Economist Joel Naroff: How the roots of inflation were laid at every step during the pandemic

Many people have theories about who is at fault for high inflation but few have presented ideas about how to ease the pain — and for good reason. There are so many variables driving prices that there is little that can be done, short of creating a recession, to get inflation under control.

And we inflicted high inflation on ourselves. How? Through our responses to the COVID-19 pandemic.

First, governments around the world shut down their economies because of the surge of coronavirus. Was that wrong? The stark choice was either risk overwhelming the health care system or shutting down and creating significant economic distress but reducing mortality rates.

Governments opted to shut down and then decided to do everything possible to support households, businesses, religious institutions, nonprofits, municipalities and local authorities.

As is the case with public policies, a risk is either to do too much or too little. Fearing a recession, governments around the world, but especially the U.S., decided to do too much.

Before you criticize our politicians, remember that these massive stimulus plans were largely bipartisan.

Unfortunately, no good deed goes unpunished, and the huge influx of funds lit the flame. Vast amounts of government subsidies hit the economy, causing demand to rise sharply. Meanwhile, businesses reopened, but at a much slower pace. The result: excess demand and the rise of inflation.

But that was just the beginning. The conflagration we now face was the result of what came next: A flood of issues that were out of policymakers’ control.

First, there was the tangled supply chain. Remember when just-in-time inventories, fed by a global supply chain, were the mantra of cost-conscious businesses? Well, that worked really well until it didn’t. The U.S. supply chain is heavily dependent on Chinese production, which tanked.

But the global supply chain didn’t get or remain tangled simply because China is a mess. The surge in demand created labor shortages across the economy, making it difficult to offload ships coming into the U.S, and transport those goods to manufacturers, wholesalers, and retailers across the nation. Freighters were stacked up for 30 miles, waiting to unload cargo at the Los Angeles and Long Beach ports alone.

Without the global supply, prices of producer and consumer goods had to surge, and they did in almost every industry.

The growing labor shortages not only affected the supply chain, they also changed the employee/employer relationship. For the first time in decades, workers had bargaining power and they used it to secure higher wages. The result: Wage inflation kicked in and the continued existence of COVID variants kept labor force growth down, restraining labor supply and pushing up wages further.

With labor and material costs soaring, businesses realized that they had to raise prices. And wonder of wonders, they discovered that they had pricing power, something they hadn’t had in decades.

So, companies decided to raise prices, and when they got little or no push back, they raised prices a little more and then even more. Firms have been behaving like kids in a candy store with no limits.

Just when we thought things couldn’t get worse, Russia invaded Ukraine.

The Russian invasion triggered a surge in energy costs, as the supply of petroleum products from Russia to Europe was put at risk. Geopolitical factors often create wild swings in energy pricing. Even if supply didn’t change, the threat of Russia cutting off the flow of oil and gas to Europe caused world energy costs to skyrocket.

We are not likely to return to more reasonably pricing until the war is settled. But we could have.

The markets are pricing in a potential reduction in Russian supply. However, OPEC could have opened the spigot and eased the supply concerns. It appears that our friends in OPEC prefer higher prices. By not expanding production, OPEC is subsidizing the Russian war effort, as Russia reaps the benefits of high energy prices, as well.

Ukraine is also Europe’s breadbasket. Grain shortages are affecting the price of agricultural products ranging from baked goods to meat, pork, and poultry, which use grain as feed. And to add insult to injury, there is the reappearance of bird flu, which is devastating chicken and turkey flocks and raising poultry and egg costs.

Is it any wonder food prices have skyrocketed?

But it doesn’t stop there. The Fed went to sleep, believing that inflation was transitory and would just go away. Wrong again.

Interest rates remained too low for too long, helping support a surge in home prices and rental costs, as well. To catch up, the Fed may have to raise rates so high and so quickly that a recession results. It might have to kill the economy to save it from inflation.

So, let’s summarize. Massive stimulus, coupled with China’s COVID policy and the slow re-opening of businesses started the fire. Continued global supply chain issues added fuel to the fire. Labor and goods shortages created worker and business pricing power that fanned the flames. The Fed’s failure to heed the inflation fire alarm helped allow inflation to accelerate. And the Russian invasion of Ukraine and OPEC’s unwillingness to expand supply kicked up energy and food costs, further exacerbating the problem.

That is how the current inflation firestorm was created, and almost none of the driving forces could (or can) be controlled by U.S. policymakers.

Joel L. Naroff is the president and founder of Naroff Economics consulting firm in Bucks County.