5 Things You Need to Know About Inflation

Inflation has been poking its way into our lives lately - on the political scene and as we swipe our credit cards in the check-out line. We’re breaking down the basics you need to know about inflation and how it works.

  1. Inflation is about a loss of money's purchasing power.

  2. Inflation is hard to measure.

  3. Our cost of living is rising; experts disagree about whether this is a long-term inflation problem.

  4. Central banks are entering the chat; we will probably see higher interest rates.

  5. Monetary policy is not science or magic.

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Episode Resources

Transcript

Sarah [00:00:00] So much of the rise in price is that the cost of things was built on a very precise model of like flex staffing, low inventory, nothing going wrong in our global economy that kept the prices cheap. And what we're paying for right now is the adaptability when things do go wrong, which maybe should have been built in from the beginning, right? 

Sarah [00:00:30] This is Sarah Stewart Holland. 

Beth [00:00:32] And this is Beth Silvers. 

Sarah [00:00:33] Thank you for joining us for Pantsuit Politics. 

Beth [00:00:49] Hello and welcome to Pantsuit Politics, we're so glad you're joining us today. One of the things that we prioritize strongly here is learning new things, and that's the spirit we try to bring to our Five Things You Need to Know episodes. Today, we're going to be sharing some things that you should know about inflation, especially because it's a hot topic of conversation around the world and a practical reality for our wallets. So, hopefully, you'll find today's episode to be illuminating about this topic that everyone keeps discussing. Now, listen, we know that lots of you would like to hear us talk about what's happening over at Spotify with Joe Rogan. Sarah has started talking about that on Good Morning, our premium offering, and we are going to talk about it together on Friday. 

[00:01:29] We kind of think about it a little bit though. Sarah, I have some notes that look like I am trying to map the universe. I've got arrows everywhere. It's a tough one. So we'll talk about that on Friday. And because we just love controversy, we're also going to talk about alcohol on Friday's episode. The other thing that we have not yet addressed that we know is on your mind is the Supreme Court vacancy. And I'm just excited that we can sort of have a normal process here. The justice didn't die. He can finish out his term. So we don't need to celebrate his work right away or do a retrospective of it because he's going to write more opinions before he comes off the bench. And we don't have a nominee yet. When we have a nominee, we'll talk about that. I hope that we have not much to say about the confirmation process because it doesn't, I don't know, traumatize America. So we'll get to those things. 

Sarah [00:02:14] Yeah. When President Biden was like, I'll have a nominee by the end of February, I was like February? And then I remembered, oh, right, that's the normal length of the process. Not like 10 and a half days. So that'll be a little normalcy. That'll be fun. Also, if you follow us on social media or our Pantsuit Politics premium member, you know that we have lots going on in and around the show that we don't always have time to fully talk about here on the show itself. The very best way to stay up to date on all that information is to subscribe to our newsletter. In addition to getting all the news about the work that we're doing, we also share notes from our team that often compliment the podcast episodes or notes from that community of listeners that adds so much depth and context to our conversations. It comes out on Fridays and you really don't want to miss it. You can subscribe on our website or through the link in our show notes. 

Beth [00:03:09] The first thing that we want you to know about inflation is that it is about a loss of moneys purchasing power. And money is the key. It's really hard to define inflation accurately. I sent you a note, Sarah, when I was putting this together saying "I've kind of convinced myself that maybe we're not experiencing inflation in the classical sense." 

Sarah [00:03:28] Yeah, I suggested the title Inflation's Not Real. Stay woke. That was a good title. 

Beth [00:03:34] Because we use inflation colloquially to describe almost any situation where prices are going up. And that's okay, language evolves. We agree on its meaning together, and that is fine. On the other hand, when we're talking about inflation as it relates to the Federal Reserve, it's important that we precisely define the problem so that we know what tools can actually come in and help solve the problem. And if you haven't already listened to it, we have a five things you need to know about the Federal Reserve episode that will pair really well with this one. 

