Understanding the pain, and sometimes the purpose, of rising prices
“You need inflation to get reallocations after supply shocks," says Richard Portes in The New York Times
During the period of inflation surge during 2021-23, the inflation rate in the US and the eurozone peaked in the second half of 2022 and sharply declined in 2023. At its peak, the US is reported to have had the highest inflation rate since 1981 and the eurozone its highest since records began in 1997.
As painful as this period will have been for US consumers and the business community, some economists, politicians and business leaders maintain that moderate levels of inflation are needed to drive consumption, assuming that higher levels of spending are essential for economic growth. The Fed typically targets a low rate of inflation for the long-run, believing that slowly increasing price levels keep businesses profitable and prevents consumers from waiting for lower prices before making purchases.
In his column in The New York Times, journalist Peter Coy writes (People Keep Making These Six Mistakes About Inflation, The New York Times, October 21, 2024) that there is a school of thought in the US - voters who might be inclined to pin the period of inflation squarely on the shoulders of the Biden administration - who are making what he describes as "several related mistakes that cause them to overestimate the size of price increases, [and] the harm they have done".
"The first mistake is to focus on the rise in prices without taking into account the rise in wages — or, for retirees, the increase in Social Security payments, which are tied to the cost of living," writes Coy.
"At the beginning of the inflation spike, prices really did race ahead of wages. That opened up a household deficit that had to be filled with savings or borrowing. .. But lately wages have grown faster than prices, as the White House Council of Economic Advisers keeps saying. Inflation-adjusted wages are still down from January 2021, but by only 1.4 percent, compared with a decline of 4.2 percent at the worst point.
" ... People focus on their higher expenses and ignore their higher income partly because they attribute price increases to inflation, while they attribute the compensating wage increases to their own hard work and excellence."
London Business School's Professor Richard Portes is quoted in the article, adding the thought that the "price shock was necessary”. "You need inflation to get reallocations after supply shocks. That was necessary. It was right, economically. And now it’s been completed.”
Coy believes that it is possible that former President Donald Trump will get back into the White House "in large part because Americans misunderstand inflation".
"Combined with Trump’s undeserved reputation as a mastermind of business, [this is] causing [some voters] to believe that Trump would be better than the Democrats at managing the economy."
