Inflation: How it Has Changed

• April 23, 2023

• Mustafa Eren

Inflation is the rise in prices in an economy. Rises in prices essentially reduce our purchasing power. An item that we could buy last week we can’t purchase today. It can change significantly due to increasing consumer income, demand, and wide-scale disruptions like war and supply shortages. The more inflation rises, the more it will inhibit growth, making it one of the most vital elements in the economy.

Over the past two years, our economy has been erratic, to say the least. Since the first Covid-19 lockdowns, consumer demand has risen substantially because the federal stimulus provided people with more money, causing producers a supply shortage. With this fall in supply, the inflation rate naturally rose. Consumers also changed their purchase preferences, spending more on goods than services such as restaurants and hotels. After all, online shopping is the most viable option if you're stuck inside all day. Last year, supply was hurt massively by Russia's invasion of Ukraine. Gas prices have soared globally after the attack, increasing forty percent in the US and between sixty-seven to two hundred and seventy-one percent in Europe, depending on the country. Prices have skyrocketed worldwide, with demand increases and supply plummeting in response. We can understand the gravity of the issue as US president Joe Biden addressed his office's top priority as inflation, planning on reducing the energy bill prices and softening the consequences of Putin’s price hike. The Central Bank took action to decrease inflation by increasing the interest rates, which raised the cost of borrowing. Overall, this strategy worked, lowering demand, slowing the economy, and reducing the consumer price index. However, the inflation rate still stayed the same after the Central Bank implemented this action.

In June of this year, the consumer price index rose to 9.1 percent, the highest it has ever been since 1981. In the 1980s, however, the fed could solve the problem of extreme inflation with the paramount role of one man - Paul Volcker. Volcker's adamant economic approach was to raise the federal funds rate until inflation alleviated in the economy. He believed that short-term economic pain far surpassed the suffering of long-term inflation. Fortunately, Volcker's implacable approach worked in 1987, reducing the inflation rate from its pinnacle of 9.8 percent in 1981 to 3.4 percent. While the effects of inflation over the past two years are still noticeable in our economy, the situation has improved in the last three months of 2022, with the consumer price index dropping to 7.7 percent in October.

It's safe to say that the labor supply didn't fare well throughout these two years. During the pandemic, millions of people lost their jobs in the countries with the largest economies on earth (USA, China, Japan). Consequently, businesses were forced to close and reduce their supply of outputs. There were also numerous supply chain disruptions due to staff shortages. The prices of Essential goods such as food and gas skyrocketed. To beg the question, how did governments respond to the widespread labor shortages and their effects? Firstly, they politicized their approach to ameliorating the economy. For instance, the impetus in Europe is the covid vaccines; these passports are vital to travel to other countries, which impelled most people to get vaccinated. The economic regression has alleviated in Japan, however, with its current interest rate at 3 percent and covid cases dropping under fifty per day. Usually known for a remarkably low income inequality gap, Japan even faced some increase in inequality due to the global economy. We need to understand that pouring more money into the economy in the short run can shrink inflation, but the excess stimulus will eventually cause stagflation (a period of high inflation, high unemployment rate, and slow economic growth) in the long run.

In the US, Americans are staying away from jobs that make the country operate while businesses are desperately searching for new employees. Gas stations and fast-food businesses are offering twice as much income as a result of this sparse labor supply. The disequilibrium between demand and labor supply is slowing down the economy. Since the pandemic, more people have preferred to stay at home and receive stimulus checks than enter the labor force. Employees look at compensation: why would I exert myself to work when I can acquire money doing nothing? Since there is a decrease in the demand for labor, the economy needs immigrants, who are integral to service jobs, to fill the labor force gap. Overall, job openings in the US have increased to 10.7 million in June 2022. As is the case with a healthy economy, the best remedy for the long run is to equate the number of jobs demanded to the quantity supplied.