Whose Fault Is Inflation?

Whose Fault Is Inflation?

With mid-term elections just around the corner, the Washington blame game is heating up. Republicans are asserting that the upsurge in inflation we’ve been living with since the beginning of this year is all due to the Democrats’ American Rescue Plan that pumped billions of unnecessary dollars into the economy. Democrats counter that the inflation was a result of the supply chain dislocations caused by the Covid pandemic, and point out that inflation has been spiking globally, not just in the U.S. Who’s right?

I don’t know.

But Adam Shapiro, an economist at the Federal Reserve Board of San Francisco, has come up with an economic model that he believes can answer the question.

Before getting into his rationale, it helps to briefly review once again the two basic causes of inflation. When the number of people buying a product or service (demand) increases, its price will go up. The price will also go up if the number of buyers remains the same but the supply of the product or service declines. This is how market-driven supply and demand economics works under capitalism.

Shapiro applied microeconomic theory to analyze the contributors to the Personal Consumption Expenditures (PCE) price index, an aggregated measure of the prices that Americans pay for over 100 goods and services. He was able to separate those where prices moved due to a change in demand from those based on supply-driven price changes. His analysis revealed that demand factors played the largest role early in 2021 but explain only about a third of current 2022 inflation. He attributes supply as the larger factor, contributing to more than half of inflation today. The remaining sources are factors that could not be labeled as either supply or demand.

Supply shocks not only increase inflation but also suppress economic activity. As a result, Shapiro suggests that if supply disruptions persist we could begin a period of high inflation and low growth, similar to what we experienced as “stagflation” back in the 1980s. But the likelihood of this outcome is highly uncertain.

As to whose fault all this is, you can draw your own conclusion. It’s not apparent to me which political party has the best answer for righting the ship. Meantime the Fed is doing what it believes to be best. Only time will tell…

Here’s a link to Shapiro’s research: https://www.frbsf.org/economic-research/publications/economic-letter/2022/june/how-much-do-supply-and-demand-drive-inflation/.

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