjudging the causes for the price increases. While it is true that some manufacturers, like in the automobile industry, continue to see some chain disruptions, the vast majority of the inflation is caused by far too much excess demand.
That means even when all of the supply chain disruptions have been eliminated, inflation will still be a problem. The excess demand is simply caused by poor government policy, which has resulted in very high inflation in some markets.
The housing market is an example. Because households can get a mortgage for 2% and because the federal government has given free money to all households, more people are entering the market to buy a house. A typical family of four has received more than $11,000 in free money from the government in the past year.
The family of four will receive at least another $3700 in child care tax credits this year. Even if the household was not considering buying a house, with a 2% mortgage and nearly $15,000 in free money from the government to pay the down payment, tens of thousands of households sought to buy a house. The excess demand pulled up housing prices.
The same is true in the automobile market. Near zero percent financing and free government money to cover the down payment, meaning tens of thousands of households sought to buy a new car, which pulled car prices up.
Excess demand also comes from Federal Government spending. In 2020 and 2021, the federal government has deficit spent more than $6 trillion. For an economy operating near full capacity, this is purely inflationary.
The Fed has increased the money supply by about 20% in the last 12 months while keeping interest rates near zero. For an economy operating near full capacity, this is purely inflationary.
On the supply side, business has had to raise the wages for lower-income workers. That’s mostly because generous government unemployment compensation has resulted in those workers earning more by not working. Raising wages for entry-level workers pushes wages up for all workers. This drives up costs for the firm and pushes up prices.
And finally, the Biden Administration has declared war on fossil fuels by canceling the Keystone pipeline, halting any drilling on federal lands and halting oil production on the Alaska shelf. This has driven up fuel prices and created shortages that will continue to drive up prices.
The Fed should act immediately before we experience runaway inflation. Interest rates should immediately and gradually be increased. The Fed should slow the growth of the money supply by immediately and gradually reducing the $120 billion monthly purchase of government bonds.
The longer the Fed waits, the more drastic the action will have to be.