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Inflation On The Rise?

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Why Inflation Matters

It hurts workers and retirees, disrupts investment, and can be hard to control.

Allison Schrager

Americans under 40 live with no memory of high or unpredictable inflation. Thus, the generational divide over the new, rising risk of inflation, with younger Americans more complacent, is no surprise. I don’t remember the high-inflation days, but I still fear the prospect of their return—in part because I study economic history and because most of my research focuses on financing retirement, but mostly because whenever we count out a risk, it seems to come roaring back.

Policymakers and observers may be tempted to let the price level creep up to 4 percent yearly growth and see what happens, but inflation can quickly spiral out of control. (The Federal Reserve currently targets an average inflation increase of 2 percent; inflation rose in April at a 4.2 percent yearly rate.) If prices seem poised to increase, then people will demand higher wages. They will then have more money to spend. Businesses, paying higher labor costs, will produce fewer goods, pushing inflation higher. Inflation makes the dollar less attractive as it depreciates; buying imported goods becomes more expensive, too.

The only tactic to break persistently high inflation is aggressive central bank policy, such as hiking interest rates, as Paul Volcker did in the 1980s. Volcker tamed inflation but caused a recession doing it. Yet, it was a worthwhile trade-off, because he made markets believe that the Fed would do whatever it took to control inflation—which they believed for decades.

In theory, this credibility means that today’s Fed won’t need to resort to Volcker-style rate hikes to keep inflation in check. But that’s true only if the Fed today is as credible as Volcker was back then. Fed policy and communication in the last 25 years suggest that the central bank can barely tolerate a daily dip in the stock market, let alone a recession. The Fed has even less credibility lately, as it faces political pressures to keep rates low to solve everything from racial inequality to climate change.

That should worry us. Inflation imposes direct costs on many parts of the economy. Making investment decisions is hard during high inflation. The economic outlook becomes more uncertain when prices are volatile. Producers don’t know if rising prices mean more demand for their products or just more money sloshing around.

Inflation also erodes the value of debt. That erosion is great for people with a fixed-rate mortgage but bad for lenders. So when inflation goes up, lenders charge higher interest rates on everything from bonds and mortgages to car loans. Interest rates rise not only to compensate investors for inflation but also to account for the risks associated with an uncertain inflationary environment. Even the threat of high inflation can cause rates to increase, making investment more expensive and less appealing.

Inflation also imposes costs for consumers: just ask anyone who lived and shopped in the 1970s, when prices quickly outpaced their paychecks. And not everyone experiences inflation the same way. It has become popular to argue that tolerating higher inflation will boost low-skill employment and wages, but the supposed beneficiaries are the same people most hurt by rising prices. Someone on a fixed income, perhaps retired with a pension, will get poorer each year. A low-skill worker with less market power will be less likely to get a raise to keep up with inflation. Low earners are also less likely to have money invested in assets, like stocks, that offer inflation protection; they spend more of their income on goods—oil, food, housing, and health care—that are susceptible to high inflation.

We still don’t know what the latest burst of inflation means. It could be transitory, mostly a result of the end of the pandemic. It could also soon make people under 40 learn why their elders are so worried. In any case, a loose Fed policy that courts high inflation won’t be cost-free.

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5 COMMENTS

  1. Valuable coment. I have been thinking about this a bit.
    Housing of course isn’t measured in our inflationn measuring program but look a what is happening.

    Jacinda and the nice Mr Key have set this time bomb off. Key set the way and Jacinda and co have lit the fuse.

    Our inflation has been under control for a long time, not for the reason the writer suggests at all. Raising interest rates as was done simply created the depression that came with them.
    The reason inflation came down was China.
    No one with their eyes open could have failed to notice the impact of Chinese made goods on the world markets.
    Items came from China for way less cost than could be produced anywhere else in the world. Computers came along an aided that process in so many ways. The cheaper cost/price juggernaut got underway with suppliers like Walmart /Wharehouse/ Bunnings and so many others supplying goods at less cost today than 40 years ago. A new Mitsi for example cost less than a holden of those days and is a far superior vehicle.
    But, the wheel is turning, China now has rising costs, a rising standard of living and ageing population and is intent on having wars around many places.
    Trump realised this when he imposed tariffs and in return got a big lift in the farm commodity prices suppiled to China.
    What that all means for NZ is that while we will get better prices for our produce for a while we will also get inflation, not just from China but from many other countries as well. Who doesn’t want to keep up with the standard of living stakes?
    Add to that the current Govt. management of things and the legislation making business very tough in many ways and we have a problem.
    Buy all the land and houses you can. But, make sure you can pay the interest at a much higher level. Your cash in the bank is not earning now but will devalue like you probably can’t conceive.
    Seen it all before.

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  2. The Budget is predicting inflation to be 2.4 per cent this year falling mysteriously to 1.7 per cent, never to exceed 2 per cent. The whole Budget depends on believing inflation is going to pass through and disappear. When has that ever happened?

    The Consumer Price Index is an artificial construct. If ministers did not live rent free and be chauffeur-driven they would know there is raging inflation.

    Food prices went up a whopping 9.5 per cent last year and continue to increase.

    Rents are rising.

    Petrol this time last year was $1.96 a litre. Today it is $2.29.

    The building industry is over-stretched with a record number of building consents. There are shortages of tradesmen and materials. Costs are rapidly increasing.

    The blue sky Budget’s proposed infrastructure spending is in addition to last year’s 150 “shovel-ready” projects costing $2.6 billion. Half have not yet started. These government-funded projects will be competing for the tradesmen and resources.

    https://www.nzherald.co.nz/business/richard-prebble-a-black-cloud-in-the-blue-sky-budget/IPYG22SJIRISHE2SQTR2P37TRM/

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  3. Once inflationary expectations get established, it takes very tough measures to eradicate them. In the battle against inflation, interest rates reached their all-time high of 67.32 per cent in March of 1985.

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  4. Of course they need inflation to erode the massive debt they are accumulating.

    However the debt mountain will be so high that the 1970s inflation level will not erode it.
    Nonetheless following Muldoon policy and actions to a tee.

    Of course there is a solution …
    Turn Ao tear Zealand into New Venezealand

    Yep, I think that might work .
    Work has commenced.
    Watch out for the orange cones.

    5

    0

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