Three months ago, when you could still buy a used car for a reasonable price, the debate on inflation was on whether or not it was real. Now, we have moved onto whether this inflation is a ‘transitory’ effect of the lifting of COVID restrictions or if it will be more sustained. The best indication that it is likely going to be a longer-lasting level. Managing the ramifications of that inflation is where things get hairy.
Unprecedented levels of both fiscal and monetary policy were helpful in stabilizing an economy in free fall, but they also pumped unprecedented amounts of money into the market. After the financial crisis, loose monetary policy resulted in a booming stock market and widescale employment, but it never really brought about rising wages and thus consumer goods’ prices stayed relatively stable. This time around, the federal government stuck money directly into the pockets of consumers. On top of that, generous unemployment benefits have kept many out of the workplace unless induced by higher wages. Low-wage workers have experienced their fastest raises in decades.
Unemployment levels have not yet reached the lows of 2019, so the economy is not suddenly exploding with double-digit growth. Wages, however, unlike consumer goods, are what economists like to call ‘sticky.’ People who make higher wages are generally unwilling to accept lower ones. That means, when people DO go back to work, they will probably be making more money. More money in the hands of consumers, especially the lowest-income consumers, means higher spending and, you guessed it, inflation.
There are two questions remaining: 1) will wages continue to rise? and 2) will wages rise more quickly than the cost of living? If people start blasting off applications at the same time, supply of labor will balance with the demand and wages will stop rising. Less cash flooding consumer goods markets and housing markets will mean slower inflation. Asset prices, however, will continue to climb and inequality will climb even higher (wealthier people tend to hold more financial assets, which benefit from loose monetary policy even as wages stagnate).
Even if the supply of labor returns a bit more slowly, real wages could decline, though, if inflation comes too quickly. Soaring prices on everything from vehicles (in part due to a shortage of silicon chips) and coffee (due to poor yields, probably from climate change) can individually be explained by temporary factors. However, the whiplash on supply chains could prove an enduring problem, especially with the continued protectionist behavior by countries across the globe. If supply issues take years to resolve, the higher prices can hardly be called transitory.
The economy will have to be monitored closely to determine the proper course of action. If labor supply is tight, spending $1 trillion on infrastructure may put too much pressure on it, crowding out private companies. If, instead, people return to work rapidly, we could experience a recession while waiting for Congress to hammer out the details of a package. The best possible way forward would be to put automatic releases on projects based on economic benchmarks like total employment and real wage growth. Spending too rapidly could cause everything to come crashing down around us, but the same could be true of an overly miserly approach. It was true three months ago and it’s truer now: this is a high-risk economy, but we could come out of it in better shape than we have been in for a long time if we can manage it well.