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Sound Off: Inflation Guessing Game

By Adam Jones, posted Dec 17, 2021
Adam Jones
The quantity theory of money is dead! Well, maybe not, but it’s certainly not a full explanation for inflation and the more complex process has some interesting implications for Southeastern North Carolina.
 
First, if the current inflation is a story all about the Fed increasing the money stock, then the 85% increase in the monetary base suggests there’s a lot more inflation to come!
 
While economists often get lost in their equations and data, people make decisions, not the perfectly foresighted, equation-driven character, lovingly referred to as homoeconomicus.

Managers, company owners and customers make pricing decisions based on their expectations of the future, not a 17th-century relationship.
 
Economists used to think that costs and benefits drive decisions, but psychologists have disrupted the field by pointing out that it is really people’s perceptions of costs and benefits that matter.
 
To the extent that most people believe the pandemic-related supply chain disruptions are pushing prices upward temporarily, what Atlanta Fed President Raphael Bostic descriptively calls “episodic,” inflation may run higher than usual but normalize as global production catches up with demand.
 
(The Fed Chairman cryptically refers to this process as “transitory inflation.” Can’t he just say temporary?)
 
But the longer disruptions last, and the longer inflation persists, the more people will begin to believe it is less “episodic” and more permanent. If people believe higher inflation is permanent, it may become a self-fulfilling prophecy.
 
Traditional economists would argue that wages will adjust along with prices, and the changes will have little net effect on economic patterns following the adjustment period.
 
But psychologists turned economists, what we now call behavioral economists, would point out, once again, that people are not homoeconomicus.
 
For example, traditional economists would suggest that a $13 increase in the cost of a trip from Charlotte to Wilmington won’t have much of an effect on travel.
 
But behavioral economists would suggest an 80-cent increase in the price of gasoline ($13 total trip) will have a big psychological effect on people’s travel plans.
 
If consumers perceive prices to be increasing faster than their wages, they may well tighten their belts and nix the trip to the beach or the night out.
 
Southeastern North Carolina’s economy is largely based on services catering to travelers, college students and retirees, so we are particularly exposed to the risk of belt-tightening in the face of inflation scares.
 
Certainly the Fed’s policies are part of the story as well.
 
But if one focuses on the price of services, rather than goods, which are more subject to supply chain disruptions, then inflation is running 3.5%; higher than recent history, but well below the headline numbers getting all the attention.
 
We should also remember that the Fed has stated they are willing to tolerate slightly higher levels of inflation and may well be willing to wait out the current episode before undertaking drastic policies.
 
With a little (okay, a lot) of luck, these events could serve our corner of the world very well though.
 
If supply chains begin to normalize and goods prices including gasoline retreat, we could see wage gains for our service workers supported by visitors who feel a whole lot richer than the extra $13 in their pockets.
 
But, and this is a big “but,” if supply chains and labor markets don’t normalize quickly, and people begin to expect prices will keep rising faster than a full-moon king tide, we may be in for a bumpy ride on the inflation front.
Adam Jones is a regional economist with UNCW’s Swain Center and an associate professor of economics in UNCW’s Cameron School of Business.
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