Where is inflation?
I have been puzzled by the seemingly missing inflation in the economy. After all, a ton of cheap money has been pumped into the markets, and ECON 101 would suggest that prices should rise… somewhere.
However, inflation, as measured by the standard basket of goods, is nowhere to be found. Do we need to re-think our economic theory or are we missing the forest for the trees somehow? Frankly, I don’t know, but here is a thought:
Traditional measures of inflation typically exclude things like housing, and they certainly exclude equity or other forms of household savings. Why would they include them, you may ask? Well, I may argue that there is no real reason to exclude them. A household not only needs to eat and bank (goods and services basket), but they need to live (housing) and save for retirement and inheritance (savings & equity).
Taking that premise for a moment, if you consider savings as a consumer product that has its purchase price, you can argue that households wanting to “buy savings” are looking at massively inflated product basket. Looking at you, Wall Street. The other common alternative to use extra money is to move up to a more expensive house. Yes, mortgage rates are cheap, but the product itself — the house — has gone up in price significantly. If housing and savings were included in the inflation calculation, I suspect the indicators would be blinking at least yellow if not red.
Why does that matter and how may this all come back full circle? With their ability to spend on goods and services, and with extra stimulus money in their pocket, consumers put the extra cash to savings and into equity in particular. There is no other place to put it, and data has consistently supported that this behavior is indeed already happening. Then, looking forward and assuming that at some point COVID restrictions go away, it is reasonable to expect that consumers will pull the money they had parked and will go on that vacation, buy that new suit and those dress shoes they didn’t need for their Zoom calls.
When that happens, because many businesses were forced to reduce their structural capacity to survive COVID and some will have gone out of business completely, post-COVID increased demand will be met with restricted supply. Those businesses being fortunate to face demand surge will want to and almost need to charge higher prices, which then leads to the classic rise of inflation and most likely higher interest rates will follow.
An interesting collateral to observe will be the impact on the stock market. Will the Robinhood investors take enough cash out to burst current bubble (if you believe in one)? Will the emergence of real-world interest rate that is almost certain to return in this scenario lead investors to rebalance their portfolios to more “normal” bond-stock ratios?
The bigger point and the bigger question for the policy makers at the Fed and elsewhere is this: in the world where retirement incomes are more likely to be private (coming form individual savings) than public as they used to be when pensions were a thing, should we re-think what is a meaningful definition of inflation that informs our policy? A simple definition of inflation is a rise in price because too much demand is chasing too little available supply. To me it is obvious that this is already happening, except it is not happening with the price of bread and butter but with equity.
The worst-case scenario for all of us is that the Fed and other policy makers are watching the wrong dial to keep this plane on course through the fog while keeping the foot on the gas. Fortunately, there are other ways than monetary policies to stimulate the economy without taking it off balance too much. We just need to recognize when is the right time to change economic strategy from monetary to fiscal.
