U.S. inflation, as measured by the CPI, rose at an annualized pace of 6.2 percent in October, which was the highest since 1990. Prices increased 0.9 percent on a monthly basis, which was ahead of the 0.6 percent that economists were expecting. What's causing inflation in 2021 and should you blame President Joe Biden for rising prices?
The U.S. Federal Reserve has maintained its stance that inflation is transitory, which basically means that the price rise isn't structural and it's temporary. Meanwhile, the price hike looks a lot stickier than Fed policymakers might have envisioned a few months ago.
What's causing inflation in 2021?
There has been a perfect storm in 2021, which is leading to higher prices. Several factors lead to high inflation, including:
- Demand-pull inflation
- Supply-side inflation
- Cost-push inflation
- Higher energy prices
- Higher wages
- Base-year effect
- Asset bubbles
- Accommodative monetary and fiscal policies
- Currency depreciation
Now, barring currency depreciation, all of the other factors support higher prices.
Why are prices for everything going up?
The prices for almost everything have been going up due to several factors. First, demand has been quite strong for most products. No one anticipated that demand would bounce back so strongly from the COVID-19 pandemic lows. To make things worse, the supply of many goods hasn’t kept pace. The demand-supply mismatch is the simple reason behind most inflation, including now.
There's also cost-push inflation as higher raw material prices force producers to increase finished product prices. Prices of all commodities have spiked over the last year, which is adding to the inflation.
Generally, we could have also added higher energy prices to the cost-push inflation bucket, but it deserves a special mention. Higher energy prices have a domino effect on inflation. Higher energy prices lead to higher prices for most goods by adding to logistics costs.
Higher wages are also adding to inflation
There's also a domino effect between wages and inflation. Higher wages lead to higher inflation and vice versa. While wages have been rising in nominal terms, they fell on a real basis in October after accounting for inflation.
Then we have an environment where most of the assets, from equity to crypto, and housing have surged. Asset inflation adds to inflation since people have more money to spend on other goods. One offshoot of asset inflation is rising shelter costs, which account for a third of the CPI.
Also, at least for the YoY comparisons, we have an unfavorable base year comparison. Simply put, the higher inflation in 2021 is coming from a lower base in 2020 where prices were weak amid the COVID-19 pandemic.
How’s the Federal Reserve’s policy adding to inflation?
The massive money printing by the Fed also added to inflation. The simple economic rule is that a higher money supply tends to fuel inflation. For the Fed, firefighting the slump in the U.S. economy was a bigger concern than flighting inflation.
The U.S. central bank even changed its inflation-targeting approach to containing average inflation rather than raising rates when inflation rose above the 2 percent level that it targets.
Should you blame Biden for higher prices?
While it's customary to blame politicians for inflation, the Biden administration isn't fully to blame for higher inflation. However, many people think that Biden’s energy policy, which is tilted towards green energy, is leading to higher oil prices in the U.S. There certainly is some merit to that argument.
Also, the Biden administration is pursuing an accommodative fiscal policy, which is also adding to inflation. Since the bipartisan infrastructure bill passed, the administration is working to get the Build Back Better bill passed. While these investments are a long-term positive, they could add to inflation in the short term.
Biden said that the increased spending will help control inflation by addressing the supply-side bottlenecks. However, not many economists would buy that argument since the supply problems are only short-term headwinds.