VIRGINIA POLICY REVIEW
  • Home
  • About Us
  • The Third Rail
    • The Third Rail Editorial Board
  • Academical
    • Archived Podcast Episodes
  • National Journal Conference
  • Journal Submissions
  • Journal Issues

The Third Rail

An Online Publication of the Virginia Policy Review

Inflation in a Post-Pandemic Economy

3/29/2021

0 Comments

 

With the end of the pandemic in sight, many are hopeful for a swift economic recovery. But as the exact timing of a return to normal remains uncertain, so too does the fate of millions still looking for work and wondering if homelessness is just around the corner. In an attempt to extend a lifeline, Congress passed the American Rescue Plan. This $1.9 trillion dollar measure not only provides another round of stimulus checks, but also extends unemployment benefits, doles out aid to families with children, assists state and local governments, and bolsters pandemic response efforts.

Many cheered the Act’s passage, but it turns out that neither politics nor economics admit of happily-ever-afters. And so the story continues, featuring a small but growing chorus of economists warning that excessive stimulus risks “overheating” the economy and causing difficult-to-manage inflation.

Given the Rescue Plan’s party-line backing, it might be tempting to brush these claims aside as political attacks. Yet the inflation hawks are not so ill-intentioned. Not only are they bipartisan, led in part by former Obama official Larry Summers, but they are also correct in pointing out that inflation can have potentially dire consequences. In the 1970s, for example, “The Great Inflation” severely eroded consumers’ purchasing power and led the Federal Reserve to force a recession.

While few might see a return of that era on the horizon, it nonetheless illustrates why we ought to take inflation seriously. This article is an attempt to do so, and to provide a balanced assessment of the future.
What is inflation and what causes it?

Put simply, inflation is an increase in the average price of a bundle of goods and services. Like anything else, a little inflation is good in moderation, with rising prices translating into more revenue for firms and higher wages. But if it flies out of control and prices rise faster than wages, inflation can erode consumers’ purchasing power and leave people struggling to make ends meet.

At bottom, inflation is a symptom of a larger problem — the fact that a limited supply of resources constrains economic growth. In other words, there are only so many people, machines, factories, and natural resources that are available to produce the goods and services we want to buy. So when demand increases at a rate faster than the economy can respond by hiring new workers or building new factories, scarcity pushes prices upward (demand-pull inflation). Conversely, when the cost of hiring those new workers or building those new factories increases, that will also push up prices (cost-push inflation).

There are a number of theories describing what variables set these forces in motion, but the majority of economists focus predominantly on employment and public expectations. In explaining cost-push inflation, their reasoning is that when unemployment is low and workers are scarce, wages rise. This translates to an increase in prices, as firms push the costs of those higher wages onto consumers. As inflation increases, so too does expected inflation, and workers continue to demand higher wages to afford the higher prices they see down the road. Firms will acquiesce (again, because workers are scarce) and will once more raise prices in response. It is this “wage-price spiral” that marks truly dangerous inflation and motivates the belief that there must be some natural unemployment in the economy.

Employment is also related to demand-pull inflation. In a demand-pull scenario, factors such as economic growth or government spending stimulate consumer demand at a faster rate than the economy can respond by increasing supply, resulting in higher prices. Very low unemployment is an indicator that the economy is reaching its capacity and that additional spending would be inflationary. 

What is the Risk of Inflation in a COVID-Free World?

This explains why some economists are worried about the American Rescue Plan. By injecting so much money into the economy, the government is stimulating demand and lowering unemployment. If the current recession were to continue past the pandemic (keeping both demand and employment low), that might not be a problem. But once the economy gets back on its feet, the question is whether it will come back with a vengeance, spurred on not only by a natural recovery, but also enormous amounts of government investment.

The most likely answer is no, though there are some warning signs. Inflation hawks note, for example, that the price of basic commodities like copper, lumber, iron, and tin are on the rise as suppliers struggle to meet resurgent consumer demand. And some are concerned that investors are starting to demand higher interest rates on long-term Treasury bonds (in order to protect the value of those investments from being watered down by increasing prices).

