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MainStreet Macro: How much is too much inflation?

July 19, 2021 | read time icon 5 min

Nela Richardson, Ph.D.
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What do used cars, gasoline and hotel rooms have in common? No, not summer road trips. They’re among the handful of consumer goods and services that saw their prices surge last month. 

Inflation often is defined as a general increase in the price level of goods and services, like cars and healthcare, or inputs, like oil and wages.

Think of inflation and the economy like salt to a pot of soup. Just the right amount seasons the broth, but too much or too little can ruin the dish.

Of course, how much is too much or too little is a matter of taste, and in the case of inflation it’s subject to a lot of debate.

This week, we discuss three areas in which inflation is affecting the economy to see if recent price spikes could soon overwhelm economic growth.

Growth and inflation

One superpower of U.S. economic growth between 2010 and 2020 was extremely low levels of inflation. Subdued inflation allowed the Federal Reserve to keep interest rates low and money flowing to Main Street businesses and consumers. Mortgages were cheap and auto loans plentiful. Stock prices boomed.

Despite all that, the economy didn’t overheat. The expansion became the longest in U.S. history, trotting at a slow pace with no risk of burning out before its time. But wage growth mucked around at low levels for most of the expansion, too, barely keeping up with inflation. More on that in a minute.

The coronavirus pandemic disrupted that slow-growth, low-inflation pace. Economic activity cratered, hitting the lowest downturn since the Great Depression.  Inflation dropped like a stone, too, from around a 2% rate of growth before the pandemic to 1.2% after the initial shutdown. 

More recently, the economy has been supercharged by unprecedented amounts of federal spending — $5 trillion and counting– and rock-bottom interest rates that have allowed Wall Street and Main Street to borrow on the cheap.

No surprise that inflation, too, has accelerated. In June, it hit 5.4%. Subtract volatile food and energy prices, and inflation was still 4.5%.

The question now is whether inflation increases could grow more widespread and lead to hyperinflation, which can eat away at Main Street incomes and corporate profits.

For now, big jumps in inflation seem to be confined to a few segments of the economy deeply affected by the pandemic. They’re not broad-based.

Supply shortages and inflation

Shortages can boost prices. I remember the Cabbage Patch Kid craze of the 1980s, where anxious demand and too few dolls led to a black market and massive price increases.

The pandemic created its fair share of shortages. Shutdowns across the globe disrupted supply chains, and we’re still feeling the pain. Semiconductors for automobiles and laptops, lumber for houses, even chicken wings, have been in short supply. 

But do shortages cause persistent inflation? Only if the mechanics of supply don’t adjust quickly enough to fill demand. 

Take the chicken wing. Poultry-processing closures caused by Covid-19 restricted supply, which caused wing prices to jump a month ago. But over time, higher prices dampened demand, constraints were reduced, and supply increased. Wing prices have edged down in time for our summer picnics.

If shortages are more enduring – if chicken wing production remains low — one of two things happen. Prices continue to accelerate, or chicken-wing fans learn to embrace nachos or giant meatballs.

Covid-driven supply shortages so far look temporary. Health conditions have improved and production is returning to normal. Wing supply is up, as are supplies of other economic necessities, such as lumber. 

Wages and inflation

Wage-push inflation is a potentially strong driver of broad-based price increases. It happens when employers raise worker pay, then pass along the cost to consumers in the form of higher prices.

Persistent wage increases could trigger an inflationary spiral of higher and higher prices for consumer goods as the economy tries to keep up with the increased dollars in circulation.

The economy hasn’t witnessed wage-pushed inflation since the 1980s. On my summer road trip last week from New Jersey to the great state of Alabama, I saw a multitude of hiring signs at fast-food chains along the interstate. The rush to hire this summer could cause companies to raise wages to compete for workers.

A one-time jump in wages to attract summer workers isn’t likely to produce the inflationary spiral that characterized price increases 30 years ago.

In a healthy economy, wages are boosted by productivity increases that make the economy better, not by labor shortages that limit production. It’s more likely that current bottlenecks in the labor market will ease in the next few months and wage growth will slow.

My Take

Last week, Federal Reserve Chair Jerome Powell tried to alleviate concerns about growing inflation, calling it a transitory by-product of the super-charged economic recovery. 

From a macroeconomic point of view, his assurances are reasonable and I largely agree.  However, that doesn’t mean there aren’t areas of concern for Main Street. 

Home prices are on fire, accelerating by double digits compared to last year. Rental prices also jumped in June.

Pickups in food and energy prices, which are often excluded in policy debates, are a big drain on household pocketbooks.  Yes, wages are higher as well, but that’s partly because so many low-paying jobs were lost during the worst of the shutdown.

Over the past year, the economy has benefited from massive public and private investment in hard-hit areas. Continued investment in historically unaffordable segments of the economy such as housing and health care, could lead to a short-term boost in national output and a big future payoff of robust, sustainable and — importantly — inclusive economic growth.

For now, inflation isn’t something to fear.