Sarah [00:04:06] So some people talk about inflation like your your dollar doesn't go as far today as it did yesterday. And that's correct, but the key is the focus on the dollar. Inflation is about the supply of money, not just about prices. Now, I think the reason that is hard to keep in mind is because when the average consumer is talking about inflation, they are taking in lots of information about prices. For example, I'm about to redo a bathroom. I'm doing it just like I did my other son's bathroom last year. And so I'm rebuying the same things at much higher prices. The tub I bought last year is now $150 more. So it's like when that information -- because all humans do is gather information and categorize it. That's what our brains are meant to do. And so when we're taking in that price information, that predominates our thinking in a way that can really mess with our conversations about inflation.

Beth [00:05:03] And there's a matter of degrees there because you probably would not be surprised if the bathtub were $20 more than last year. 

Sarah [00:05:10] I wouldn't have even noticed. I wouldn't even notice. 

Beth [00:05:12] We expect some things to get more expensive over time. We expect some things to get less expensive over time. Consumer electronics. We're accustomed to the first fancy new thing comes out, wait a while it'll be cheaper because they'll learn how to make it cheaper. That's not deflation. Inflation and deflation are not just about prices, they're about purchasing power and pressure in the whole of the economy. So when prices rise because of supply and demand, or because of management practices or because of a natural disaster that is not inflation. Inflation is about there being more money circulating from our country's central bank than the public wants to hold. We don't get inflation because we all fall in love with the new iPhone or because a hurricane destroyed a semiconductor chip factory or even because of a pandemic. There's a difference between the cost of living rising and inflation. 

Sarah [00:06:07] Knowing what we're dealing with in precise terms helps us figure out what tools can actually solve the problem. And our real question around inflation is whether the Federal Reserve or a central bank in another country, because inflation is global right now, can help. When the cost of living increases, it's possible that our ability to maintain a certain level of well-being has diminished. That's something that happens all the time, and the Federal Reserve can't do much about that. When prices rise because the central bank has created too much money, that's inflation. Too much currency is in the system, that is the Federal Reserve's job to pay attention to. 

Beth [00:06:42] So the whole notion of inflation was originally about creating too much paper money compared to the gold that backed that paper money up. We don't rely on gold anymore, so it's a little harder to assess when we've created so much money that it has caused money to lose its value. And that leads to the second thing we'd like you to know about inflation, which is that it's difficult to measure. 

Sarah [00:07:03] A few different tools are used to measure inflation, and one that you might be familiar with, probably heard a lot about it in the news recently, is the consumer price index. The dollar cost of a fixed basket of goods and services purchased by the average urban consumer. It is produced by the Department of Labor's Bureau of Labor Statistics. It's been criticized a lot because it's hard to create a baskets of goods and services that's reflective of what most households actually need and purchase. The CPI helps us see if prices are rising in general, not just for fuel or just for food, or just for a particular goods or services, but because of market factors. And there's like so much reporting now about the CPI, and they'll say, "Well, this was really driven by the cost of used cars." Because that's a part of the basket. So you'll  see even critiques of this basket within the reporting itself. 

Beth [00:07:49] And, obviously, what the average urban consumer needs is not reflective of everyone across the United States. It's a difficult job coming up with this. So we've got another measurement tool. We have the personal consumption expenditures index or PCE. It measures things we consume but don't pay for directly like health care. That it factors in that health insurance is a step in between what we actually pay for and what we use. So the PCE take some of those more esoteric issues into account. The Federal Reserve, the Central Bank for the United States, targets two percent annual increases in the PCE index on average over time, because we generally think it's desirable for prices to go up over time.

[00:08:30] And they need to use more sophisticated tools to understand what's really happening in the supply of money, so they're often looking to understand what they refer to as core or underlying inflation. That is an attempt to isolate the persistent rise in the general price level. So now we're adding a layer. It's not just our prices rising in general over a basket of goods and services, it's our prices rising in general over some sustained period of time. That helps central banks figure out whether price increases might have a monetary component. And the best known core inflation statistics actually exclude food and energy from that basket of consumer goods because those prices tend to be so volatile. So looking at core inflation is dramatically different than looking at what drives one household's cost of living. 

Sarah [00:09:22] And so there are a lot of really statistically sophisticated ways of trying to measure core inflation that involve rating goods differently based on how volatile those markets are. We don't need to understand all of those as noneconomists. What we do need is a hold on the central idea that our cost of living going up is not always a problem that the Federal Reserve can solve. The cost of living is about welfare. How good can your standard of living be? And cost of living would be relevant even in a world without money. If our economy was just based on bartering, we could still assess the cost of living. And inflation arises only when the money cost of things increases over time, and it's a challenge to know when that's been happening. 

