What Is Causing Inflation and How Long Will It Last?


Globalization typically depresses prices of goods, but the pandemic changed that. Because fewer people were working in production and distribution facilities over the last 15 months, supplies were constrained and the supply chain lengthened, causing a sharp rise in prices. All the experts point to this inflation as being temporary and believe it will return to the normal 2-3% per year range. 

 

I wrote about the chip shortage two weeks ago. Another big part of this temporary inflation deals with the service inflation. Most inflation is labor related in the service sector and is connected by six inter-related constraints that affect the labor supply. These six constraints are:

    1. 27% of the schools were still closed in April, forcing parents to choose between employment and taking care of their children.
    2. Many jobs are entry-level jobs and they are traditionally low-paying
    3. Generous unemployment benefits have affected the decision for parents to stay home and unemployed.
    4. In April, 4.2 million workers had been unemployed for 27 weeks or longer and they may not be psychologically prepared to return to the routine of work any time soon.
    5. There has been a lot of migration during the pandemic, so the labor supply in some cities is now more constrained than before COVID-19.
    6. 3.8 million workers who left the workforce have told interviewers they do not want a job anymore; 58% are women and 70% are 55 and older.

So, just as labor demand is picking up, there are artificial impediments on the supply side. Some will clear up in the next four months; others may become a permanent drag on the service sector. Here is what may happen:

  • There will be a labor shortage across the service sector for the next four months. Technology is driving new business models that include software-as-a-service, e-commerce, and the gig economy. As the labor costs increase, a business will find technology to address the shortfall and a “workaround.”
  • As supplemental unemployment benefits expire, more individuals will re-enter the workforce.
  • Goods-related inflation will be moderated by the combination of technology innovations and plateauing demand. New technologies will continue to increase the productivity of labor and improve efficiency rapidly.
  • The changing expectations and pace of price increases may have a psychological impact. If enough workers and businesses think and see the world as a constantly increasing demand on wages and prices, we will see inflation return above the 3% mark. This will be the beginning of an increasingly upward spiral drive on wages and prices that will accelerate inflation.

Just some thoughts to watch over the next four months, to see how long inflation will impact the economy.