Federal Reserve Chair Jerome Powell and Treasury Secretary Janet Yellen have said that if there is inflation, it will be “transitory,” meaning a short-term phenomenon. The argument is that COVID-19 has disrupted global supply chains, resulting in price increases for various goods. Once these disruptions are fixed, inflation should subside. It is like when gasoline prices spike during a hurricane, then fall once the supply comes back online.
Prices have risen during the pandemic. Lumber prices have more than doubled with the price of construction materials in general increasing by 17%. Home prices have risen by 12% nationwide with more rapid price increases in some markets. Bidding wars are routine for new homes on the market with the final sale prices above asking. Food prices have increased by less, but are still 4% higher than when the pandemic began.
It would be comforting if these price increases were transitory, and prices moderate when life gets back to normal (hopefully by this summer). However, there is reason to believe that this inflation might be longer lasting than what would occur from mere supply chain hiccups.
The amount of spending the federal government has undertaken in response to COVID-19 is unprecedented. The most recent COVID relief package that was signed into law in March gave each person a $2,000 check so long as they fell under an income threshold, regardless of whether that person suffered a loss of income or employment. The COVID relief package also expanded the child tax credit to $3,600 for children six and under and to $3,000 for children over six. Thus, a family of four with two young children would have received $12,800 from the federal government through this relief package on top of the assistance received from the two previous packages.
Some of this money was saved, as the personal savings rate increased from about 8% pre-COVID to nearly 30% today. Much of this money was also spent. It is not surprising that prices are rising for goods that have been purchased with this money, as stimulus money was used for things such as a down payment on a new home and home improvement projects. It also explains why grocery prices have risen by less, as people are unlikely to use the stimulus check to purchase additional groceries once weekly food needs are met.
These stimulus packages have been financed largely by printing money. The Federal Reserve has increased the money supply by $2.5 trillion during the pandemic, a 43% increase. This means that nearly half of all dollars in circulation were created last year. This is the classic recipe for inflation, namely printing money and spending that newly printed money. If this is what is driving price increases, then it will not end when supply chain disruptions do. It will only end when the federal government spends less, the COVID relief payments end and the Federal Reserve stops rapidly increasing the money supply.