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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?

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

— Jason Furman (@jasonfurman) May 24, 2023

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.

Tuesday, October 25, 2022

Not Enough COLA

Main Takeaways:

• Even with Cost of Living Adjustment, Social Security Beneficiaries fall behind because of inflation.
• Because inflation is cumulative and continuous and COLA is once a year, beneficiaries' real payments are falling throughout the year.
• The average beneficiary actually lost almost $800 because of inflation.

Background

It should come as no surprise that many government programs that involve payments (either to or from the government) are indexed to inflation. If you pay attention when you do your taxes, the tax brackets are updated every year, as are the standard deductions, 401k contribution limits, and more. Indexing the tax code was signed into law by Ronald Reagan in 1981 and took effect in 1985. Before that, as prices rose and incomes grew to keep pace, taxpayers' effective tax rates would go up even if their real incomes stayed the same. Indexing fixed that problem.

Government payments would also be affected by inflation, but this would be more direct. In the 1970s, as inflation grew, Social Security recipients found that their checks were buying less and less. In 1975, cost of living adjustments (COLA) began being made to Social Security payments to ameliorate that problem for the nation's retirees. The first adjustment in 1975 was 8.0%. In 1980, the highest adjustment ever was made to the payments--14.3%.

In the 1980s and on, inflation ebbed and fell from prominence as an issue. In fact, there was no adjustment at all either 2009, 2010, or 2015. In fact, in 2009, the inflation rate was negative, so seniors essentially got a raise.

Now it's 2022, and inflation has returned with a vengeance. Last week, we found out just how large the adjustment would be--8.7%, the largest in more than 40 years. This will put more than $140 into retirees' pockets every month.

The White House is celebrating this historic increase.

Thanks to President Biden, Social Security checks are going up while Medicare premiums are going down.

— The White House (@WhiteHouse) October 24, 2022

While the White House is trying to take credit for a policy signed into law by his second most infamous predecessor. It also escapes him (and many voters undoubtedly), that what he's actually taking credit for is the high inflation itself.

While the White House and news outlets claim that the adjustment will put approximately $140 in the average recipient's pocket every month going forward, in fact it will actually just bring retirees back to where they were a year ago. So, yes it's an additional $140 compared to the month before, but in real terms, it's $0 more than the year before

And because this adjustment is made only once a year, since inflation is rising throughout the year, retirees in fact have fallen behind, even after including the additional $140! From January through November prices are rising for retirees yet their benefits remain the same, so they must purchase their groceries with less money. Just because the checks are adjusted in December and then onward, this does not make up for the fact that their bills have been increasing all year long.

As an illustration, imagine someone receives a monthly benefit of $1500 from Social Security. (This is not far from the actual average).

Each month, your benefit buys less and less, until December, when it is adjusted up and then the payment catches up with your costs of living, but only going forward. You're still in the hole.

In the hypothetical example above, the recipient would lose $761, in real terms, over the course of the year before SS adjusted the payment to account for inflation.

Using actual Social Security data, the average beneficiary will lose just under $800, in real terms because of 2022 inflation. As the White House tweet says: Thanks to President Biden.

Notes: For actual calculations, I used the CPI-E, a price index created exclusively to track prices for retirees. Using CPI-U would actually lead to an even higher number. I also used the average payment from December 2021. The average payment increases every month slightly due to changes in the composition of beneficiaries. Finally, for October, November, and December inflation numbers, which have not yet been reported, I used the average inflation for the most recent three months as a forecast.