Inflation is low, yet, inflation fears are growing. Especially as Democrats begin the final push of their $1.9 trillion stimulus package, commenters on the Right and Left predict generalized price increases.
The Left is generally more sanguine about this than the Right. Liberals emphasize the benefits of “running the economy hot,” while conservatives worry about ordinary people losing their purchasing power. As is usual in American politics, both the Left and Right offer a kernel of truth amid a heap of confusion. Let’s see if we can’t separate the wheat from the chaff.
The fundamental cause of inflation, always and everywhere, is “too much money chasing too few goods.” When the money supply grows faster than economic productivity, we get inflation. When economic productivity grows faster than the money supply, we get disinflation, a slowdown in the rate of price increases. And if economic productivity grows much faster than the money supply, we may even get deflation.
Contrary to Keynesian fever dreams, deflation isn’t always a bad thing. When the economy grows more efficient, when we get better at taking labor and capital and transforming them into goods and services, the natural consequence is for prices to fall. This kind of deflation is benign. But there is a kind of deflation that is nasty: the kind resulting from a sudden slowdown in total spending. We need to distinguish carefully between unremarkable supply-side deflation and undesirable demand-side deflation.
But deflation isn’t what everyone is anxious about right now. Inflation is. Should they be worried? First, note the public conversation now is all about the demand side. Exhibit A is the stimulus package. Everyone is talking about whether inflation will stay low or rise. This isn’t wrong, per se, especially if we’re concerned about the business cycle. But it blinds us to other consequences.
Can a big boost in federal spending generate inflation? It’s possible, but unlikely. For the stimulus package to drive up prices, at least one of the following must happen: The money supply must increase, or the rate of turnover of the money supply, how fast dollars change hands, must increase. The Federal Reserve isn’t responsible for the stimulus package, so it’s not going to be a money supply issue. If inflation happens, it must lie behind door number two. There’s some support for this; a big injection of public cash might prompt increased private spending.
Then again, it might not. Previous rounds of spending, which included checks for households, haven’t stoked an inflationary fire. Families saved a large amount of their COVID-19 bucks, which resulted in a much higher private savings rate, along with stronger household balance sheets.
That’s great if your goal is to help people survive lean times. But these relief acts were sold to the public as economic stimulus, which is a very different thing. The former is a worthy goal. The latter never had much merit.
The whole problem with the stimulus discussion is that it overlooks why the economy is still in the doldrums. Remember: Don’t confuse the demand side and the supply side! Very early during the COVID-19 crisis, it was plausible there was a demand shortfall. But those days are gone. Now, all the problems are on the supply side. No amount of economic “stimulus” can solve the problem of labor and capital staying home. Once we make more progress on the virus, things will really start to pick up.
What does all this mean for inflation? Short answer: not much. Don’t expect big price increases if the Democrats have their way. The stimulus package, quite the misnomer, won’t put more dollars into circulation, and it won’t much increase the rate at which dollars are spent. If inflation occurs down the road, it’ll be because of the central bank, not the Biden administration.
Alexander William Salter is an associate professor of economics in the Rawls College of Business at Texas Tech University, the comparative economics research fellow at TTU’s Free Market Institute, and a Young Voices senior contributor. Follow him on Twitter @alexwsalter.
