Skip to Main Content

Capital Comments: What Will Happen to Inflation?

The inflation rate was 7.5 percent from January 2021 to January 2022, the highest inflation in 40 years. It arrived suddenly and unexpectedly. A year ago the inflation rate was 1.4 percent, which was lower than the 1.7 percent average rate over the previous decade.

It’s an unwelcome throwback to the Great Inflation of the 1970s. What happened, and when will it go away?

The pandemic happened, of course, and that spiked the unemployment rate up to 14.7 percent in April 2020. The Federal Reserve and Congress acted faster than ever before, with sharp cuts in interest rates from the Fed, and massive relief payments to just about everybody from the Congress. That worked to bring unemployment down to 4.0 percent as of January 2022, the most rapid recovery ever.

Recovery and relief payments gave consumers money to spend. In the face of a deadly, contagious disease, many did the sensible thing and avoided contact with crowds of people. They cut their spending on services—which mostly require contact with people—and bought goods instead. About $600 billion in spending switched from services to goods. The share of spending on goods rose from 31 percent at the end of 2019 to 35 percent now. This reversed a very long-term trend. The goods share had declined almost every year since World War II.

Our production, transportation and trade systems couldn’t handle a change that sudden. People wanted to buy goods, and prices went up when those goods weren’t available. Over the past year durable goods prices rose 18 percent and non-durable goods prices rose 10 percent. Services prices rose only 5 percent. Add the 27 percent increase in energy prices, and you’ve got that high 7.5 percent inflation rate. It’s mostly a problem with goods prices.

Why couldn’t manufacturers expand production? The pandemic messed up trade channels and caused shortages of raw materials and parts. It also caused a labor shortage. As of December, there were 10.9 million job openings and only 6.3 million job seekers. That’s a shortage of 4.6 million employees, by far the largest gap since the Bureau of Labor Statistics started measuring job openings in 2000.

The labor force is the total of employees and unemployed job seekers. In January the labor force was about 800,000 less than it was in January 2020. The labor force usually grows. Based on 10-year trends, without the pandemic the labor force now would be about 1.9 million higher than it was two years ago. Add the actual shortfall and we’re 2.7 million workers short.

Who are these people? Mostly, they’re baby boomers. Again, based on trends, of the 2.7 million shortfall about 1.9 million are age 55 or older. We’re missing 800,000 mid-career folks age 25 to 54. Younger workers under age 25 are back where the pre-pandemic trend says they’d be. That’s why the “Great Resignation” has also been called the “Great Retirement.”

The employment gap is 4.6 million, though, so businesses are trying to hire more people than would be available, even if the pandemic hadn’t happened. So perhaps the stimulus from the Fed and the Congress was too big.

When will inflation end? That depends on COVID. Suppose we are truly near the end of the last surge. Goods spending will slow if people feel safer buying services. Perhaps mid-career workers will return to the labor force, and some boomers will unretire, so the labor force could grow. Slower growing demand and more employees would take some pressure off manufacturers. The Federal Reserve will raise interest rates this year, which should dampen borrowing and spending growth. With no new COVID relief, federal spending is expected to drop by 19 percent in 2022. Long-term inflationary expectations remain low, so we may avoid a wage-price spiral.

All these are reasons to think that inflation will subside by the end of 2022.

But what if we get a new COVID surge, and people keep demanding goods? What if too few boomers rejoin the labor force? What if war in Europe causes a spike in oil prices?  What if that thing happens that absolutely nobody can predict?

Then I’ll be wrong. Predictions are hard.

To Top