Inflation just hit 7%. But in an important sense, that’s still too low. Prices need to rise more – and the sooner, the better.
I know that sounds crazy, but hear me out. I’m not saying that we need more monetary or fiscal stimulus. Quite the opposite. Aggregate Demand policy has been absurdly expansionary for over a year.
The reason why we need more inflation is simple: ubiquitous shortages. This problem isn’t merely on the news; at this point, something I want to buy is unavailable practically every day. Pre-Covid, that would have happened roughly one a month.
So what? Well, as any standard econ text tells you, shortages exist because at the current market price, the quantity demanded exceeds the quantity supplied. To solve these shortages, we need market prices to rise. This discourages consumption and encourages production until everything you want is conveniently available. Like in the good old days before Covid.
In the real world, admittedly, prices are never perfectly calibrated. Some prices are too low, creating shortages. Other prices are too high, creating surpluses. Yet in the current environment, prices low enough to create shortages are many times more common than prices high enough to create surpluses. Nowadays, we need lots of prices to rise, and very few to fall. And if this happens, inflation – a general rise in prices – is precisely what we will get. And given our predicament, that’s precisely what we should hope for.
If you’re still puzzled that I’m actively wishing for more inflation, let me remind you of an old analogy. When inflation hits, populists routinely call for general price controls. Economists’ standard response is to say, “That’s like breaking a thermometer because it says you have a fever.” My claim is that continuing shortages are a sign that our thermometer has been responding sluggishly to unprecedented Aggregate Demand. 7% inflation has been insufficient to get the economy back on track. We probably need more like 10% or 12% for a while.
It would have been better if fiscal and monetary authorities hadn’t gotten us into this mess. Yet given where we are, the best way out is for prices to spike until the shelves re-fill.
P.S. If you want to blame “supply-chain issues” instead of insufficient inflation, you’re confused. Higher prices, as usual, are the remedy for supply problems. When you’re not producing enough of X, higher prices cut consumption and spur production. And if price rises enough, everything you want will suddenly be available… if you’re willing to pay the new market price.
READER COMMENTS
Josh
Jan 25 2022 at 9:57am
Of course you’re right in general. But I think currently supply is being constrained by factors that won’t go away with higher prices (covid rules, port issues, fear people have of working, etc). So supply is unlikely to increase substantially even with much higher prices.
And we have an administration that seems determined to make sure demand remains high regardless of prices levels, either by giving people money, or worse. The most important thing for the next few years is for inflation to be just a bit below the level that makes Washington respond with something really bad like price controls. 12% inflation, while it would help lower demand and thus leave shelves more stocked, would almost surely usher in some really disastrous policies.
astew
Jan 25 2022 at 12:42pm
I guess I’m not totally sure what you mean when you say that inflation should be higher. Are you saying that the inflation numbers we’re calculating are too low (i.e. the calculations aren’t capturing inflation accurately)? Or are you saying we should be taking steps to actually increase inflation further?
If the former, is the idea that if we were actually measuring inflation accurately, we’d see that inflation is higher than we thought and then prices would automatically rise to account for that?
Or am I just confused and making semantic distinctions where there’s no real distinction to be made under the surface?
astew
Jan 25 2022 at 12:42pm
That was meant to be a top-level comment. My bad.
Mark
Jan 25 2022 at 12:16pm
It would be better to cut the red tape, get rid of regulations, import duties and all protectionist policies + lower the taxes. You said it yourself many times: to consume, you have to produce first. Thus, creating market conditions for easier production is the best remedy.
Andrew_FL
Jan 25 2022 at 1:48pm
The general level of prices cannot be too low-there cannot be a failure of the general “market for goods and services in exchange for money” to clear. By Walras’s Law, shortages balance surpluses. You see the shortages, you don’t see the surpluses, but they are there.
Wade
Jan 26 2022 at 1:45pm
I think you’re asking too much of Walras’ Law. It doesn’t mean that shortages and surpluses aren’t failures because they “offset” each other mathematically. They’re still failures. The more shortages and surpluses there are, the bigger the failure, even if they equal each other.
Andrew_FL
Jan 26 2022 at 2:23pm
This is irrelevant-Bryan is saying that the *general price level* must rise more because there are so many shortages, but if there are balancing *surpluses* then Bryan is wrong, the implications of the need for *some* prices to rise to clear their markets for the *general* price level is ambiguous, because others also need to fall to clear their markets.
nobody.really
Jan 25 2022 at 1:53pm
What does “need” mean? Who has this need? Who would stand to benefit from meeting this need? And what prohibits that person from doing so?
I sense Caplan argues that higher prices would shrink the current quantity demanded for specific goods and services into balance with the current (limited) supply. So far, so good.
Who has the incentive to engage in this behavior? Presumably vendors/suppliers.
So here’s the jackpot question: WHY DON’T THEY? (And the corollary: Why does Caplan think he understands their business better than they do?) Vendors would seem to have every incentive to raise prices, right?
Well … maybe not.
Perhaps vendors/suppliers have learned that customers take offense at apparent “gouging,” and will retaliate in the future. Maybe vendors/suppliers have learned that it can be difficult to build customer expectations around prices, so they are unwilling to tamper with those expectations for what they anticipate will be a brief period. Maybe each vendor/supplier has more to fear from raising prices and losing business to competitors in the short run than from frustrating customers by asking them to wait for delivery. (Old joke: “How dare you charge $1.15/lb for sausage? Kowalski only charges $1.10!” “So go buy from Kowalski.” “I would—but he’s out of sausage.” “He’s out of sausage? When I run out, I only charge $0.95!”)
