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Demand Pull and Cost Push: Two Sides of the Inflation Coin

A nonfactor for decades, Inflation is now parsed in terms of demand pull and cost push

To excel at textbook economic analysis, you are told to look at one variable, “assuming all other variables constant” or ceteris parabus. But the real world never works that way. It becomes particularly alarming for economists when their textbook explanations are not borne out by what is happening.

Such a situation occurred in the late 1970s as economists sought to explain the high inflation and high unemployment of the Jimmy Carter presidency that carried over into the Ronald Reagan presidency. It was during this period when the term stagflation was coined to explain the inexplicable. As we seek to get our thinking around inflation today, we have a better parsing of the multiple factors that can drive inflation.

Demand Pull Inflation: the classic definition

Demand pull inflation is classic, 20th century thinking. This loosely corresponds to “too many dollars chasing too few goods.” Traditional Keynesian economic thinking asserts that this situation means the economy is overheating. That the solution is for central banks to raise interest rates to slow down demand to bring it in line with current supply. Low unemployment is expected to be a compatible condition to this kind of economic overheating.

Cost Push Inflation A fancier definition for resource scarcity (and potentially disruption)

Cost push is what drove the high inflationary cycle of the 1970s. Oil price shocks from OPEC production decisions triggered choke points across the entire economy. Companies had little recourse but to pass along price increases, or to “push” the costs onto the consumers.

Today we have a blend of Demand Pull and Cost Push

Today we have a blend of both inflationary triggers. Demand pull influences have been more on the consumer side. Record high savings during the pandemic shut down plus various government relief payments spiked consumer purchases and housing prices. Similarly, unemployment remains low, and certain skilled positions remain hard to fill. Textbook moves to raise interests to slow the economy are being deployed to cool this economic overheating. Whether it results in an economic soft or hard landing remains open to at times contentious debate. The debate revolves the extent to which the aspects of cost push inflation are going to ease at the same time.

Cost push is readily apparent to any purchases of basic staples. Energy and food are about as basic as they get, and there are no simple solutions to those issues. Energy is a heavily regulated industry with public opinion about moving away from fossil fuels mounting, especially among younger individuals. Food prices are being hit both from the energy cost increases and due to supply chain disruptions as a result of the Ukraine conflict. Neither fuel nor food disruptions are likely to abate soon, and the food issues around wheat and the attendant products manufactured from wheat are likely to worsen before they improve.

If that news is not dire enough, energy supply chain constraints, when delved into, do not appear to be a short-term blip on the way to resuming normal productive capacity. A Grid News article lays out in great detail the supply chain constraints now impacting the refinery segment. The constraints are a blend of rising demand, conversion of refinery capacity to renewable diesel, shuttering of older domestic refinery capacity during the pandemic. Further, expansion of US refinery capacity is unlikely given regulatory and environmental risk, as well as a fundamental shift in financial outlook. The article expects gas prices to rise over the summer which is a normal occurrence, but the article is not optimistic about increased refining capacity happening in the U.S. due to cost, environmental regulation, and long term industry outlook as public sentiment grows for green alternatives.

What can government do?

 The first thing our government could do is own up to the reality of the current situation and the contributions past government action has had to the situation. High inflation today is not entirely the result of government actions, but it has contributed. Our leaders pumped trillions into the economy during the pandemic. We had so called quantitative easing prior to that, and we have had persistent government deficits for decades. Labelling it “Putin inflation” to place all the blame on Ukraine is flat out disingenuous.

We have had various political ads talking about suspending gasoline taxes as though that will solve the problem. It won’t. It’s a small contributor, but it’s not an “end all be all” solution.

But an honest answer to the public is not one that is necessarily what people want to hear. Government, as one of the largest entities in our economic activity, has been putting more into the economy that it has been taking in tax receipts. So the honest answer has three components:

  1. Demand more efficient delivery of government services.
  2. Reduce Spending
  3. Increase Taxes

Some blend of all those three elements are necessary from our government going forward. Efficiency is citizen accountability. We must demand more efficient government operating methods. The government should be tasked with delivering the same or better service for the same or less money. An example of this would be toll roadl automation through EZ-Pass. EZ=Pass cuts the labor associated with government collecting the  fees while providing a more convenient way for the public to pay those fees.

There’s less leeway in government spending than many people think. Transfers payments (Social security, Medicare, Medicaid) and interest on the national debt are a large share of the total budget. Further, as inflation rises, so too, does the interest expense on the national debt.

Tax increases are never a popular policy suggestion. Still, when it comes to federal income taxes, there is much we could do. Presently about half of the adults pay no tax. Why would this half of the population care about efficiency when they are not paying anything into the system?

Similarly, adding a higher tax bracket for the most successful among us, what I call “the professional athlete bracket” could add additional receipts with minimal pain on individual’s daily budgets. A top bracket for those who earn several million dollars in a specific year is a simple way to make that happen.

Again, none of these suggestions on their own are a solution. A blend of efficiency, austerity, and targeted tax increases are the only practical path forward after decades of bipartisan business as usual in Washington.

Citizens have to demand accountability

We have arrived at this point from citizens not holding politicians accountable. We listen to how much they will spend on this or that program without asking our politicians to also be specific on how they will pay for those programs. We have to view our public sector operations like a business and demand efficiency.

It’s why I’m running.

 

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