Why is America Witnessing High Inflation?

Factors causing inflation

Inflation

You go to a grocery store and buy goods that you need; it’s a basket of different goods. You pay $100 for the goods and leave the store. A year later, you visit a grocery store and buy the exact goods that you bought a year ago, but this time the basket of goods cost you $110.

Now, you may not understand what has happened, but economics calls it inflation.

The cost of goods has increased over a year, and at the same time, the purchasing power of the dollar has decreased.

Demand push inflation

Inflation can happen for several reasons, but one of the most common reasons for inflation is when demand exceeds supply in an economy. It’s called demand push inflation, and this is what the United States is going through.

It will be wrong to point at any single factor for inflation, but a combination of factors has led to 40-year-high year-to-year inflation. The consumer price index rose 6.2 percent from October 2020 to October 2021, the most rapid 12-month increase in prices in more than 30 years.

The pandemic has triggered events that have led to a high inflation rate. Let’s start with the government’s benevolence.

Stimulus package

In the early phase of the pandemic, fiscal spending was not stimulating the economy but ensuring that people had access to basic goods and services. But by early 2021, it was clear that the economy was reopening, and the household incomes for 2020 were above normal.

Given the circumstances, spending wasn’t to keep the lamp burning but to provide the lamp with extra fuel. Even though the $1.9 trillion stimuli was reasonable, the timing and speed — all at once approach — led to above normal demand.

Limited option to spend

With all the pandemic allowance, people have cash with them, but pandemic has limited the options for people to spend money.

Fear and COVID-related rules have directed demand to the goods sector, with the service sector facing a slump in demand. For example, people are still reluctant to see a movie in the theatre; others don’t want to don a mask while watching a movie. This creates a demand for home-entertainment equipment. Fear of public transportation increases demands for cars and bikes.

During the period — 4th quarter of 2019 to the third quarter of 2021 — inflation-adjusted household spending on services dropped 2%, and spending on durable increased 20%.

Workers quitting the workforce

Workers are unwilling to go back as they have enough savings, at least for the short term, to go without work for the near future. Then came the unemployment benefits that many states have stopped from September this year, but its effect will remain for some time.

As the article puts it, “For much of the year, expanded unemployment that paid many people more to stay home than to work played a role.” And the pandemic rules are also ensuring that they stay out of the workforce.

Approx 95,000 people are tested COVID positive every day, and let’s say 50,000 out of the 95000 are employed, and on average, a person who tests positive misses three days of work.

Further, contacts of COVID-positive people also need to quarantine, and some need to take care of sick in the family, so the number of people staying away from work, directly or indirectly because of COVID, is approx 300,000 to 500,000.

And all these leaves are unplanned, so either employer will need to spend to find a replacement or continue with the posts being vacant.

COVID contracted the workforce; the workforce is more than 2 million smaller in November than it was in February 2020. Schools and daycares are not operating the way they used to before the pandemic. As the article puts it, “Some districts continue to cancel classes because of staff shortages and demands for extensive cleaning.”

So there are fewer workers in the economy than there were before the pandemic. But the demand remains high and companies are having a hard time meeting the demand. But this isn’t the only problem.

Imports declining

The imports that countries rely on directly or indirectly also took a hit because of the pandemic, which has caused the prices to surge. For example, lockdown in Vietnam in August disrupted the computer-chip supply.

What can be done?

The government has to look beyond the usual raising interest rate. Most of the factors are temporary so managing COVID in a better way, a better policy that vaccinates more people and provides people with cheap and rapid tests. The last one would lead to quick isolation of the infected before the virus spreads or the infected comes into contact with people.