If shortages go on long enough, I expect more vendors/suppliers will adopt Caplan’s suggestion. But the fact that they haven’t done so yet suggests to me that vendors/suppliers don’t believe that most shortages will last, even at current prices.
AMT
Jan 25 2022 at 6:56pm
This is all correct, especially:
Though many businesses certainly fail to perfectly maximize profits, we should be extremely hesitant to suggest we know better than the business owner.
Have economists not heard the ubiquitous marketing trope along the lines of “it’s a bajillion times more expensive to attract a new customer than to retain an existing one”?
https://hbr.org/2014/10/the-value-of-keeping-the-right-customers
If you spend any time outside of the ivory tower interacting with the general public, you realize how fickle the average consumer is. There is a significant probability they will vow to never ever return to your business, PLUS tell everyone they know to never ever use your business based on one bad experience, which could include perceived price gouging. Don’t assume you can explain the higher prices based on “supply and demand,” to these “mythical rational voters.”
https://en.wikipedia.org/wiki/The_Myth_of_the_Rational_Voter
Ron Browning
Jan 26 2022 at 6:46am
Even if sellers of merchandise faced much less uncertainty than they are currently faced with, they would still be very unprepared, thru lack of knowledge and experience to smoothen out the flow of their merchandise by adjusting prices. If a seller knew with complete certainty, for example , that 7% inflation was here to stay for many years, it would still take him quite a while to gain the experience to survive in that economic world. Those who are more experienced with uncertainty do not act in a vacuum. They must act, compete with, and co-operate with others who are somewhat flailing around.
Colin Haller
Jan 25 2022 at 4:15pm
Unless prices are high due to monopolists and oligopolists, eh?
Jon Murphy
Jan 26 2022 at 7:11am
That would not explain shortages of goods.
vince
Jan 27 2022 at 6:53pm
A monopolist could constrain supply.
Mark Brophy
Jan 25 2022 at 5:13pm
Inflation is vastly understated. For instance, the government uses owner equivalent rent, a discredited measure used by nobody else, to calculate housing inflation at 3% even though rents are rising 17% and residential real estate is rising faster. Housing is 25% of the Consumer Price Index, which has been modified 20 times in the last 30 years to understate inflation.
Dylan
Jan 25 2022 at 5:27pm
I keep hearing about these shortages, but I have to say they’ve been pretty invisible to me, and I’ve been buying a ton of things recently that are supposedly hard to find. New computers. Bought 2. Furniture. Lumber. Grocery store shelves are well-stocked. I’ve been told there is a dire shortage of aluminum cans for beverages, yet there’s never been a shortage of Coca Cola, and it seems like every week there are more and more beers sold in cans and less in bottles, something I wouldn’t expect if there were such an acute shortage.
About the only thing I can think of that is consistently hard to find is Oatley, which is a situation that predates the pandemic, and is despite the fact that the price has gone up by more than 50% in the last couple of years.
Even graphics cards, the perennial favorite poster child of “shortages” ever since crypto became a thing, are readily available if you’re willing to pay triple the list price.
So, what are you buying where you notice missing products every day?
BC
Jan 25 2022 at 8:42pm
“My claim is that continuing shortages are a sign that our thermometer has been responding sluggishly to unprecedented Aggregate Demand. 7% inflation has been insufficient to get the economy back on track. We probably need more like 10% or 12% for a while.”
Are we sure about that? Shortages are real phenomena, inflation a monetary or nominal one. A shortage indicates that the *relative* price of a good is too low so that resources have been inefficiently allocated towards the production of something else, which presumably has a relative price that is too high. That would seem especially to be the case given Bryan’s claim that Aggregate Demand is more than sufficiently expansionary so that no resources are left underutilized. If prices were sufficiently flexible, presumably the *relative* prices of goods in shortage would rise until the shortages were alleviated, and the relative prices of other goods would fall so that resources could be freed up and allocated towards the production of the goods in shortage. Overall inflation would be left unaffected.
Isn’t the claim that AD is sufficient equivalent to saying that inflation, or at least NGDP, is sufficiently high? Saying that we need 10% inflation instead of 7% is saying that AD is insufficient because AD at 10% inflation is higher than AD at 7% inflation, right?
John Fembup
Jan 29 2022 at 2:44pm
“Higher prices, as usual, are the remedy for supply problems.”
Usually, yes.
Are you perhaps tacitly assuming today’s shortages result from producers voluntarily withholding their products or services because of inadequate prices?
But the withholding may not be voluntary or even mostly voluntarily. It may be because of environmental or governmental constraints that are imposed on the market and that won’t go away at any price. (Graft excluded).
I could see continuing price spikes putting enough political pressure on the government to relax the constraints it has stubbornly maintained. Wouldn’t that be largely a political way out of the supply shortage, not an economic one?
Jim Moroney
Feb 15 2022 at 7:18pm
According to shadowstats.com, the CPI should be closer to 10-15% increase over the past year. So, you are right, 7% is too low. It shouldn’t be a shock to anyone that the Biden administration is working to minimize the reported CPI. I notice that the PPI increased as an annual rate of 12% in January. Biden does not seem capable of keeping a lid on reported price increases for long. It would be nice if some independent journalists could research this attempt by our government to fudge the figures.
Prices should be going up and they are, and at a faster rate than the government is telling us. Fuel has increased 75% in the past year with double digit increases in rent, food and other big ticket items.
This will be big news come election time this year. It will be interesting how the government and the liberal media spin this. We need to have some journalists research this data now and report soon!
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