Inflation: Why and How to Fix It

June 12, 2022

Last week, the Labor Department issued its May Consumer Price Index Report, which showed that consumer prices overall rose 8.6% compared to the year before – the highest rate of annual inflation since 1981. This has caused a sharp rise in the cost of living for most Americans, and significant resulting hardship. Inflation is now one of the top issues among voters in virtually every poll (including our own). It comes as no surprise that political leaders of every stripe have their own explanations and diagnoses for how to end inflation – some of them wise, and others self-serving and dubious.

The blunt reality is this: there are no simple solutions, and anyone saying there are is either uninformed or worse. Today’s high rates of inflation are a direct result of intertwined and complex causes: mainly COVID, the resulting labor market dislocation and the war in Ukraine, though economic and monetary policies have also played a role.

Most importantly: what can be done about it? There are answers, but none of them are simple.

Everything is global

One important fact about inflation rates is that they are not just an American phenomenon. Inflation is currently rising quickly in virtually every country on earth:

The first, and biggest reason for this is also the most obvious: COVID.

The COVID pandemic wrought havoc on the global economy. In China alone, which accounts for about 12% of all global trade, COVID-related disruptions idled many factories and warehouses for months and economic unrest continues. The pandemic sidelined workers, panicked families and political leaders alike, and caused a snap global recession in 2020. In the United States alone, unemployment hit 14.7% in April of 2020, and most other countries saw the same.

Around the industrialized world, consumer demand was effectively pent up for over a year or more, as governments enacted measures to protect public safety. But then, something happened: demand for goods almost immediately recovered, and then began to skyrocket at a rate previous not seen. U.S. retail sales recovered to 2019 levels by June of 2020, while spending on services did not reach that level until June of 2021.

In other words: Americans went shopping, and so did consumers in most other wealthy nations. The resulting spike in consumer demand coincided with constricted supplies of the very goods they were buying, along with a clogged global supply chain. This led to higher prices.

COVID had another, more important impact: many people died, and lots more developed serious health complications as a result. As of this writing, the COVID pandemic has killed almost 6.5 million people globally, according to Johns Hopkins University. One million of those were Americans. This is very likely an undercounting of the total global death toll. This leads to the second major reason for inflation: a great re-sort of who does the work.

The Great Labor Re-sort

When a million Americans died of COVID (and continue to), they also obviously drop out of the workforce. Even though roughly 70% of Americans who have died of COVID are over 65, many of them were nevertheless still working, usually because they have no other choice. Those workers are not, of course, coming back.

Even those who survive COVID did not all automatically rejoin the workforce. Research from the Federal Reserve Bank of St. Louis found that COVID accelerated shifts to retirement among American seniors and took a huge swath of them out of the workforce, probably permanently. Restrictive immigration policies over the last decade, which greatly accelerated during the Trump administration, have also reduced American labor supply by about a million workers.

Now, there are simply fewer workers around than before COVID – while consumer demand keeps rising. This leads to higher wages, which is precisely what we have seen. Workers today are “trading up” for jobs. Workers who used to be part-time are increasingly opting for full-time, salaried jobs with benefits. Part-time hourly employers, especially in sectors like retail and food service, are scrambling to keep up.

See: How North Carolina’s leaders can put hourly workers first.

War in Ukraine

While the ongoing war in Ukraine may seem distant, its effects on inflation are very significant for two reasons: oil and food.

Russia is one of the world’s largest oil producers, and its war against Ukraine removed about 3 million barrels per day from the global oil market – one of the largest drops in supply since the 1970s. Once again, we see a huge drop in global oil supply just as demand increases, hiking oil prices.

Critics have complained that the Biden administration is somehow responsible for high oil prices because of reduced domestic production. But this claim doesn’t hold up to scrutiny – in fact, oil production is actually higher under the Biden administration than his predecessor. It is also noteworthy that the American fracking industry experienced a boom under President Obama (where then-Vice President Biden was of course involved), much to the dismay of climate activists.

Note: Voters in North Carolina support expansions of both renewable and nuclear energy sources.

Oil is a major component of prices in many or most goods consumers buy – from food, to fertilizer, to cars and refrigerators. When oil prices increase, everything does – including, of course, gasoline. This is part of Putin’s strategy to exert economic pain on the west. Russia’s political calculation is that higher oil prices will hurt voters in the U.S. and Europe and that this will weaken western military resolve to assist Ukraine.

The second way the war in Ukraine increases inflation is through food prices. Ukraine is a major grain exporter to the world, accounting for about 7% of all global wheat. As Russia blockades Ukraine’s major ports in the Black Sea, it is largely unable to export that wheat, increasing global commodity prices. (Russia is also a major wheat exporter, and is now making those exports available only to its allies – also at higher prices.) The higher prices Americans face for food are a direct result of these actions.

Domestic policies

There are undeniably monetary policies that contribute to inflation as well, though economists debate their role and significance. Central banks around the world, including the Federal Reserve, have dropped interest rates in the name of economic growth and low unemployment, though these have the effect of increasing the money supply. Whether this increase is called “artificial” or not largely depends upon one’s political ideology.

There are also arguments that large budget deficits have also caused inflation. But in fact, the U.S. federal budget deficit is not increasing – it is now dropping. After a major increase under the Trump administration, the Biden administration is cutting spending.

So what to do?

Perhaps the most glaring aspect of the inflation controversy is the lack of practical solutions most political leaders are putting forth. Even those politicians shouting loudest about inflation seem to put forth the fewest ideas about what to do about it.

But last week, that may have changed. A pragmatic coalition of centrist Democrats in Congress put forth a comprehensive plan to fight inflation and Americans’ reduce the cost of living. The plan includes measures like reducing tariffs and barriers to trade, loosening immigration restrictions to enable more workers to enter the United States, and investing heavily in clean energy, which will shield Americans from the costs of future energy shocks. We’ll see if these leaders are able to win bipartisan support for their proposals.

Another major component of the rise in cost of living is housing. For most Americans, housing is their single largest household expense, and the price is going up fast. Significantly expanding the available housing inventory should be at the top of the list of any realistic plan to fight inflation. State leaders have many options at their disposal to do this.

In the meantime, there are no easy or quick fixes to inflation. Beating inflation will require steady, serious and empathetic political leadership that understands the pain it inflicts on Americans’ wallets. As usual, real solutions are difficult, while cheap grandstanding is easy. Pay attention to which leaders do what.

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