Beth [00:10:20] So the third thing we want you to know is that our cost of living is rising right now, and experts disagree about whether this is really a long term inflation problem. We said a minute ago that the Federal Reserve generally likes to see a two percent increase in the the personal consumption expenditures index annually. We are very far beyond two percent right now. Without going into a lot of numerical tedium, it is accurate to say that we are seeing our highest inflation points when you're talking about our prices rising since 1983. There is something going on that is really significant in our economy that we need to pay attention to. 

Sarah [00:11:00] Yeah, it's that really difficult combo of, like, we know that. We know that prices are going up and that our cost of living overall is going up beyond just like the price of a latte, which is bananas right now for just the most stereotypical generic example of all time. But it's that combination of like knowing something's happening from a lot of complex input and wanting to then make a simplistic conclusion, which I think is the heart, right? So because it's also true that we are already moving in a healthier direction. On Friday, the PCE was coming down. Some analysts expected to continue to fall, meaning we could have already had our peak inflation and be on track for a healthier economy. It's just too soon to know. But that's true that there are reasons for some optimism. But now let's go back to the previous conclusion Beth made, which is our cost of living have been rising. So why is that? 

Beth [00:11:50] Oh, million reasons. 

Sarah [00:11:51] So many reasons. Just a million reasons. So we've had a demand for goods increased when we expected it to decrease. We didn't realize that when we came home for the pandemic that we'd shop our behinds off or that the supply chain couldn't keep up with our online shopping. I think so much of the rise in price is that the cost of things was built on a very precise model of like flex staffing, low inventory, nothing going wrong in our global economy. That kept the prices cheap. And what we're paying for right now is the adaptability when things do go wrong, which maybe should have been built in from the beginning, right? So I think that's part of it. But these problems didn't materialize evenly, right? So some businesses didn't survive the pandemic. Child care has suffered tremendously. Used car sales have, as we all know, been hugely affected and like the price has gone up. 

[00:12:51] My cousin sells cars, and he told my dad this week that they had three cars on the lot. Three. Three cars available for purchase. On the other hand, despite a worldwide shortage of semiconductor chips, apple's crushed it. Tesla's increased market share has been because they've been able to navigate the shortage, which seems like something you shouldn't be able to navigate, something like a like a global supply chain, but they have. So when some people manage it better, they're going to be able to demand a higher price. We're traveling again, that's going to send prices higher. 

[00:13:20] Gas prices have gone up because at the beginning of the pandemic we had a massive oversupply of gas. So all producing countries like OPEC backed off their production. Then there was a ransomware attack on the Colonial Pipeline. Hurricane Ida shut down a bunch of drilling and refinery capacity, so all of that contributed to rising gas prices. And the government stimulus, which includes unemployment and PPP loans, let's not forget about those, kept consumer spending throughout the pandemic. So where we just tried to forecast something that we haven't all lived through in 100 years, and we were wrong about a bunch of it. In summary. 

Beth [00:13:54] We were wrong about a bunch of it. And look, I have personally contributed to the demand side of things. I did not realize that when I had COVID, all my brain would be capable of doing was watching trash TV and shopping online. But the number of things that I ordered -- and it makes sense. So when you talk about that  flex staffing, just in time inventory management, we had all of that. It was very strained and precarious to begin with. And then we guessed wrong. We thought that demand for everything would plummet. And so we took things offline instead of ramping up capacity. So you can see why just from a supply and demand perspective, it's very easy to understand why prices are high right now. 

Sarah [00:14:37] Just to illustrate how wrong we are, I vividly remember sitting down with a friend of mine who had purchased a lake home being like, you should try to back out of that deal. Her partner works in used cars. So you know what, they're fine. I'm glad they stayed in that house because that was bad advice I gave them. They were more than fine with used car sales. 

Beth [00:14:59] And I think here, you know, three years in, it is time for us to have some grace about all of this and look back and recognize that everything has been so unpredictable at every point. People have been doing the best that they can. It is still hard. We still need to bring some creative thinking to it. So why are we talking about inflation instead of just recognizing, hey, the world's been really messed up for a few years, so obviously supply and demand have changed. Well, beyond the things we just mentioned and beyond fuel and food, we are seeing factors like rent increasing; to Sarah's example, home prices rising, workers negotiating higher wages to cover those costs. These are the kinds of factors that could add that element of persistence, not just that prices are increasing, but that they are trending to increase over time. 

