To understand why inflation is so worrying to so many people,
you could look at price charts for lumber or used cars or
New York strip
steaks. There is no doubt that the prices of many of the things that people buy
are rising at an uncomfortably rapid rate.
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But to really understand why there is a persistent longer-term
buzz of
inflation concern, you have to wrestle with the ways in which money
itself is fundamentally ephemeral.
Ultimately, most money is a mere electronic entry in the ledger
of a bank. It is worth only what it will buy, and what it will buy changes all
the time. Or as the humor publication The Onion once wrote, money is “just a
symbolic, mutually shared illusion.”
When prices move abruptly — as when an economy that has been
partly shut down for more than a year tries to reboot — that inherent
uncertainty becomes all too real. When wild swings like these can happen, what
else might be possible?
But inflation isn’t so scary if you focus on the precise
mechanics by which the value of a dollar changes over time — and how it might
affect you. In an inflation-scare moment like this one, you can boil that down
to five essential questions:
Is this a change in relative prices, or a change in overall
prices? Are the prices of items becoming more expensive likely to rise further,
stay the same, or go down? Are wages also rising? Is inflation so high and
erratic that it is hard to plan ahead? And is this really inflation at all, or
is it a shift in the price of investments like stocks and bonds?
Let’s take these questions in turn, and look at what aspects of
the current price surge look more benign, and which are worrying.
Relative prices vs. overall prices
At any given moment, some things are becoming more expensive and
others are getting cheaper. That is how a market economy works; prices are what
ensure that supply and demand eventually meet.
Sometimes, this happens quickly. Airlines constantly adjust
ticket prices; the prices of fresh vegetables bounce around depending on
whether they are plentiful or scarce. Other times it happens more gradually. A
hair salon may not raise prices the first day there is a line of customers out
the door, but it will do so if it is consistently overbooked.
Those shifts can be annoying — nobody wants to pay $1,000 for a
short-haul plane ticket or see the price for a haircut double. But they are a
healthy part of an economy working as it should.
Typically, these relative price changes are not a problem of
macroeconomics — something best solved by the Federal Reserve (by raising
interest rates) or Congress (by raising taxes) — but a problem of the
microeconomics of those industries.
The core challenge of an economy emerging from a pandemic is
that numerous industries are going through major shocks in demand and supply
simultaneously. That means more big swings in relative price than usual.
One-off prices vs. long-term trends
Not all price changes have equal meaning for inflation. Much
depends on what happens next.
If the price of something rises but then is expected to fall
back to normal, it will act as a drag on inflation in the future. This often
happens when there is a shortage of something caused by an unusual shock, like
weather that ruins a crop. In an opposite example, in 2017 a price war brought
down the price of mobile phone service, pulling down inflation. But when the
price war was over, the downward pull ended.
On the other hand, a price that is expected to rise at
exceptional rates year after year has considerably greater implications.
Consider, for example, the multi-decade phenomenon in which health care prices
rose faster than prices for most other goods, creating a persistent upward push
on inflation.
So an essential question for 2021 is in which bucket the
inflationary forces now unleashed should be put.
Wage inflation vs. price inflation
Media coverage of inflation typically focuses on indexes that
cover consumer prices: numbers that aim to capture what it costs to go to the
grocery store, buy a car and obtain all the other things a person wants and
needs.
But more properly defined, inflation is about the full set of
prices in the economy — including what people are paid for their labor. Whether
there is wage inflation goes a long way to determining how people feel about
the economy.
Even relatively high price inflation is bearable if wages are
rising faster. From 1995 to 2000, inflation averaged 2.6 percent a year. But
the average hourly earnings of nonmanagerial workers were rising 3.7 percent a
year, so it should be no surprise that workers felt good about the state of the
economy.
It is too soon to show up clearly in the data, but there are
anecdotes aplenty that companies are rapidly increasing pay. Just this week,
Bank of America said it would start a $25-per-hour minimum wage by 2025, up
from $20, and major chains like McDonald’s, Starbucks and Chipotle have
announced significant moves toward higher pay in recent weeks.
For individuals who benefit from bigger paychecks, that will
take the sting out of higher prices for goods. Some may end up better off
financially than they had been in lower-inflation environments.
Steady inflation vs. erratic inflation
Many people take it for granted that high inflation is a bad
thing.
But in truth, it’s not obvious why a country couldn’t
comfortably have prices rise significantly faster than they have in the United
States in recent decades. Imagine a world where consumer prices rose 5 percent
every year; workers’ wages rose 5 percent, plus a little more to account for
rising productivity; and interest rates were consistently higher than Americans
are accustomed to.
In theory, the only problem would be what economists call “menu”
costs, the inconvenience of companies having to revise their price lists
frequently. (In a way, the pandemic shift away from physical menus in
restaurants might even make that concern moot.)
In practice, though, not many countries have managed to have
higher inflation like that arrive steadily year after year. And there can be
big negative consequences when inflation is erratic, swinging from 2 percent
one year to 10 percent the next and so on.
So far, there is not much sign of that happening in the United
States. Bond investors appear confident that whatever inflation takes place in
the next year or two is a one-off event, not a new normal in which the value of
a dollar is unpredictable.
But keep an eye on markets for any evidence that is changing.
Price inflation vs. asset inflation
Even when consumer price inflation is low, some financial
commentators may point to a worrying surge in asset inflation, meaning rising
prices of stocks, bonds and other investments.
Economists generally don’t think of asset price swings as a form
of inflation at all. If stock prices rise, it may change the future returns on
your savings, but it doesn’t change what a dollar can buy in terms of the goods
and services you need to live.
But semantics aside, it certainly seems apparent that millions
of people have been plowing money into meme stocks and cryptocurrencies (as
well as more traditional investments) that might otherwise have gone to bid up
the price of home grilling equipment or other things in short supply.
And while there is plenty to worry about in terms of bubbly
signs in financial markets — and what it would mean if they corrected downward,
as major cryptocurrencies did Wednesday — that doesn’t mean they are making
ordinary consumers worse off. You can’t eat Bitcoin; you can’t clothe yourself
in shares of
GameStop.
Sometimes asset prices rise while consumer prices stand still,
as in much of the 2010s. Sometimes consumer prices soar while financial assets
languish, as in much of the 1970s. Other times, they move together.
The implication: High asset prices and rising price inflation
aren’t the same thing. Whether with asset prices or other aspects of inflation,
being precise and detailed is a way to make the essential ephemerality of money
a little more concrete.
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