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.