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.  

Fed Transcripts for 2006

Did the Fed see the impending financial train wreck coming?

Nope, in fact they thought things were going swimmingly.

Damodaran on Taleb

Aswath Damodaran is a Prof of Finance at NYU.  He's well known for his book on equity valuation, which is excellent.  He also maintains a blog, which unfortunately he doesn't update that often, but when he does, he posts some gems.   For example, here is his take on Nassim Taleb's rant about the Nobel prize committee.

As readers will remember, I've posted on Taleb before.

Aswath also posts on QE2 with the memorable title "QE2 or Titanic"

The Fed's QE plan in plain English

There's plenty of talk about the Fed's plan for quantitative easing.  If you're having trouble understanding the details, then follow this link for a plain English version.

HT: Felix Salmon

A few interesting posts from the blogosphere

Rolf Winkler talks about last night's frontline documentary on for profit education.
http://blogs.reuters.com/rolfe-winkler/2010/05/05/frontline-exposes-for-profit-education/
The frontline documentary is well worth a look.

Greg Mankiw posts a graphic of what the federal budget will look like in 2020.
http://gregmankiw.blogspot.com/2010/05/federal-budget-in-one-picture.html
Bottom line, after you take out defense, social security, medicare, medicaid and interest expense you're left with 23% that goes to "other". The clear reality, that perhaps the tea party crowd have not appreciated is that if you want to cut the government debt you need to make cuts in these four areas.

Mankiw also talks about price gouging. http://gregmankiw.blogspot.com/2010/05/in-defense-of-price-gouging.html
Apparently there has been a water shortage in New England leading to spikes in the prices of bottled water. Politicians are crying foul and accusing vendors of price gouging. Further evidence of how clueless politicians are when it comes to Econ 101.

Finally, Steve Allen talks about how GM paid back its TARP to the government by borrowing money from the government. Ultimately tax payers are likely to take a $30bn hit on GM. http://stevenallenblog.blogspot.com/2010/05/truth-about-gm-repaying-its-tarp-loan.html

Alan Greenspan - it will happen again...

The ex-fed chief talks about the current mess and the likelihood of it happening again.

A visual guide to the Federal Reserve

A cute guide here.