[00:15:49] And that's what worries us. And I wanted to just put a little side note on labor in here. We're going to discuss this more on an episode soon, but something I hear from people in my life all the time right now is why are there not enough workers? Are people staying home because of that government stimulus, because of the unemployment, because the child tax credit? Why don't we have enough people in the labor force? It is really important to understand that we have a long term problem compounded by a bunch of short term problems here. And our long term problem is that the United States of America has an aging population, a relatively low birth rate compared to other countries, and we are seeing several years in a row of net migration declining. We don't have enough immigrants -- we don't have enough immigration. 

Sarah [00:16:35] Yeah, I was like, I wouldn't say that the migration is declining. I would say that we have shut down the inflow. It's not that people don't still want to come here. We just won't let them in. 

Beth [00:16:44] And it is a big problem when every conversation that you have with someone about labor shortage, if it doesn't include immigration, we are missing a very key long term, non-pandemic related component. And then you add in pandemic stuff, especially the child care issue, and that's why we are where we are. And so the cost of labor from a supply and demand perspective is going to be higher. The question is, do we have a monetary policy problem compounding that? So the Biden administration has used the term transitory inflation quite a bit, and I am interpreting that as shorthand for like, oh no, it's a mixed bag. Like these are mostly supply and demand issues. Don't panic, y'all. 

Sarah [00:17:27] They've really focused on the cost of goods that too much is being spent on the cost of goods instead of the cost of services. We have too much money for people to spend on goods, and the services haven't recovered to the pandemic level yet, and I think that's pretty fair. Now, whether or not it was temporary, as long as they hoped it would be temporary, I don't know. That's fair. 

Beth [00:17:50] The other thing they focus on is like corporate greed. And one of the examples that they use about that, the meat industry, I think, is a pretty fair example. I think that they try to use that example a lot to make a broader point that is not fair for everybody. And so it's a tough thing because are there places where the costs are higher because they can be and people are taking advantage of the situation? Sure. But there are also a lot of businesses under enormous pressure from every angle, and I don't think it's fair to characterize all of this as a corporate greed problem. 

Sarah [00:18:23] The important part is less how the Biden administration feels about things and more how the Federal Reserve and other central banks feel about things. And the fourth thing we want you to know is that the central banks have entered the chat. They see that inflation. They recognize the inflation. They do not feel it is transitory. And so we are probably going to see higher interest rates. 

Beth [00:18:42] So in our five things you need to know about the Federal Reserve episode, we discussed that one of its main tools is the interest rate, specifically the federal funds rate. That federal funds rate sets a benchmark for how much money is going to cost throughout the economy. And if the idea that money has a cost attached to it makes your brain glitch for a second, we spent a lot of time on that in that five things episode about the Fed. So the Federal Reserve is telling us that it plans to raise that interest rate probably by a quarter percentage point in March when their Open Market Committee meets again. It also plans to stop buying so many bonds probably also in March. These are its efforts to pull back that money supply and in doing so, increase the value of the money that's in circulation. 

Sarah [00:19:29] And an important note that we talked about in that episode too is that, they did unheard of a historical levels of that spending at the beginning of the pandemic. And some of what we're seeing now is the result of that policy. So inflation is a global trend. It's not just in the United States. The Bank of England has raised interest rates. The Bank of Canada is expected to. Most economists think the European Central Bank and the Bank of Japan will hold off just a little while longer. But central banks and many countries with emerging economies are watching the Federal Reserve closely to decide on their next steps. And if the Federal Reserve goes forward with this plan, it will be the first time in more than three years that it has raised interest rates on short term borrowing. 

Beth [00:20:21] It's really tricky because, overall, our economy is rocking. Like, it's really good. The trouble is, our economy is never rocking evenly. We still have people and families and businesses that need support. And so figuring out how to bring these tools that the Central Bank has to try to solve a problem like rising prices is really difficult. And that leads us to the fifth thing we want you to know. Monetary policy is not science and it's not magic. An increase in interest rates will not solve all of the supply and demand problems that we're experiencing. 

