Inflation causes and solution are complex

David MoonBlog

If you tell me your politics, I can probably guess what you believe are the root causes of inflation. Republicans blame Joe Biden, Covid relief checks, increased deficit spending and the Federal Reserve. Democrats blame Vladimir Putin, Covid shutdowns, PPP loans/grants and (my favorite explanation of all) corporate greed.

All these explanations are right, at least partly so. Except for the corporate greed one. Do people really believe that executives at ExxonMobil, Home Depot and Kroger suddenly woke up one morning two years ago and thought, “maybe we should try to maximize our profits?” While it manifests differently in different business cultures, corporate greed is a constant. Criticizing highly competitive retail industries for high prices without evidence of price fixing is simply blame shifting.

Inflation occurs when the amount of money in a system grows faster than the amount of stuff the system produces. This can happen in lots of different ways.

If you stop production of everything, while simultaneously dropping $1,400 checks out of airplanes, inflation will ensue. If you reduce the supply of refined petroleum products without simultaneously reducing the demand for them, higher gasoline prices are guaranteed. If there is an increase in the demand for medical services without a corresponding increase in the number of medical service providers, healthcare cost will increase.

Now imagine that all those things happen essentially simultaneously.

Politicians’ simpleton proclamations to the contrary, deficit spending does not automatically create inflation. It depends on the use of the borrowed funds. If the federal government uses borrowed funds in a way that increases the productivity in the country by at least as much as the newly borrowed money, it does not cause inflation. Think about roads. If a billion-dollar debt to fund a road/bridge project will support more than a billion of new economic activity, it creates no inflation. (This doesn’t necessarily mean that the project or the use of borrowed funds was necessarily wise, but it would not be inflationary.)

The inflationary implications are more complex when the Federal Reserve creates money out of thin air. When the Fed “prints” money, it doesn’t go directly into projects. It goes onto the balance sheets of banks and, more recently, the US Treasury. The inflation effects of this newly created money depend on whether the money sits on bank balance sheets (non-inflationary) or ends up in the hands of consumers (inflationary.)

Albert Einstein once said that everything in life should be made as simple as possible, but not more so. When we latch onto a single inflation cause, we are likely to assign it too much blame.

But when policymakers focus on a single cause, they significantly reduce their odds of successfully combatting the problem.

David Moon is president of Moon Capital Management. A version of this piece originally appeared in the USA TODAY NETWORK.