Why are prices rising? The answer is more complex than campaign rhetoric

By: - October 25, 2022 9:56 am

Susan J. Demas

With prices climbing over the last year and a half for everything from gasoline and groceries to lumber, appliances and restaurant meals, Republican campaigns have eagerly blamed Democrats in the White House and Congress and signature legislation they’ve enacted over the last two years for the inflationary surge.

“We have to understand what caused these 40-year-high inflation rates is out-of-control deficit spending,” Sen. Ron Johnson said during his debate with Lt. Gov. Mandela Barnes on Oct. 13.

The reality is a lot more complicated, economists say. The cause of the spike in inflation is more diffuse, and most of it is outside the control of lawmakers or the president.

There’s no denying that the trend of rising prices has outlasted hopeful predictions a year ago that it would moderate in a few months. On the day of the Johnson-Barnes debate, the federal Bureau of Labor Statistics reported that the Consumer Price Index for September showed inflation running at 8.2% annually. Core inflation — all goods and services except for the volatile food and energy sectors — came in at 6.6%.

 Kundan Kishor 

“My main concern is the increase in core inflation to around 7%,” said Kundan Kishor, economics chair at the University of Wisconsin-Milwaukee. “The numbers are very persistent. It’s going to take some time for inflation to drop down.”

There isn’t consensus about the scope of the current problem, however.

Mark Copelovitch, a UW political scientist who studies where politics and economics intersect, is optimistic about current trends moving “in the right direction” but  finds the monthly data “noisy.” Housing is one of the contributors to the most recent spike, but as an indicator, it lags others, he said, and there are more recent indications that rent inflation is trending downward.

A year ago, the most visible culprit behind the price spiral was the disruption to the supply chain caused by the COVID-19 pandemic. Russia’s invasion of Ukraine sent oil prices climbing and disrupted agricultural trade, driving up the cost of food.

Since then, however, “inflation has become much more broad-based,” Kishor said. It has also spread to the service sector where it had not previously shown up.

More recently, some analysts have pinned responsibility on rising wages as employers have more difficulty hiring workers. That helps explain service sector inflation, according to Tim Smeeding, an economist at the University of Wisconsin’s La Follette School of Public Affairs.

Yet wage hikes have probably been unavoidable, particularly for service industry employers such as restaurants and hotels. “In order to keep people in low-wage service jobs, they’re going to have to raise wages,” Smeeding said.

The idea that three rounds of COVID-19 stimulus checks that Congress and the White House issued in the first two years of the pandemic helped drive the current inflation is based on the assumption that by spending that money, the recipients increased demand for goods and services and drove up their price.

But attaching all the blame for inflation to wages or even the stimulus checks — the last of which went out a year and a half ago — ignores the fact that inflation is a world-wide phenomenon.

 Menzie Chinn 

It is showing up “despite different demand conditions,” said Menzie Chinn, another La Follette School economist, and “that suggests supply shocks are important” — meaning that the pandemic’s global supply chain disruptions continue to play a significant role in current price increases.

In a paper for the American Enterprise Institute in September, Steven B. Kamin and John Kearns found that economies around the world showed little correlation between their wage growth and price spirals.

Adam Shapiro, an economic researcher for the Federal Reserve Bank of San Francisco, concluded in a paper in June that supply strains accounted for at least half of the inflation — and that continued disruptions posed a threat of continued inflation.

“Because supply shocks raise prices and suppress economic activity, the prevalence of supply-related factors raises the risk of entering a period of low growth and elevated inflation levels,” Shapiro wrote. “This risk depends crucially on how long labor shortages and global supply disruptions persist. While supply disruptions are widely expected to ease this year, this outcome is highly uncertain.”

Copelovitch said the role of federal fiscal policy in the current round of inflation has been wildly exaggerated.

 Mark Copelovitch 

He estimates that one-fourth to one-third of the current inflation is due to additional government spending. “But the tradeoff has been a rapid and unprecedentedly strong recovery,” Copelovitch said. Without the support that spending provided to households and to the economy, “we’d still have inflation of [about] 6%,” in line with global trends.

“So much of the public debate and media coverage over the past 18 months has, either explicitly or implicitly, framed U.S. inflation as purely, or predominantly, the result of U.S. fiscal policy, and that’s simply not an accurate prediction of what’s happened,” he said.

Solutions to the current challenges are likely to take time.

Copelovitch worries that if central banks around the world tighten up money too aggressively by raising interest rates in the midst of what is still “primarily a global supply shock,” the result could “drag down the global economy.”

Kishor of UWM points to the drop-off in immigration as a major factor in the difficulties employers have finding workers. “Immigration reform can be one factor that can improve the overall capacity of the economy,” he said — but not in the short term.

The Inflation Reduction Act that was enacted in August won’t have an immediate impact in the short term either, Kishor said, but can help in the longer term by increasing the productive capacity with measures such as investments in green energy.

In the face of complaints about deficits and inflation and the need to restrain demand, Smeeding sees another path he’d like Washington to take.

“Why can’t we raise taxes?” he asked rhetorically. While the Inflation Reduction Act did institute a minimum corporate tax and a surcharge for companies that buy back their own stock, “other than that we’ve had no deliberate increase in taxes, particularly on the well-to-do,” he said.

Smeeding says raising taxes on higher earners would help dampen the demand that is helping to drive inflation. “You have to restrain demand somehow.”

This story first ran in the Advance‘s sister outlet, the Wisconsin Examiner.

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Erik Gunn
Erik Gunn

Erik Gunn reports and writes on work, the economy, health care & policy, and related subjects for the Wisconsin Examiner. He spent 24 years as a freelance writer for Milwaukee Magazine, Isthmus, The Progressive, and other publications, winning awards for investigative reporting, feature writing, beat coverage, business writing, and commentary.