I was right about inflation in 2021

Preface

The root cause for the origin of inflation in recent years is a debated topic. I wrote this article in 2021 explaining why in my opinion inflation was going to become rampant. I was right about inflation but was my logic correct? I will explain what in my opinion was going to be the cause of inflation and I find it fascinating.

What is inflation?

Inflation is the increase in the average price level, it is most commonly measured using the consumer price index or the retail price index. The main difference is the consumer price index does not include housing costs. CPI is more commonly used.

What causes inflation

Cost-push

Cost-push inflation cost push inflation is caused by increasing the cost of production. Which in some economic models is show by a shift inwards of short run aggregate supply. Basically a shift inwards of supply due to an increase cost of production

The most volatile cost in the cost of production equation for firms is raw materials. This will be important.

Demand-pull

Demand pull is caused by a sudden shift in demand and consumption in an economy. This can be explained with a shift outwards of aggregate demand which is Comprised of injections into the economy. For example investment, consumption, government spending etc.

Quantity theory of money

This theory suggest a proportional relationship between shifts in money supply and the price level. This can be represented using the equation:

M x V = P x T

M=Money supply, V= velocity of money P= average price level T=Volume of transactions

Velocity of money is measurement of the rate at which money is exchanged in the economy.

When does high inflation usually occur?

In the large majority of hyperinflation cases, an economy was coming out of an economic crisis as well as having high levels of national debt and spending. Michael burry, one of the men who predicted the 2008 financial crash, tweeted about a book called the ‘dying of money’ comparing the U.S to the Weimar Republic.

The U.S do meet these requirements but so do many other countries so why should the U.S be more worried than others.

A case for inflation

The U.S has increased its money supply at an unprecedented rate. Considering the quantity theory of money, the current increases in money supply predict very high levels of inflation. Even for those who disagree with the quantity theory of money, inflation seems to be on the horizon due to a large amount of stimulus in the economy as well as the sudden demand for raw materials. This can be seen in the soaring lumber prices increasing roughly 140 per cent since December.

Money supply

Inflation usually is delayed after a lot of money is pumped into the economy.

The delayed onset of inflation can be seen from 1971-1980. It should also be recognised that inflation grows to a similar magnitude of the percentage increase of the money supply. This requires the velocity of money to be unchanged however in the U.S the velocity of money is at an all-time low.

Inflation is currently being held at bay by low levels money velocity. However this will not be the case in the near future because of the reopening of the economy and large amounts of stimulus and government spending.

The eventual increase in money velocity will lead to transitory inflation which no one is denying will happen, but will this inflation be sustained over a longer period?

Why inflation might last longer

A key reason inflation has been kept at such low levels over the last 10 years has largely been due to the low wages in America. An increase in wages grows inflationary pressures by increasing the disposable income of workers and therefore increased consumption and demand-pull inflation. Increased Wages also increase the cost of production leading to cost-push inflation. There is a substantial labour shortage in the U.S the exact cause is unknown republicans have blamed the high unemployment benefits. So it is unlikely at the moment, an increase in wages will lead to mass unemployment decreasing the inflationary effects of increased wages. This can be seen as chipotle has raised its wages to 15 dollars an hour to attract more workers.

It should also be noted that the unprecedentedly high money supply may also cause inflation the medium term especially if the extra 4 trillion in spending is passed. Increases in the money supply forces firms to raise prices as there is increased demand for the same supply.

Conclusion

It seems that there is a substantial risk for inflation, and the Fed is backing itself into an inflationary corner which will be tough to get out of. The Fed has a range of contractionary monetary tools but these may cause more harm than good. This is evident with the stock markets taking a tumble when Janet Yellen, the secretary of the treasury mentioned raising interest rates to prevent overheating of the economy.

The rampant spending and the current economic conditions have many big investors worried, like, Warren buffet who explained the substantial inflation experienced in his own companies and sounded the alarms for high inflation at Berkshire Hathaway’s most recent press conference. This worry is justified; inflation can be controlled but, the problem must be recognized, and greater caution from the federal government is imperative otherwise the U.S may be headed for very high levels of inflation.