Inflation: Turning the Tide
There are at least three economic theories on what causes inflation. They all point to an upturn in the coming months.
If you are a monetarist — a follower of Milton Friedman — inflation is a monetary phenomenon. Assets of the Federal Reserve have increased nine-fold from about $800 billion on Lehman Day (September 15, 2008) to over $7.3 trillion as the central bank went on a binge to buy bonds from the open market in exchange for newly printed money. Just a year ago, the Fed’s assets were $4.1 trillion — meaning that they increased by 78% since last January. This factor alone was not sufficient to cause an upsurge in prices for reasons I will not go into here.
If you approach inflation from a Keynesian perspective, the price rise is a consequence of increases in the cost of production that get passed on as higher prices (“cost-push inflation”). President-elect Joe Biden’s proposed $1.9 trillion economic aid program has components that could push up costs, reducing the beneficial impact on recipients.
A key part of the package of measures is an increase in the federal minimum wage from the current $7.25 to $15 per hour — the first increase in over a decade. Even though the increase will be phased in over time, employees whose productivity level cannot justify a higher wage will probably lose jobs rather than find employers willing to fork out the extra cash. Elsewhere, Masood Sohaili and I have argued that a well-structured Universal Basic Income program would be a better alternative to enhance the bargaining position of low-skill workers.
A third theory — also Keynesian — traces the cause of inflation to “demand pull’ factors. Higher prices result from an increase in overall demand. Even though consumer demand has been held in check by the high unemployment rate and fewer trips to retail stores, application of the vaccine should reverse the trend by mid-year. At the same time, expect government spending to continue to stay at higher than pre-covid levels. It is politically far easier to provide stimulus than to withdraw it!
These are the reasons why I believe that faster paced price increases are likely later this year. For me, it is a shift from repeated forecasts over the past decade that inflation was not likely to rise to the 2% annual rate that the Federal Reserve has consistently targeted and forecast.
Yes, the latest inflation numbers are tame. But signs are that the tide may be turning.
Komal S. Sri-Kumar
President, Sri-Kumar Global Strategies, Inc.
January 17, 2021
Sri-Kumar Global Strategies, Inc. advises multinational investors and sovereign wealth funds on global risk and opportunities. Dr. Sri-Kumar is regularly featured on business TV and Radio media, and is a frequent speaker in global financial centers on major topics that affect markets and investments.
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