Almost every time I see an expert being interviewed about macroeconomics, they suggest that most of the inflation over the past 5 years has been on the supply side. That is wrong; nothing has been the supply side. I will move on; in fact none of the inflation over the past 50 years has been in the supply side.
To be clear, I’m talking about the absolute increase in prices over 5 years, or over 50 years. It is true that some of the inflation in 1979 was on the supply side, and some of the inflation in 2008, or 2022. There were each year when supply shocks raised prices, but only in most years when supply shocks increased. low prices.
Many experts apparently seem to think that there is some kind of “ratchet effect”, where negative feed-in shocks raise prices, and then inflation returns to its equilibrium. That is false. If a negative supply shock does not cause inflation to rise above average, a positive supply shock causes it to fall below average.
West Texas crude it is currently trading at just over $70/barrel. The graph below shows real oil prices over the past 80 years (discounted by CPI):
Adjusted for inflation, oil prices are about the same as they were in the late 2010s, and about the same as they were in the mid-1970s. That means the price of oil has risen at about the same rate as the overall CPI over the past 5 years, and indeed over the past 50 years. Oil does not explain long-term inflation at all.
[To be fair, there was a permanent one-time rise in real oil prices during 1973, when the OPEC moved the industry from being a competitive market to a cartel. Since then, it’s been mostly fluctuations round a real price of about $70/barrel.]When oil prices rise faster than the CPI, it puts upward pressure on the CPI. Technically, the Fed can prevent this, but because of its dual mandate it often allows higher oil prices to pass through to higher consumer prices. If oil prices rise less than the CPI, it puts downward pressure on the CPI. Because oil prices have risen at about the same rate as the CPI over the past 5 years, and even over the past 50 years, oil shocks have had no long-term impact on the cost of living. Nothing. The same is true for food price shocks, supply chain shocks, and other types of commodity shocks. They are not inflationary in the long run.
So why do so many experts insist that commodity panics played a major role in the hyperinflation of the past 5 years? They seem to have made the following mistake. They correctly noted that a negative supply shock lowered consumer prices in 2022, but they forget to note that a positive supply shock had an equally strong downward impact on inflation during other recent years. In other words, part of the asset shock problem was passing.
So why hasn’t the overall inflation rate gone up, as many had predicted? The answer is simple. All cumulative inflation from 2019 is part of demand, and demand inflation is permanent. PCE inflation over the past 5 years has exceeded the Fed’s 2% target by nearly 8%. NGDP growth exceeded 4%/year for a total of approximately 10%. That’s the whole problem—asset shocks have nothing to do with it. If anything, we’ve had enough of a supply shock (mainly immigration) to hold inflation to 2% below what you’d expect from the oversupply stimulus. The Fed was really lucky.
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