What's going on with inflation?

I recently posted an article on the Poole College Thought Leadership page titled: "What's going on with inflation?". 

This was a pretty general, high level article, so in this post, I wanted to add a few extra resources and details. 

Why doesn't the Fed target inflation at zero percent?

2% inflation provides a buffer against deflation (which is generally considered a bad thing).   In addition, a low level of inflation can lead provide some inherent flexibility for employers to adjust wage costs in slower economic times.  This is achieved by simply not increasing nominal wages, which results in a real wage cut for a worker.  See for example, this Cleveland Fed article for more details.  Also see https://www.federalreserve.gov/faqs/economy_14400.htm in which the Fed explains its 2% target.

In addition, there's evidence that a policy of complete price stability (0% inflation) could lead to a significant decline in GDP and employment.

What other factors might lead to inflation, aside from supply chain issues?

It's pretty clear that at the current time, inflation is being driven in large part by supply chain problems.   We can look at the price changes of new and used cars to see the impact the global chip shortage on car production.  But other factors might also lead to inflation.  

One possible factor might be stimulus money that was pumped into the economy during the pandemic.   This extra cash may result in fewer workers choosing to participate in the labor market.  Under classical economic theory, inflation is in part driven by labor market supply.

An interesting paper by the San Francisco Fed shows that the stimulus money (the American Rescue Plan) did indeed lead to a tightening of the market, but that the overall effect on inflation was fairly small.  A more general discussion can also be found in this NYT article (maybe paywalled).

 

Does everyone's wage increase when inflation increases?

The answer is clearly no.  There are many individuals who are perhaps on a fixed retirement income (technically not a wage), and also those in professions where wages are sticky.  A lot of government positions have fairly sticky wage structures.

There is some evidence the service/front line workers have seen wage increases, for example this Brookings Institute article shows wage changes at several retailers and restaurants chains.