A Discussion on Inflation

Episode 19: In today’s episode, host Jim Ray is joined by Dr. Frank Raymond (Professor of Economics) and Dr. Bradley Stevenson (Professor of Finance) to discuss inflation and its impact on the US economy. Both of whom are teaching a Bellarmine’s Rubel School of Business, in Louisville, KY.

Inflation from the Demand Side and the Supply Side

Demand side drivers of inflation include factors such as the COVID relief bills (i.e. the CARES Act), as well as a strong housing market partly as a result of millennials who are now buying houses.

On the supply side, a tight labor market is a key element of what’s driving inflation. Certainly, the supply chain issues are also limiting the supply of available goods, which puts upward pressure on the cost/price of those goods in the market. China’s current approach to dealing with COVID may lead to additional supply chain disruptions.

The oil and natural gas supply shocks, obviously driven by the Russian-Ukrainian conflict is also putting pressure on the availability, and thus the price, of oil. Oil is considered “a universal input” because it impacts so many of the products, production costs, packaging cost and transportation costs of virtually every item from food to the fuel we put in our cars.

Frank explains that the supply shocks will have a lingering effect on the economic. Interestingly, regardless of what people think, the Federal Reserve Bank, the president and the administration have little means to impact the shocks – in the short term.

Millennials in the Housing Market

Brad comments on how the shift from living at home or in an apartment to an interest in buying a home is impacting the market. There’s a belief that the current high prices in the real estate market won’t be coming down anytime soon. Rather, the prices will be sustained. This is impacting the buyer-behavior. They are less fearful of a sudden downturn in prices, which could make it more difficult to sell.

COVID Relief Funds and Inflation

Frank believes the funds may have added 1-2% to the current inflation rate. The COVID relief money is now gone, but it’s been pumped into the system, fueling consumers’ ability to pay for goods and services. Although, Frank states that only about 45% of the funds were spent.

As a result, the relief funds didn’t necessarily drive up inflationary pressure from the demand side. In the short term, it’s resulted in a tighter labor market because people were able to either stop working or delay reentry into the job market. This has cause inflationary pressure from the supply side as wages have had to increase to entice workers.

The Impact of the Fed on Inflation

Brad explains the role of the Federal Reserve Bank. The Fed sets monetary policy. They focus on the overall rate of inflation in the economy. They control interest rates as a tool for heating up or cooling down the market. Lower rates can heat up the market, because money is deemed to be cheaper. More economic activity generally takes place because it’s more cost-effective to take the risk of starting a new business, expanding an existing one or buying additional inventory.

As the economy heats up, demand may outpace supply, which leads to inflation. In this situation, the Fed will then try to raise rates to cool down the market. The art is in trying to time it properly, which doesn’t always happen because economic indicators often lag the current reality.

Wage Pressure and the Economy

Frank comments on the impact of wage pressure. The hospitality industry, for example, was crushed during the pandemic. Many employees were either laid off or decided to seek employment in other industry segments, such as logistics with UPS and/or Amazon. People also decided to reduce their levels of spending.

Your economic demographic (lower-income, middle-income, high-income) often determines how you experience recessions. Lower-income individuals and families tend to struggle more, for a variety of reasons. This might be a good lesson for economic policy for how relief funds are target, in the future.

Frank believes wages may not come down, but they may actually begin to stabilize. This will make it easier for employers to rehire and to invest in expansion.

Supply Side Pressures

The supply chain issues have begun to resolve themselves, compared to the situation a year ago. The oil shocks seem to be having a more important impact right now. Although how China handles the COVID resurgence will have an impact in future months.

Frank discusses how the Fed really only affects the demand side via interest rate changes. It has very little impact on wages, supply chain, oil supply and other economic factors. The Fed doesn’t have the tools to impact many of the factors. Frank believes the Fed should have started gradually increasing the interest rate, quite some time ago.

Brad explains the lag that often delays the impact on the economy after the Fed decides to raise the interest rate. It can be 1-2 years before the intended result is fully realized. Think of it as stopping or starting a freight train. Ideally, the Fed should have forecasted the risk of inflation and would have already begun slight, but steady, increases. Unfortunately, inflation is happening and the Fed is only now beginning to take action.

Brad recently attended a presentation by the CFO of UPS Airlines (a Bellarmine Alumnus). He discussed some of the factors impacting the supply chain. Of note, the lack of available cargo containers and ships is limiting capacity. The cost of transporting goods across the oceans has exploded in the past several quarters. He forecasted a supply chain backlog potentially lasting a couple more years.

Oil Shocks and Russia

Both the US and Europe are actively walking away from Russian-supplied oil and natural gas. This decision was prompted by the invasion of Ukraine. The uncertainty in global markets and global politics is creating spikes in commodity prices. This could lead to additional investment in alternative energy options. However, the economy overall will suffer in the short- to medium-term.

Frank doesn’t see this period of inflation lasting as long as it did in the 1970s. The risk he sees is how predictions from fellow economists about the potential risk of inflation. These predictions impact the psychology of the market, as well has consumer behavior and confidence. The fear of continued price increases is what expanded the duration of the inflationary mentality during the 1970s.

Where Did the Labor Market Go?

Brad details a study from the St. Louis brand of the Fed. The presenter theorized that after people have left the market, they tend to return to the same industries. As it relates to self-employed people, those who incorporated (as LLCs) didn’t experience as deep of a dip during COVID. They were able to take advantage of relief funds to sustain themselves and their businesses. Those who weren’t incorporated dipped deeper, but bounced back stronger, afterwards.

A significant portion of the workforce simply decided to retire. Those individuals aren’t coming back. From a demographic standpoint, a large segment of our society is in the Boomer segment. This group has already begun the transition into retirement. The segments following the Boomers aren’t as large.

Beware of Political Agendas

As we close this segment, we recommend a little caution. The current situation is temporary. Inflation is happening and it won’t be over soon. The risk right now is agenda-driven predictions meant to impact the mood and emotions of consumers (i.e. voters).

Demand is still strong. Nonetheless, costs are going up. Supply levels will eventually stabilize. That will reduce or eliminate the sustained increases in the costs for goods and services. Expectations are the key to how long this current situation lasts. Like a storm, the clouds will eventually pass.

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