By Demetrios Giannaros, PhD in Economics
In the past few quarterly and monthly economic reports, the US, Greece, and other European countries announced a substantial increase in the rate of inflation at the producer and consumer levels. Many have stated that the tripling of inflation rates, over the past couple of years, is a result of bad central banks and government public policies. Others have referenced the pandemic as the cause of supply chain breakdowns and delivery disruptions across the globe. In our opinion, to some degree, all the above have contributed to higher rates of inflation in 2021. However, the lead cause may be the supply chains malfunction — even though, in the case of the US, the economy grew at 5.7% in 2021 and is operating now at full employment with huge labor market shortages.
The supply chain’s malfunction can also be attributed to some structural changes in the economy such as the decrease in labor force participation, reduction of labor mobility, and structural changes in demand for goods and services over the past two years. These factors cause production, distribution, and supply bottlenecks and change the need for certain products. For example, the pandemic resulted in higher demand for computers and electronic products as more people worked from home. However, suppliers cannot provide these new demanded products and services fast enough, given the supply chain complexities and labor force rigidities which are partly caused by irrationally restrictive immigration policies. Thus, the supply of goods and services has been warped by multiple factors.
What exactly do we mean by supply chain? We use workers (labor), machines and equipment (physical capital), land resources and technology (technical and managerial know-how) to produce and transport goods and services to their destinations – wholesale and retail businesses and their consumers. Normally, supply chains run smoothly responding to demand/needs in the marketplace. Economies around the globe produce, distribute, and consume goods and services. These activities are impacted by prices which reflect prevailing demand and supply conditions – with some influence by central bank and government policies.
We note that prices in the US rose in the 10 years prior to the pandemic at about 2% annually. However, in 2021 consumer prices increased at 5.8%, based on the personal consumption expenditures price index. This is partly due to the pandemic related supply chain disruptions. Goods and services are not arriving at their destinations on a timely basis (if at all) creating shortages resulting in price increases. An example can be seen in the January 23, 2022, Hartford Courant newspaper’s business headline “Toyota slammed by parts shortage” …. Production will be reduced by 47,000 vehicles, due to shortages of computer chips, among other things. Guess what? When you go to buy a Chevrolet, Ford or Toyota car for yourself or a van for your business, prices will be higher than normal, if computer chips are not arriving on time causing car production decreases. Then retailers have fewer cars to sell and, given the number people buying cars, they raise prices.
Alternatively, if cars are ready for shipment but there are not enough truck drivers available to bring the cars to the dealer, the same will happen. Less inventory to sell results in higher retail prices. Also because of the pandemic, more people work from home and if they now prefer a sedan to a SUV, the car manufacturers will not be able to change their production overnight to meet the restructured demand. Thus, the price of sedans goes up. All the above scenarios result in a higher rate of inflation, if similar conditions impact the average supply of goods and services.
In the current economic situation, these supply chain inflationary problems are aggravated by the 2020-21 significant economic stimulation by government programs (the Federal Reserve Bank and the federal government) to prevent an economic depression resulting from COVID-related lockdowns and economic disruptions. Unfortunately, these actions were needed to avoid an economic collapse which would have been devastating to business and individuals for many years ahead. Thus, the current inflation problem is caused by supply chain and demand distortions, some of which are human reactions to a pandemic and government related policies.
About six months ago (July 2021) in our Hellenic News of America article on the state of the US and world economy, we predicted positive US and world economy prospects. Six months later, we are comfortable to say that the US economy’s production and employment is at what economists consider to be full employment production. This condition results in higher economic growth, employment, income, and wages.
Given these facts, we stated in 2021 that we expect some increased inflationary pressures ahead. This has happened and will continue until the anticipated interest rate increases by the central bank decrease the excessive demand for goods and services, while supply chain logjams resolve themselves over the next twelve months or so. In our opinion, our biggest problem going forward is the availability of workers, due to our baby boomer generation retirements with fewer younger people in the pipeline and excessively restrictive immigration policies which cause a lower supply of workers. This makes it difficult for businesses to hire the workers needed to continue increasing production, employment, income and our standard of living.
On January 7, 2022, the US Labor Department announced that in December 2021 “employment increased by another 199,000 and the unemployment rate fell further to 3.9% and that employment will continue to trend up in industries, such as, hospitality, leisure, construction, manufacturing, business services, transportation and warehousing.” The central bank now predicts that the inflation rate will drop to 2.3% and the unemployment rate to 3.5% in 2023, from 5.8% and 3.9% in 2021, respectively.
On the inflation front, we believe loosening up of the supply chain constraints and the central bank’s policy of increasing interest rates, will slowly bring down the rate of inflation, over the next couple of years. Therefore, unless some unforeseen event occurs, we are confident that our economy will continue to grow at a relatively healthy pace and the rate of inflation will be lower by the end of 2022.
Demetrios Giannaros, Ph.D. in Economics – Prof. Giannaros, has taught economics, public policy and business studies for over 35 years at Boston University, Suffolk University, and the University of Hartford. He also served for 16 years as State Representative in the CT House of Representatives, was the first foreign-born Deputy Speaker and served as member of the Finance, Revenue and Bonding Committee. Dr. Giannaros is currently an economic consultant. You can get in touch with him at [email protected]