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U.S. consumer prices are rising at the fastest rate in four decades.
On Thursday, June 30, 2022, SciLine interviewed: Dr. Martha Olney, a teaching professor of economics at the University of California, Berkeley. She discussed topics including: factors contributing to rising prices; how research on previous periods of high inflation can help us understand what is happening now; what can slow inflation, and when consumers may see relief; and why curbing inflation can harm the economy in other ways, and whether it is possible to stabilize prices without causing a recession.
MARTHA OLNEY: My name is Martha Olney. I’m a teaching professor of economics at the University of California at Berkeley, and I study economic history and macroeconomics.
Interview with SciLine
What factors are contributing to inflation?
MARTHA OLNEY: Well, if more people want to buy things—that is, if there’s an increase in demand—that’s going to make prices go higher. Because if a business, for instance—55 people show up to buy the thing that they’re selling, and they only have 40 of them available to sell, one way of deciding which of those 55—which 40 of those 55 people are going to be the lucky ones to buy this good is to let them bid the price up. So which—who are the 40 of you willing to pay the highest price? And so, an increase in demand is one thing that can drive prices up. The other thing that can drive prices up is a decrease in supply—so, if it’s more difficult to produce goods; if, for instance, there are, oh, I don’t know, supply chain disruptions; if there are disruptions in transportation; if the available inputs to the production process are not as available. So, if there’s a reduction in supply, that also makes prices go up.
What we’ve had in the last couple of years is both of those things. So, at the beginning of the pandemic, it’s not that demand overall increased, but demand shifted, and so we started buying more goods. There was an increase in the demand for goods and a decrease in the demand for services. We were buying more cars. We were buying more electronics. We were buying more goods for the home. And we saw that—the impact of that in prices. At the same time, we had supply chain disruptions where—remember early in the pandemic when people wanted to buy cars, and they kept saying, but there’s no chips? The cars are all—they’re all computers on wheels now, and they need the chips, but the chips were made in China, and China was locked down, and there was no transportation—there was no production of chips. So, the demand for goods went up, the things that they needed to produce those goods were not as available, and so those prices went up.
How has the war in Ukraine made inflation worse?
MARTHA OLNEY: Here we are dealing with the pandemic, and then the war starts in Ukraine. The war starts in Ukraine earlier this year, and that impacts both energy prices and food prices. The energy prices are impacted because of the sanctions on Russia and the oil that Russia provides to the global market. And the price of oil is set in a global market, so any disruption to the supply of oil impacts the price of oil worldwide. And now the food because Ukraine, Russia, and—but particularly Ukraine—is the wheat basket of the world and provides a very large share of the world’s wheat exports, and their ability to grow and harvest and export their grain has been impacted as well by the war. And so, we have first the pandemic effects, both on demand and on the supply side, and then we have the war effects, all of which have contributed to higher prices.
How can previous periods of inflation help us understand what’s happening right now?
MARTHA OLNEY: For those of us who are old enough to remember the 1970s, the OPEC oil crisis manifested itself in a reduction in the supply of oil, which sent oil prices up, which sent fuel prices up. And that was, again, one of those supply restrictions that caused prices to go up. And at the time, because fuel was an important ingredient in so many things that we produced, that led to increases in the prices of many, many things, and inflation took off.
And so that’s the historical period that I think is particularly relevant because the piece that’s relevant from that time and relevant now is—how are our expectations of inflation changing? And what that means is—there is a survey that’s conducted every month where they go out and they ask a bunch of consumers, hey, what do you think the inflation rate is going to be next month? What do you think the inflation rate is going to be in a year? And people’s answer to that question—what do you think the inflation rate’s going to be next month? People’s answer to that question—that’s our inflationary expectations. So, the official term for that is inflationary expectations.
And in the 1970s, the inflation of the 1970s followed about a 15- to 20-year period of very stable inflation, where people’s answers to that question had not changed much from month to month for a 15-year period. This episode we’re going through right now is following 30 years of very stable inflation, where people’s answers to that question have not changed very much from month to month for the last 30 years. And so, the parallels are—we have rising prices. We have rising prices that are driven at first by supply constraints, and we have people’s answers to that—hey, what do you think the inflation rate is going to be next year? People’s answers to that question are going up. People are answering a higher number than they were a few months ago. And that’s why I think the parallel is 50 years ago, in the 1970s.
What stabilized prices after that similar period in the 1970s?
MARTHA OLNEY: The way that we broke the back of that inflation was the Federal Reserve undertook extraordinarily tight, conservative, contractionary monetary policy. They increased interest rates to as high as 18%. So, to buy a house—to get a mortgage to buy a house—the interest rates were 16-, 17-, 18%. And that enormously high level of interest rates basically brought demand to a screeching halt. So, it really made the economy contract. It triggered a very severe recession—the most severe recession we’d had since the 1930s. And that—remember I said supply and demand? That reduced demand for products and led to, ultimately, a decrease in prices.
The other thing that happened in the early 1980s was Ronald Reagan had been elected president in 1980. And remember, I said the other piece of the inflation puzzle is what’s happening to people’s expectations. Ronald Reagan, as president, was the first president who really knew how to use the camera, as he had been trained, as we know, as a film actor. And so, he, unlike the presidents before him, was able to look into the camera and talk directly to people in their homes—to make eye contact with people in their homes. And he went on camera from the White House and assured everyone that he was in charge, he was in control, that his Federal Reserve—even though the Federal Reserve is officially independent—that his Federal Reserve was going to solve this problem. And he was very reassuring that this was going to get fixed.
Who is responsible for reducing inflation, and what tools do they have?
MARTHA OLNEY: The primary agency in the United States for fighting inflation is the Federal Reserve. And the tool that the Federal Reserve has is changing interest rates. There are other agencies that can do some work in terms of affecting inflation. So, there are some regulatory agencies who may be able to adjust their regulations, and that may be able to bring prices down a little bit, but that’s just kind of doing little changes around the edges. The real changes that matter are the Federal Reserve and its use of interest rates to either slow the economy when they increase interest rates. Or what they do in the reverse—it’s when they decrease interest rates, it boosts the economy.
Is it possible to stabilize prices without causing a recession?
MARTHA OLNEY: Is it necessary that there be a recession? No. It’s possible for the Federal Reserve to slow the growth of the economy and not actually make it contract. So let me back up a little bit. When we talk about a recession, we’re talking about the total amount of goods and services that are produced in a month is less in one month than it was the month before. So, there is some amount that we produced in May, and then we produced less—fewer goods and services—in June than we did in May, and fewer still in July than we did in June, and fewer still in August than we did in July. And that’s the essence of a recession. So, the amount of goods and services that we’re producing is getting smaller and smaller and smaller.
An alternative to that is to just slow the growth. Because, in normal times, the amount of goods and services that we’re producing is growing from month to month to month. So normally, how much we produced in June is more than what we produced in May, how much we produced in July is more than June, how much we produced in August is more than July, and so on. And so, what the Fed is hoping to do—and this is what they mean by a soft landing. What the Fed is hoping to do is they’re hoping to slow the rate of increase. So instead of increasing at, say, 2% per year from month to month, maybe we could increase it 1% per year or one half of a percent per year in the amount of goods and services that we’re producing. In that case, we wouldn’t have a recession because a recession, by definition, is a contraction or a decrease in how much we’re producing month over month, but we would have a decrease in the amount of growth.
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