Sarah [00:20:52] You know, the Federal Reserve controls a lot of things, but it doesn't control every single person's behavior. So impacts on the stock market, for example, isn't certain. And the stock market it feels a little volatile right now to me. So what do we expect to happen knowing always that forecasting is a limited human skill? The cost for banks to borrow money will go up, so banks will probably charge more for loans on houses, cars and other forms of short term credit. There will likely be fewer opportunities to refinance, and that should also increase the interest rates your savings earn. So that's good. So borrowing money will be expensive, but saving money will be more lucrative. These savings rates will take longer and it will probably not be very dramatic because they've been so low for so long. 

Beth [00:21:37] All of these changes will probably be fairly gradual, and again, it will not be in lockstep or totally predictable. The Federal Reserve will not instantly have control over every price at every bank, so you won't see this distributed evenly. Banks will still be competing with each other. Higher interest rates, and this gets to your point about the stock market, sarah, can slow down economic growth. That is part of what is meant when they say, "We're trying to cool down the economy." That our economy is overheated, we're trying to cool it off. So those higher interest rates can mean fewer people have access to credit. So fewer people are out there starting businesses or expanding businesses or whatever. 

[00:22:13] It's really hard to know, though, because everything about the economy during the pandemic has been pretty different than our prior experiences with recessions and recoveries. The stock market does not love the idea of higher interest rates and the Federal Reserve selling off some of the bonds it's carrying, mostly because the stock market likes things to be predictable. The stock market is about confidence, and anything unknown can shake confidence. And a lot of what the stock market doesn't know right now is exactly when the Federal Reserve will act and how fast it will act. So it just doesn't like those changes in monetary policy in general. But nothing with the stock market is forever. 

Sarah [00:22:54] Maybe Elon Musk could give them a little pep talk. They really like to hear from him. That seems to affect the stock market pretty dramatically. The most important thing to keep in mind is that even though the Federal Reserve is going to bring monetary policy to the problem of inflation because it is not a simple problem, there will not be a simple solution. And so inflation is not the sole driver of price increases, so we can expect a change in monetary policy to magically solve these price issues and everything to go down. That's not how it's going to work. The interest rate will could increase. Gas prices could still keep going up. Everything that matters to the economy, which is everything from what happens with Russia and Ukraine, natural disaster supply chain, new technology trends, about like what's happening on TikTok and what people like and what they don't like, like that's this huge behemoth. And what the Federal Reserve does is significant, but it's it's not the behemoth. It's just a tiny little person trying to steer the behemoth as best they can. 

Beth [00:23:52] Yeah, and it's like the most powerful, tiny little person trying to steer it that we have. But a lot of what's happening right now is just very weird in the scope of our experience and trying to manage it is hard. And I think one thing we could do as citizens is maybe just stop with the praise and blame memes. The president doesn't control the price of gas. You know, the president has some tools to bring to that, but they are limited tools. The United States Congress could be acting with more aggressiveness about prices going up. There are some members of the House of Representatives -- I've noticed it's mostly women. It's like Cynthia Alksne, Susan Wild,  Abigail Spanberger. There are members of the House who are saying, "Hey, we have tools in Congress. We could legislate things that make the supply chain work better. We could help with the logistics of moving goods in and out of this country a lot. That is within the scope of our power, let's bring those tools to it." So this is going to have to be a multilayered solution, and consumer behavior is always going to be a big part of it, including that sort of investment behavior that happens in the stock market 

Sarah [00:24:59] And also COVID sort of, you know.  

Beth [00:25:00] And also COVID. And also the weather. And like a million other things. So I think that these conversations, as wonky as today has been, it's important to just remember that we can't capture in a social media post why something is happening with the economy that we don't like and what could fix it so that we would like it again. All right. Very different conversation today than we're going to have on Friday. So we appreciate you being here for the multitudes that we try to contain at Pantsuit Politics. Please don't forget to subscribe to our newsletter and stay up to date on all the things happening on and around the show. You can sign up on our website, pansuitpoliticsshow.com. We'll talk with you again on Friday. Until then, have the best week available to you. 

[00:25:52] Pantsuit Politics is produced by Studio D Podcast Production, Alise Napp is our managing director. 

Sarah [00:25:58] Maggie Penton is our community engagement manager. Dante Lima is the composer and performer of our theme music.

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