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When will inflation be reined in? The answer depends on your school of thought about what's happening in the economy

Financial Markets Wall Street - Federal Reserve
Richard Drew
A television screen on the floor of the New York Stock Exchange shows the rate decision of the Federal Reserve on Nov. 3, 2021. The Federal Reserve will begin dialing back the extraordinary economic aid it's provided since the pandemic erupted last year, a response to high inflation that now looks likely to persist longer than it did just a few months ago.

The Federal Reserve is tapering back on COVID-19 stimulus measures to reign in inflation. But is that enough to bring prices back down?

Tim Shelley spoke with Bradley University economics professor Colin Corbett about how long sticker shock might linger.

This interview was edited for length and clarity.

COLIN CORBETT: They're definitely trying to stop sort of juicing the economy quite as much as they had been. But tapering is different from actually sort of putting on the brakes. So, for the past year and a half, the Fed has been purchasing treasury bonds and real estate assets, which means that they are sort of taking these bonds into their portfolio, and then giving out cash in return. And so they're effectively sort of increasing the money supply.

And so just recently, they announced that they're going to sort of taper off these asset purchases over the next 10-ish months, which will lead to slower increasing money supply, and hopefully thus, less inflation.

TIM SHELLEY: Because the inflation is something we see right now with a lot of things — gas, we talked about cars a little bit — it seems like everything is so much more expensive.

CC: Yeah. And so there's two competing schools of thought on that. Some people think that this is sort of pure transitory inflation. The main thing that's causing it is supply disruptions due to the pandemic, and somewhat non-pandemic, things like the chips shortage, which isn't just from the pandemic, but at least partially so.

And also, gas prices are determined by global energy markets with and so energy, energy prices, not just gasoline are much higher all over the world. So there's very little that the Fed can do to affect energy prices. And there's very little that they can immediately do to facilitate increase car production, or increase port throughput, which is another issue.

So, if we just have these sort of supply chain bottlenecks and constraints, if that's the only cause of inflation, then there's not a whole lot that the Fed can can do about that. And many economists believe that, again, the primary causes of inflation are these supply chain kinks and bottlenecks.

TS: So this move by the Fed is not going to perhaps solve all the problems.

CC: Right, it's not going to bring down gas prices. That's just not within the power of the Fed.

But on the other side, there are some economists who believe that what we're seeing is actually demand-driven inflation. And that just people have too much money, and they're buying too many things, and straining...not just sort of these specific supply chain bottlenecks, but our entire supply chain.

So we're seeing overall labor shortages, and we're seeing factories running at capacity and even being strained of air. So if that is the cause of inflation, if there's just too much money floating around that people have to spend, then yes, this Fed tapering and other policies that the Fed could eventually use would have a potentially greater effect on inflation.

TS: So there's kind of two competing schools of thought on this, in terms of what's causing all the inflation right now. So there's a chance we're not coming out of this anytime soon. What should people anticipate here?

Yeah, so in turn, so one more thing to clarify. So the 6.1% number for October, that is comparing this most recent October to last year. And obviously, a lot has changed in that year. So particularly gas prices have gone way up. But that's because they were absurdly low last year. That's a part of that is just sort of getting relatively back to normal. If you look back two years ago, gas is more expensive now than it was two years ago, but not, in fact, much more.

However, a different number to pay attention to is what was the actual change in prices from September to October of this year, and that was 0.9%, which is still a very large increase. So that 0.9% increase in prices doesn't sound quite as awful, but still, for a one month change, it's big.

But in terms of sort of what will happen to that, if it's sort of just the supply chain problems, then the hope is that it'll sort of work itself out relatively soon. One thing that we've seen, though, is, there's been a big shift in consumption from so called services to goods. A lot of that was sort of driven by the pandemic. Where people eat; people were unable to go to restaurants and performances and travel and stuff like that.

So potentially, as we continue to get this vaccination rates continue to improve, as boosters get approved, as children get vaccinated, the transmission rates continue to decrease, people feel safer, going out to restaurants going to performances, traveling etc., and so we can sort of move our demand from highly stressed areas of the economy, like automobiles and other manufactured goods towards less stressed sectors of the economy, which will hopefully slow down inflation. But so, yeah, that might help. Also, just as sort of the specific supply chain kinks get worked out, that can help. And so a lot of policymakers are saying that next year, spring and summer is when inflation will sort of finally get back to normal.

But on the other hand, if it's a demand side thing, as people just still have lots of money, prices have increased. Stocks have gone way up. people's houses have gone way up in value, so they feel wealthier. Other less common investment classes like cryptocurrencies, a lot of those have gone way up. So people just have more money to spend driving up inflation.

So as people like run out of money, as our pandemic aid starts to sort of, as people run out of additive starts to slow down, then that might cause inflation to slow down. But on the other hand, if we continue to see wage rates increasing because of the labor shortage, people might just sort of have bigger paychecks. And which, again, more money, more inflation.

And that's sort of what policymakers especially fear is that if people sort of start to expect inflation, and they demand, like 5% cost of living increases, as part of their contracts, stuff like that, would inflate these inflation expectations to start to get baked into the economy, then that can sort of be really hard to slow down inflation.

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