Again, however, most data continues to predict very manageable inflation. In fact, central banks have long thought that inflation is too low, and the increase in bond prices suggests that we will finally reach the ideal 2% target, rather than overshoot it. On top of that, the economy is still in dire straits, with Goldman Sachs predicting that unemployment won’t dip back below 4% for another three years. The Federal Reserve, responsible for managing inflation through interest rates, has consistently argued that the risk of congressional inaction outweighs the risk of inflation.

Much more likely than a sustained crisis is a temporary price hike, as consumers spend what they save throughout the pandemic, and the economy struggles to immediately respond. But that occurrence is unlikely to change our key indicators — employment and public expectations — which both predict only a modest increase in long-term prices. Once the pandemic is over and people are more tempted to spend freely, there will still be a lot of idle production capacity available to match an influx of dollars with readily available goods and services.

Looking Ahead

What does all of this mean for the future? For starters, Summers is right to point out that the country still faces enormous problems, including “economic injustice . . . and inadequate investment in everything from infrastructure to preschool education to renewable energy.” Fixing these problems is going to cost a lot of money — just as it is becoming more risky to spend.

Tailoring federal aid to the people and projects most in need would go a long way, maximizing the benefits of each possibly inflationary dollar. Instead of giving stimulus checks to those who escaped COVID’s financial repercussions, for example, it would be far more efficient and effective to spend that money on public infrastructure.

Another obvious proposal is to offset the risk of new spending with deflationary taxes. This is not politically popular, but it must happen at some point if we want both ambitious reform and a stable economy.

In the end, this might not seem like a surprising place to finish. You probably already knew it is a good idea to raise taxes to pay for new programs, or to use government resources as efficiently as possible. But I think there is reason to come away from the inflation debate with a renewed sense of balance, understanding, and hope. No matter your party, current economic conditions provide neither an excuse to spend freely, nor to stop fighting for an ambitious and inclusive vision of progress. We have the resources to make a better world. It’s time to use them wisely.
​
Picture

Kevin Breiner

Kevin Breiner is pursuing a Master of Public Policy and Juris Doctor. Primarily interested in environmental issues, he has worked for Our Children's Trust as a summer clerk and is an executive editor on the Virginia Environmental Law Journal. He enjoys writing about economic and social policy issues for VPR.​
The views expressed above are solely the author's and are not endorsed by the Virginia Policy Review, The Frank Batten School of Leadership and Public Policy, or the University of Virginia. Although this organization has members who are University of Virginia students and may have University employees associated or engaged in its activities and affairs, the organization is not a part of or an agency of the University. It is a separate and independent organization which is responsible for and manages its own activities and affairs. The University does not direct, supervise or control the organization and is not responsible for the organization’s contracts, acts, or omissions.
0 Comments

Your comment will be posted after it is approved.


Leave a Reply.

    Categories

    All
    Domestic
    Economics
    Education
    Electoral Politics
    Environment
    Gun Rights
    Health
    International
    Justice
    Law
    Politics
    Social
    Urban

    Archives

    April 2022
    March 2022
    February 2022
    December 2021
    November 2021
    October 2021
    June 2021
    May 2021
    April 2021
    March 2021
    February 2021
    January 2021
    December 2020
    November 2020
    October 2020
    May 2019
    March 2019
    February 2019
    January 2019
    October 2018
    September 2018
    March 2017
    February 2017
    January 2017
    November 2016
    October 2016
    September 2016
    August 2016
    April 2016
    March 2016
    February 2016
    December 2015
    November 2015
    October 2015
    September 2015
    March 2015
    February 2015
    January 2015
    December 2014
    November 2014
    October 2014
    September 2014
    August 2014
    July 2014
    April 2014
    March 2014
    February 2014

ADDRESS

Virginia Policy Review
235 McCormick Rd.
Charlottesville, VA 22904

EMAIL

​virginiapolicyreview@gmail.com

SOCIAL MEDIA

  • Home
  • About Us
  • The Third Rail
    • The Third Rail Editorial Board
  • Academical
    • Archived Podcast Episodes
  • National Journal Conference
  • Journal Submissions
  • Journal Issues