The Bureau of Labor Statistics released its May report on inflation, showing an increase of 8.6% on an annualized basis. This is the highest reading since December 1981 when Paul Volcker was chairman of the Federal Reserve and Ronald Reagan was president. Why is inflation running so fast? What will it take to bring it down? Will America enter recession?
Why is inflation so high?
Inflation occurs when demand exceeds supply. While it is the same this time around, its reasons are quite different from at any other time in American history. It all started when the pandemic struck. Without government intervention, the pandemic would have caused a severe recession, some suggest a depression. How do we survive a severe recession?
In 2020, the Trump administration and Congress passed a series of stimulus bills that totaled just under $3.7 trillion. When President Biden took office, his administration and Congress passed an additional $1.9 trillion in stimulus money. Combined, Washington has spent about $5.6 trillion in bills related to the pandemic. The Fed has also trickled in with aggressive monetary stimulus of its own. point? During the past two years, the federal government, along with the Fed, have added enormous amounts of monetary stimulus to the US economy. This stimulus led to a booming economy, although it did not help everyone.
Then came the disruption in the supply chain in Ukraine and the subsequent war. At first, companies did not get enough labor and materials and all aspects of the supply chain (ex: source products, manufacture, distribution, etc.) were disrupted. When Russia invaded Ukraine, oil prices soared, leading to higher gasoline prices. The Russian invasion also contributed to shortages of seed oil, corn and wheat, three of Ukraine’s biggest exports. While prices of these food products have increased significantly, high gasoline prices and labor shortages are contributing to overall food inflation. Thus, the combination of excessive monetary stimulus and supply constraints has given rise to one of the largest supply-demand imbalances in American history. Result? Moderately high inflation.
What will it take to bring it down?
Two things must happen for inflation to come down to a manageable level. Supply should increase and demand should decrease. However, with a growing number of businesses warning of an economic slowdown, how much can supply go up? If businesses, many of which are already grappling with excessive inventory, fear an impending recession, they won’t rush to add supplies. Thus, even if the supply chain problem is resolved soon, it is unlikely that there will be enough businesses to spend on the additional product, except for essentials like food, gasoline and the like.
How do you reduce excess demand? Enter, the Federal Reserve. The Fed, which was late in taking action, has announced a series of rate hikes designed to raise borrowing costs in an effort to spur demand. The Fed has also announced that it will reduce the amount of monetary stimulus it will add to the economy. If the Fed’s plan to reduce demand is successful, and demand doesn’t fall too much relative to supply, the economy will have a soft landing, meaning we’ll avoid a recession. Will this happen? Will we have a soft landing, or will there be a recession?
Will America enter recession?
Recession occurs when the economy contracts for two consecutive calendar quarters. The economy (GDP) declined by 1.6% in the first quarter of 2022. If we see similar results for the second quarter, it would meet the classic definition of bearish. Is America its 16 . will experienceth Recession Since the Great Depression? probably. It is highly unlikely that the Fed alone will be able to bring down demand relative to supply to normal levels. It will also depend on the Biden administration and Congress.
who’s to blame? If you watch Fox News, everything is the fault of the Biden administration and the Democrats in Congress. If you look on the other side, it’s the pandemic and Russia and the Republicans when they were in office. What is the truth? If you take politics out of the equation, the real cause of 40 years of record high inflation is the pandemic, the Fed’s inability to act quickly, Russia’s invasion that created an oil shortage, which pushed gasoline prices higher, And Both Parties in Washington. The complexity of the issue doesn’t lend itself to media-biased sound bites. Don’t expect lots of media to provide both sides of the argument. After all, it is election year.
Credit: www.forbes.com /