The New Inflation Threat – Cost Push and Demand Pull – should we be worried?

If you are teaching macro policy this podcast from the BBC Business Daily programme is excellent. They debate whether inflation will be a short-term phenomenon or have a longer lasting impact on the global economy. It features Mohamed El-Erian, economic adviser and president of Queens’ College, Cambridge, who thinks central banks are already behind the curve when it comes to keeping inflation in check. Dana Peterson of the US Conference Board takes the view that it will be temporary. They also interview a restaurant owner Luke Garnsworthy. Now that England’s third lockdown has mostly lifted, customers are itching to spend and he can’t find enough staff for his kitchens. But, he says raising prices and wages isn’t an option for him. The key points from the podcast are below:

Demand Pressures
A year ago the global economy was in shutdown mode with no demand as consumers had nowhere to go. However with significant spending by governments to support those who have lost their job and the fact that people can’t spend has meant that there is a lot of pent up demand waiting to unleash itself on the market. Now that a lot of countries have opened up their economies, aggregate demand is surging and making up for lost time. This has been a surprise to many but something that is likely to continue especially in those countries that are able to contain the virus and vaccinate their citizens.

Supply constraints
Many supply chains have been slow to return to their pre-covid volume. Problems with containers, availability of container ships have made it very difficult for producers to access component parts, raw materials etc. Commodity prices, eg oil, are on the rise accompanied by semiconductor chip shortages and the Suez Canal tanker incident have caused both businesses and consumers to worry about rising prices.

Countries like Bangladesh, India and Vietnam are central to the global supply chain but the severe nature of the pandemic in these countries has added another bottleneck.

A further problem is the lack of available labour which has resulted in some firms increasing their wages in order to attract workers – Amazon and McDonald’s have done this. But higher wages are unlikely to compensate for structural unemployment – mismatch of skills – which has been very prevalent. In order to compensate for these increasing costs companies will be tempted to put up their prices.

But should we be worried?
Dana Paterson, chief economist at The US Conference Board, believes that the long-term threat of inflation is exaggerated. She suggests that prices are rising in areas that were very popular during the pandemic but as it subsides consumers will switch their spending to other areas that wasn’t possible during the pandemic – eg. bars, restaurants, movies, theatre etc.

The emergence of working from home should offset some of the minimum wages increases in some economies as employees can save on commuting costs and move to cheaper accommodation. Businesses can also save on office space and hire more workers from low-cost areas.

The rise of e-commerce has generated more competition and has helped to keep prices lower. International supply chains, outsourcing and the likely continued relative strength of the US dollar will work to keep prices down. The US Fed view higher prices as a healthy economy and want to see it rise above its 2% target before increasing interest rates. Also tolerating more inflation gives the Fed time to meet its full-employment mandate. There should be more concern about the type of inflation that becomes prevalent – asset price inflation. This is especially true in New Zealand.

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