Inflation rates are rising in the United States – an economist explains why


(The Conversation is an independent, nonprofit source of news, analysis, and commentary from academic experts.)

(THE CONVERSATION) Consumer prices in the United States are rising due to inflation at the fastest rate in decades. Earlier this summer, SciLine interviewed Martha Olney, professor emeritus of economics at the University of California, Berkeley, about the causes of rising prices and what government can do to encourage a return to stable prices.

The Conversation has collaborated with SciLine to bring you the highlights of the discussion, which have been edited for brevity and clarity.

What factors contribute to inflation?

Martha Olney: If more people want to buy things – that is, if there’s an increase in demand – that’s going to drive up prices. The other thing that can drive up prices is a decrease in supply – for example, if it becomes more difficult to produce goods. This happens if there are supply chain disruptions or transportation disruptions.

In the last two years, we’ve had both of those things. At the start of the pandemic, demand changed and we started buying more goods, rather than services. We were buying more cars, more electronics, more household goods. And we’ve seen that price impact. At the same time, we had supply chain disruptions. So the demand for goods increased, but the things needed to produce those goods were not as available, and so those prices went up.

How did the war in Ukraine make inflation worse?

Olney: While we were still dealing with the pandemic, the war started in Ukraine. This has had an impact on both energy prices and food prices. Energy prices have increased due to sanctions imposed on Russia – Russia supplies oil to the world market. The price of oil is set in a global market, so any disruption in the supply of oil impacts the price of oil worldwide. Ukraine and Russia also provide a significant share of global wheat exports, and their ability to grow, harvest and export their grain has also been affected by the war.

How can previous periods of inflation help us understand what is happening now?

Olney: In the 1970s, the OPEC oil crisis led to a reduction in oil supply, which drove up oil and fuel prices. And that was, again, a supply restriction. At the time, this caused the prices of many things to rise because fuel was an important ingredient in so many things we produced, and inflation took off.

So it’s the historical period that I think is particularly relevant because it leads to the evolution of our inflation expectations. There’s a survey that’s done every month where people from the University of Michigan come out and ask a group of consumers what they think the rate of inflation is going to be next month and next year. These responses are called our “inflationary expectations”.

Inflation in the 1970s followed a 15 to 20 year period of stable inflation, during which people’s answers to this question did not change much from month to month. This episode we’re going through right now follows 30 years of stable inflation, where people’s answers to this question haven’t changed much from month to month either. And so, the parallels are rising prices, driven primarily by supply constraints, as well as people’s inflationary expectations. People are expecting a higher inflation rate than a few months ago.

Who is responsible for reducing inflation and what tools does he have?

Olney: In the United States, the main inflation-fighting agency is the Federal Reserve. The tool available to the Federal Reserve is changing interest rates. Some regulatory agencies may be able to adjust their regulations and bring prices down a bit, but the real changes that matter are the Federal Reserve and its use of interest rates. The Federal Reserve will either slow the economy by raising interest rates or stimulate the economy by lowering interest rates.

What stabilized prices after this similar period in the 1970s?

Olney: The Federal Reserve broke that inflation by undertaking extremely restrictive, conservative and restrictive monetary policies. They raised interest rates to 18%. So, to get a mortgage to buy a house, the interest rates were 16% to 18%. It brought demand to a screeching halt, caused the economy to contract, and triggered the deepest recession we’ve seen since the 1930s. And it reduced demand for products and ultimately led to lower price.

The other piece of the inflation puzzle is what happens to people’s expectations. In the early 1980s, President Ronald Reagan went on camera in the White House and assured everyone that he was in control and that the Federal Reserve was going to fix this problem. Combined with changes in interest rates that drove up unemployment, Reagan’s assurances led to a drop in public expectations that some economists believe was key to lower inflation in the early 1980s. .

Is it possible to stabilize prices without causing a recession?

Olney: A recession occurs when the total amount of goods and services produced in a month is less than it was the month before. Thus, the quantity of goods and services that we produce decreases more and more, month after month.

What the Fed hopes to do is slow the rate of increase – that’s what it means by a “soft landing”.

So instead of increasing the rate of production by, say, 2% per year from month to month, maybe we could increase it by 1% per year. In this case, we wouldn’t have a recession; we would simply have a decrease in the amount of growth.

Watch the full interview to learn more about how looking at historical periods of inflation can help us understand what’s happening in the markets right now.

SciLine is a free service based at the nonprofit American Association for the Advancement of Science that helps journalists include scientific and expert evidence in their stories.

This article is republished from The Conversation under a Creative Commons license. Read the original article here:


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