Inflation Cycles Create Their Own Sustainability
What many are missing about price cycles is that they create sustainability of their own. Higher prices generate revenue and income, creating more demand and more revenue and income. Price cycles don't die out; they spread and develop momentum and sustainability. And once they gain a foothold, it takes more than a bit of nudging from monetary policy to break the cycle.
Inflation 2021 Style
Through the first five months of 2021, consumer prices have increased at an annual rate of 5% and the core inflation even more, up 5.5%. There is no so-called base effect in those figures; consumer prices started to rise at the end of 2020.
While it is true that some components of the consumer price index directly linked to sectors re-opening experienced sharp price increases, it is wrong to say the rise was there and nowhere else.
For example, the Bureau of Labor Statistics estimated that in May, core CPI less used car and truck prices and shelter rose 0.6%, the same as the overall core figure. Since the start of 2021, this measure has advanced an annualized rate of 4.6%, the highest rate in several decades.
Yet, the significance of price cycles is that it generates higher revenue and income and more demand. For example, the recent jump in airline fares reflects the sharp increase in travel. Higher airline fares result in more revenue for airline firms, generating greater demand for workers and more income. Delta recently announced the hiring of 1000 pilots to help them meet the increase in demand. There will also be spillover price effects in other sectors---hotels, restaurants, and various forms of recreation---because as the mobility of the consumer increases, so does spending.
Higher prices for materials and products are also generating more revenue and profits for manufacturing companies. That cycle of higher revenue and profits causes the need for more workers, creating more income and demand that will spill over to other parts of the economy. But the problem for manufacturing firms and services firms as well, there is a shortage of workers, so a strong wage cycle is developing, creating more income and demand.
The history of inflation cycles shows that while higher prices may today be in travel-related industries and housing, tomorrow will be somewhere else. Price cycles gain momentum and spread, and as they do, they create the expectations of higher prices. The failure of policymakers to recognize the built-in sustainability of price cycles raises the odds it will live longer as easy money will help fuel it.