The defining economic event of 2022 was inflation, a concept that the average American (Average Age: 39) has had little experience with. This is because the United States has had remarkable price stability over the last 40 years, with the last significant inflation event being the double dip recessions of the early 1980s.
The Consumer Price Index (CPI) is the most common measure of the overall price level (inflation) and can be broken out into two parts: Flexible (high volatility) and sticky (low volatility).
Changes in flexible inflation are fairly easy to explain away; their root causes are supply shocks (Cost-Push Inflation). Guided by commodity markets, these changes tend to adjust fairly quickly as the root problems are physical ones with physical solutions: the cure to high prices is high prices. The classical economic approach for flexible price increases is to do nothing and wait for additional supply at these new (temporary) higher prices. The added physical supply will bring down the price, and the cycle repeats which is the reason for the whipsaws in flexible inflation. They are accounted for in supply and demand changes. Supply chain problems and the war in Ukraine have contributed to the run-up in inflation seen in 2022.
Sticky inflation is the key measure the Federal Reserve targets as it has a much higher weight in the overall CPI index. This source of inflation tends to be Demand-Pull, too much money chasing too few goods. The major components of sticky inflation include housing, education,and medical expenses—heavily subsidized costs due to the COVID pandemic.
- The Centers for Disease Control and Prevention (CDC) took unprecedented action by issuing a temporary national moratorium on most evictions for nonpayment of rent to help prevent the spread of coronavirus.
- For federal student loans, there was a suspension of loan payments, a 0% interest rate, and stopped collections on defaulted loans.
- For healthcare, Congress enacted the Families First Coronavirus Response Act (FFCRA), which included a requirement that Medicaid programs keep people continuously enrolled through the end of the month in which the COVID-19 public health emergency (PHE) ends, in exchange for enhanced federal funding. Unwinding these programs means increasing prices, which has led to a rise in sticky price inflation.
In addition, there were numerous state and local funding measures. In total, some 4.6 trillion ($4,600,000,000,000) was introduced into the economy at a federal level.
This increased the money supply significantly.
This money needed to go someplace, which led to an increase in savings rates. That excess savings led to excess “investment.” 2021 also saw a housing prices spike, a meme and tech stock boom, and a crypto “asset” bubble.
These systems will reverse in 2023 as money is removed from the system and these assets deflate. The little dip in the money supply started in the middle of 2022, when stocks started to decline. Bringing the money supply back to trend will require much further contraction, leading to job losses and further asset deflation.
These are the economic problems and the economic solutions that are currently being used to bring down inflation. This is necessary to arrest the development of further inflation, which leads to a problem that economists have a terrible track record of solving.
The Psychological One
Inflation is, at first, a number, then a narrative. If left unchecked, it turns into a state of mind that leads consumers to spend more quickly than they otherwise would in the belief that prices are rising. At the start of an inflationary episode, people anticipate prices rising and thus will save money to deal with those higher prices. In the middle (and end) of an inflationary episode, consumers spend their money as fast as possible in anticipation of higher prices tomorrow.
The longer inflation stays elevated, the more likely people will demand higher wages to compensate for their declining economic situation. This often leads to an adversarial nature in bargaining, job switching, strikes, and labor slowdowns. This raises costs for employers, who pass those costs onto their customers, who are also their employees.
Both inflation expectations and the wage-price spiral are positive feedback loops that, once started, often lead to permanent societal changes.
Inflation makes it harder to plan for the future, and people need to be compensated for this uncertainty. This means higher wages and interest rates, as money and time have an increased cost.
A high-inflation world is a low-trust world, and a low-trust society is more costly to everyone than a high-trust society. The Federal Reserve is willing to cause pain now to stamp out inflation because the alternative is to accept a low-trust world.
The last 40 years have been a just-in-time / high-trust / high-functioning one that produced a lot of stable wealth. There is a case to be made that the next 40 years will be more of a just-in-case/ lower-trust/ inefficient world with redundancies. Only time will tell!
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Thomas Galvin is the Director of Research for Stream Realty Partners’ Southwestern Region. He is a real estate economist with a focus on understanding and explaining macroeconomic trends through a commercial real estate lens.