Inflation Is Still Too Low
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.