Four Theories Regarding Inflation

There’s a lot of talk about inflation happening right now. Are we experiencing transitional inflation, severe inflation, stagflation, or no inflation? I’ll walk through four theories around inflation from policymakers, economists, and investors below.

1. Inflation is Transitory (Demand Side Perspective)

• This is the position of the Federal Reserve (vis a vis Jerome Powell). Their argument goes that the country went through a deflationary cycle due to the COVID19 lockdowns and growth will spike and “run hot” due to historic stimulus, low interest rates, and the bursting of pent up consumer demand. Essentially, all those dollars that consumers didn’t spend due to the pandemic lockdowns are now spending those dollars all at once, driving up demand, creating supply chain shocks (exacerbated by countries who are shutting down manufacturing hubs due to COVID)
• Moreover, Jerome Powell has specifically articulated that he’s fine with inflation running a little bit hot in order to address racial and economic inequality as the stimulus has been able to support families in need throughout the country. Once the pandemic is over, consumer demand will stabilize, easing up issues related to supply chains and perhaps energy prices, and inflation will drop back down from 4% to the target of 2%. At this point, the Federal Reserve will increase interest rates and relax Quantitative Easing (QE) and the economy will basically balance out.

2. Inflation is Not Transitory (Supply Side)

Source: CBS

• This is the position of a conservative ideologues looking to criticize the sitting Democratic president, a consortium of industry trade groups, and investor analysts. They believe that the underlying need for stimulus has ended and more stimulus, quantitative easing, and low interests are driving inflation. This group fears the return of the type of inflation that ate up growth in the 1970s and 1980s. They argue that the economy is now over-heating due to much “easy” money being pumped out by the Federal government.
• A subset of this group is worried that the Federal Reserve is blind to the threat of inflation and eventually it will spike very high and the Federal Reserve will have it’s hand forced and have no choice but to increase interest rates. An increase in interest rates will…