Alert: “Getting into the weeds” here in a brief discussion on inflation and why it may not be easy to solve quickly. Bullet points below may help.
There is a bit of a “chicken or the egg” scenario when it comes to inflation.
- First, the chicken: prices rise. (Maybe due to higher demand or a healthy economy.)
- Then, the egg: workers need to be paid more to afford higher priced goods.
- Back to the chicken: companies need to raise prices for their goods or services to keep up with higher worker wage costs.
- Then, the egg on steroids: workers and consumers come to expect higher prices, which makes price rises “customary.” It is painful and dangerous. (This is called spiraling inflation. See South America for this concept.)
- Then, the chicken on steroids: A country’s central bank raises interest rates to control inflation. Central banks include the US Fed, the European Central Bank (ECB) or the Bank of England (BOE). Raising interest rates is a centuries-old, proven global economic mechanism to control spiraling prices.
- And the cycle continues.
The cycle does not always get out of control. Inflation, prices, and interest rates are known to move within ranges over periods of time, or cycles. The idea is to avoid deflation and to avoid spiraling inflation. Recently the US has experienced near-spiraling inflation and the US Fed is attempting to control it.
Higher interest rates slow inflation, eventually. Another factor, to an extent (think of it as “The Hulk” in the example above) is economic dynamics in China. These dynamics are somewhat beyond the control of the United States and even the World. In this week’s news, it was noted,
- “…the possibility that China’s reopening from the pandemic might put renewed upward pressure on global inflation, said Joe Brusuelas, chief economist at RSM US. ‘Even when the Fed does engage in a strategic pause, there’s no guarantee that’s the top of the rate cycle,’ he said.”*
The US Federal Reserve, rather unfairly, has been painted as “the bad guys and gals” as they kept pace raising interest rates over the course of 2022. The situation involves fundamental global economic concepts, and reflects the difficulty of reigning in an overly strong economy that is still trying to recover from an immense global pandemic.
The US Fed and major European central banks all increased interest rates again this week, to slightly different levels. Each central bank stated its aim to control inflation and – in a healthy way – slow down economies that have overheated following over a decade of artificially low (dangerously low) interest rates.
Inflation continues. The outcome is yet to be determined. By the way, have you seen the price of eggs lately?
*WSJ.com. Gabriel T. Rubin, Nick Timiraos. Jan. 31, 2023.