Blog
Tuesday, May 30, 2023
Too Much Money Chasing More Than Enough Goods Through a Too Small Pipe
There is a great debate on-going about what caused the surge in inflation in 2021. Jason Furman calls it the Original Sin vs. Unfortunate Events debate. The Republican view (which also includes notable Democrats such as Blanchard and Summers) is that the monetary stimulus of 2021 dumped a bunch of money on consumers who spent that on everything and everything available, and it raised the prices because increased demand and constant supply lead to higher prices. This is the "Original Sin" view.
Was inflation A Series of Unfortunate Events or Original Sin?
— Jason Furman (@jasonfurman) May 24, 2023
My discussion of the Bernanke-@ojblanchard1 paper at Hutchins @BrookingsEcon.
Short version: their model/results are agnostic. My view is *core* inflation is mostly original sin.
A ?https://t.co/5SyW6VlIyj pic.twitter.com/AUw7AfCHxu
This is an interesting way to frame the controversy, but I quibble with the characterizations of the microchip shortage and the clogged ports. It's easy to see how a microchip shortage could fall into the Original Sin category, since it could have been caused by an increase in demand for chips, either via increased demand for computers or non-computer products that require chips (like automobiles)
Less obvious is the clogged ports. In 2021, there were many stories about backups at ports (Fox Business, Barron's).
Many believe that the global supply chain disruption in 2021 is an externally-caused "unfortunate event," though the specific cause is unstated. Perhaps it was a shortage of workers transporting goods--either the ship operators, port operators, or truck drivers that distributed the goods across the country. I have not seen any analysis of that
There's a strong case that can be made, however, that the clogged ports were caused by increased demand for goods, which would mean that this issue belongs more in the Original Sin category, and was caused by the stimulus. For instance, imports increased 12.6% in 2021, exactly what you would expect to see if prices were caused by an increase in demand and not a decrease in supply.
How This Fits into the Monetary Formula
Macroeconomists use the formula MV = PY to help explain monetary phenomena. This formula is what drove many to predict that prices would increase because of the stimulus. In this formula M is the supply of money (number of dollars traversing the world economy), V is the velocity of money (the propensity of consumers to spend that money instead of saving it), P is the overall price level and Y represents the full suite of goods that are being bought and sold.
The basic foundation behind the "stimulus increases prices" argument is that the money supply (M) goes up when government dumps a bunch of money on the economy, and the the total number of goods being bought and sold stays the same because, in a short amount of time, new factories aren't being built quickly enough to offset the additional money being circulated. So if M goes up, and Y and V stay the same, then P (prices) have to go up to match.
However, one interesting thing about the post-pandemic economy was that Y probably could go up. Factories had reduced output during the pandemic, people perhaps were saving their money due to concern about where the economy might go. In January of 2021, the unemployment rate was 6.1% so there was ample space for expanded production of goods and services.
What few considered before 2021, was that in an era of global trade, the 'goods' component of Y is not constrained just by factory capacity and labor capacity in the home country, but also by the logistics. The number of goods available to consumers, historically was limited by the production capacity and transporting those goods was not an issue, particularly when the goods were manufactured locally or regionally and a robust interstate highway system and rail system offered many opportunities to distribute goods across a country.
My own view of what happened in 2021 is that M went up because of the stimulus, V went up because the pandemic was ending, Y went up somewhat as the labor utilization increased and factories ramped back up, but that it wasn't enough to offset the increases in M and V due to the limits of shipping capacity and also production capacity, so prices rose.
However, because so many of the goods Americans demanded came from overseas, the distribution network for those goods became the limiting factor. There are only so many trans-oceanic shipping vessels and containers, and even if consumers want to purchase more goods, and the international factories can produce them, if there aren't enough avenues of transportation, then the Y will still be limited and prices will increase.