Amid declining real wages, accumulating household debt and the looming prospect of recession, the problem of inflation is now firmly in the arena of US partisan politics. It is yet another issue defined by clear political divisions between Democrats and Republicans. And like many other partisan conflicts, a politically motivated understanding of inflation threatens Washington’s ability to develop a coherent response.
On 15 June, the Federal Reserve came down hard on inflation. Along with a rate hike of 0.75 percentage points, the highest since 1994, the Fed also indicated that rates could rise above 3% by the end of the year. Amid rapidly growing household pessimism about the future of price stability and the prospect of recession, the Fed is taking significant measures to steady the ship. On the same day as the rate hike, the US reported a 0.3% decline in retail sales in May and a 14.4% collapse in housing starts.
Given the high stakes of the inflation question, the partisan blame game is not surprising. This inevitable drive to simplify and exploit the causes of rising prices for political gain undermines Washington’s ability to develop a coherent federal response.
To progressives, the price gouging and greed of corporate America is the major cause of inflation. Over 50% of companies in a recent survey admitted to raising prices more than was necessary, which explains why, despite growing costs, non-finance US companies recorded their largest profits since 1950 in the past two quarters.
Yet this brand of corporate greed is a symptom rather than a catalyst of price increases. Janet Yellen, US Treasury secretary, recently argued that, although profits have been increasing, ‘demand and supply is largely driving inflation’.
Meanwhile, demand growth is being spurred by high savings among some US citizens. This is a further reason corporates enjoy the flexibility to raise prices. Yet, as Yellen pointed out, such behaviour remains a reaction to inflation, not a major reason for it.
The Biden administration has sought to explain high prices as a consequence of Russia’s invasion of Ukraine. Dubbing it the ‘Putin price hike’, the war has certainly shaken global supply chains. However, prices were rising considerably even before Russian President Vladimir Putin launched his invasion of Ukraine in February. After inflation collapsed to 0.1% in May 2020, during Covid-19 lockdowns, price growth accelerated once pandemic restrictions eased; the consumer price index stood at 7.5% in January.
President Joe Biden is correct that rising energy costs made up about 70% of the increase of inflation from February to March. But even without energy costs growing, inflation over the last year would be 7%. The war is a compounding element that struck at the worst possible time. Even if we can not say what inflation might be if not for the war in Ukraine, the movers of rapid price growth were clearly in the works before Putin invaded.
Republicans, unsurprisingly, blame President Biden and his overly generous Covid-19 stimulus policies. Cash transfers to individuals and businesses, so their argument goes, increased consumer purchasing power artificially, boosting inflation. The stimulus measures, which began with President Donald Trump’s $4tn package and continued with Biden’s $1.9tn American rescue plan, clearly were not perfect.
Yet critics must remember that lockdowns put the US economy into free fall. If it had not been for the drastic stimulus measures, the percentage of Americans in severe poverty was likely to have doubled and the economy may have been on course for a depression-level contraction. Doing too much was undoubtedly better than doing too little.
Economists have tended to believe that the stimulus did induce part of the inflationary pressure. The extent of this, however, is massively overstated by Republicans. European nations, without such large cash transfers, have also seen inflation rise to over 7%.
The most compelling explanation for inflation is one few in partisan politics talk about: lockdowns. The impact of shutting down a huge portion of the US economy while simultaneously disrupting global supply chains is hard to overstate. Pent up demand from consumers saving money during lockdowns meant that there was a spike in spending once the economy was reopened. All the while, supply chains were still gearing back up to satisfy elevated post-lockdown demand. It is these mechanisms that offer perhaps the best explanation for why inflation has persisted.
Despite comments from some economists, including Yellen, about a large ‘buffer-stock of savings’ that can protect consumers and the economy, this may be overly optimistic. An MIT study found that savings are highly concentrated among the top 10% of earners. Healthy-appearing aggregate savings figures should not serve as an indication of what the economic experience is like for tens of millions.
A Gallup poll recently reported that 71% of American households earning less than $40,000 said that inflation was causing severe or moderate hardship. The figure is just 29% for households earning more than $100,000. Evidence that a sizeable portion of the American working class is struggling is also indicated by increasing credit card debt.
The singular emphasis on the inflationary pressure of the stimulus risks overestimating the financial well-being of the median American. A focus, however, just on corporate greed or the war in Ukraine similarly denies that there are endogenous forces spurring inflation. In a moment where consumer expectations of price growth are likely to be partly self-fulfilling, a balanced understanding of what is fuelling inflation will be vital to taming it.
Julian Jacobs is Economist at OMFIF.