I participated in a panel discussion held at Fordham University in NYC, where I had the opportunity to engage in an insightful conversation with fellow panelists and an audience comprised mostly of PhD students from the university. One particularly compelling topic that emerged was inflation, sparked by the thought-provoking talk delivered by my co-panelist, Eugene Xu, who was prominently featured in a movie centered around the 2008 financial crisis. In light of this stimulating discussion, I would like to share my perspective on several key structural factors that have played a prominent role in the current cycle of inflation.
1. Previous Monetary and Fiscal Policy, especially during COVID-19
One crucial factor that has contributed to high inflation in the USA is the previous monetary and fiscal policies implemented, particularly during the COVID-19 pandemic. To counter the economic downturn caused by the pandemic, the Federal Reserve embarked on an aggressive approach by reducing interest rates and implementing large-scale asset purchases, commonly known as quantitative easing. These expansionary measures injected substantial liquidity into the economy, which, while necessary to support businesses and households, also heightened inflationary pressures.
Moreover, fiscal policies, such as the CARES Act and subsequent stimulus packages, involved substantial government spending and direct payments to individuals. While these measures provided immediate relief, they also increased the money supply and demand, leading to rising prices across various sectors.
2. US National Debt and Reduced Foreign Buyers
Another factor contributing to high inflation in the USA is the mounting national debt and doubts by foreign buyers. The United States has witnessed a significant increase in its national debt over the years, exacerbated by the COVID-19 relief measures. Concerns over the sustainability of this debt have arisen, leading to doubts among foreign buyers about the US government's ability to manage its fiscal situation effectively.
Previous debates on the debt ceiling and the potential for default have added to these concerns. As a result, foreign buyers have become more cautious, reducing their appetite for US Treasury bonds and other debt instruments. With fewer foreign buyers, the demand for US dollars weakens, which can put downward pressure on the currency and contribute to inflation.
3. Increased Labor Costs Globally, Especially in China
The escalating cost of labor globally, particularly in countries like China, has had an impact on inflation in the USA. Over the past few decades, China has been a significant global manufacturing hub, providing low-cost labor for many industries. However, as China's economy has developed, wages have risen, reducing the cost advantage it once enjoyed.
Higher labor costs in China and other emerging economies have resulted in increased prices for imported goods, as US businesses rely heavily on global supply chains. These rising input costs are often passed on to consumers, leading to higher prices for goods and services, thus contributing to inflationary pressures in the USA.
4. Deglobalization and Supply Chain Interruptions
In recent years, there has been a noticeable trend towards deglobalization, with countries reevaluating their dependence on foreign suppliers and seeking to bolster domestic production. The COVID-19 pandemic further accelerated this trend, as global supply chains experienced disruptions due to lockdowns, trade restrictions, and logistical challenges.
These interruptions have caused shortages of key inputs and raw materials, leading to increased production costs and supply constraints. As a result, businesses face higher expenses, which are ultimately passed on to consumers through higher prices, exacerbating inflationary pressures.
5. Geopolitical Tensions and Wars
Geopolitical tensions and conflicts around the world can also impact inflation in the USA. For example, the ongoing tensions and armed conflicts between Russia and Ukraine have led to geopolitical uncertainties. Such situations can increase oil prices, as oil is a crucial commodity in global markets, and any disruptions or concerns about supply can lead to higher energy costs. Elevated energy prices, in turn, affect transportation costs, production, and other sectors of the economy, contributing to inflation.
6)Expectations of High Inflation: Expectations play a crucial role in shaping economic behavior. If individuals and businesses anticipate future inflation, they may adjust their behavior accordingly. For example, workers may demand higher wages, and businesses may increase prices in anticipation of rising costs. These actions can contribute to a self-fulfilling prophecy, fueling inflationary pressures.
While the focus is on high inflation, it's important to consider deflationary factors as well. Technological advancements, particularly in artificial intelligence (AI) and the emergence of GenAI (Generative AI), have the potential to increase productivity and drive down costs. As AI technology continues to advance, it can lead to more efficient production processes, reducing prices and potentially putting downward pressure on inflation.
Monetary Policy Actions: The Federal Reserve can choose to raise interest rates to reduce borrowing and spending. Similar to the approach taken by Paul Volcker during a previous high inflationary environment, such actions can help curb inflation by tightening monetary conditions.
While deglobalization can contribute to inflation, it is important to consider the potential benefits of a rational and well-managed approach to deglobalization. Strategic reshoring of production and diversification of supply chains can enhance domestic capabilities, increase competition, and potentially lead to more stable prices. By adopting policies that strike a balance between domestic production and global trade, countries can mitigate inflationary pressures while maintaining economic growth.
Reduced Geopolitical Tensions: Geopolitical tensions and conflicts can impact inflation through their effects on global markets, particularly in the energy sector. However, if world leaders come together and prioritize international cooperation and conflict resolution, it can help reduce geopolitical tensions. A more stable geopolitical environment can contribute to lower energy prices, which in turn can alleviate inflationary pressures, benefiting the global economy.
