By Nazarul Islam

Milton Friedman, one of the greatest economists cautioned that Inflation is caused by too much money chasing after too few goods. It is also a form of taxation, without legislation.

There is a simple way to understand the recent rise in America’s inflation: As the pandemic is receding in the U.S., demand for goods and services is rebounding more quickly than the supply of those same goods and services. And when demand outpaces supply, prices rise.

Demand part of this story is obvious. More Americans are shopping in stores, eating in restaurants and contemplating vacations, in this summer. I have currently moved to the beautiful mountain country, the North Carolina to aid my daughter who is doing her Residency in Asheville hospital.

The small town is bustling, with crowded streets and summer time smiles. Traffic reminds me of Miami. The tags on vehicles are largely outside the state of North Carolina. Plazas and malls are full, with shoppers moving happily with their loaded bags.

Obviously, they are spending some of the savings that they accumulated during the pandemic, including money from government stimulus checks. As a local acquaintance shared with me – Demand is not just back but more than back, given the fiscal surge and pent-up savings.

Nationwide supply, however, is not back. The pandemic disrupted supply chains for many items, including computer chips, and household goods; This also disrupted work habits, and not everybody can — or wants to — return immediately to their old jobs.

The taxi and ride-hailing industry is a good example of what happens when rising demand (more travelers) runs up against reduced supply (a shortage of drivers). I read a report in NYT that One rider had recently paid $248 for a trip from Midtown Manhattan to Kennedy International Airport, in Queens — almost as much as his plane ticket to California.

Inflation has come in above expectations. During the meeting, Fed officials updated their inflation forecast, predicted that inflation would remain above 3 percent for much of this year, which is higher than their preferred level of 2 percent. Fed officials also announced that they expected to begin raising interest rates in 2023, sooner than previously planned.

Now, the big question is whether the forces causing inflation to rise are fleeting, as Powell believes is quite likely — or whether they will continue for months and create significant problems for the U.S. economy. Today’s newsletter lays out those two different scenarios.

There however, are some reasons to believe that the mismatch between demand and supply could last for a while.

On the demand side, Americans have money to spend, thanks partly to all the stimulus that the government has pumped into the economy. Look at what’s happened over the past year to the savings rate, which measures the portion of income that households put aside each month:

Although companies are increasing the supply of many products to satisfy rising demand, they may not always be able to keep up. One unknown, as Neil points out, is how many people have decided that they prefer the slower pace of pandemic life and choose not to return to full-time work. A lower labor supply could lead to more competition for workers and to wage increases that would translate into price increases.

If inflation remains elevated for months, it could feed on itself. Companies would increase prices, to cover the higher cost of raw materials. Workers would ask for wage increases, to maintain their buying power. The Federal Reserve might then need to raise interest rates to prevent an inflationary spiral, and rapid rate increase has caused recessions in the past.

Some companies have responded to higher prices, and to the opportunity to make higher profits, by increasing output. To take one example, lumber prices, after rising sharply, are now falling. As the economy is opening back up again, prices are now moving back toward normal levels in leisure, hospitality, airfare and the like.

The coming end to federal stimulus will also serve to reduce demand. The spending from the estimated $1.9 trillion bill that President Biden signed in March will mostly expire by early summer. Once that happens, the decline in government spending will act as a drag on economic growth and help hold down inflation.

The best outcome for most Americans is a growing economy in which incomes are increasing faster than prices, leading to broadly rising living standards. Stable inflation almost certainly needs to be a part of that happy outcome. But it is not enough – An economy with low inflation and weak income growth.

Nazarul Islam

The Bengal-born writer Nazarul Islam is a senior educationist based in USA. He writes for Sindh Courier and the newspapers of Bangladesh, India and America. He is author of a recently published book ‘Chasing Hope’ – a compilation of his 119 articles.

The post Living in the bubble of inflation first appeared on Sindh Courier.

By Nazarul Islam

The last two decades have been pretty tough times for many Americans, but there are now encouraging signs of a turnaround.

Productivity growth, a key driver for higher living standards, averaged only 1.3% since 2006, less than half the rate of the previous decade. But on June 3, the US Bureau of Labor Statistics reported that US labor productivity increased by 5.4% in the first quarter of 2021. What’s better, there’s reason to believe that this is not just a blip, but rather a harbinger of better times ahead: a productivity surge that will match or surpass the boom times of the 1990s.

Annual Labor Productivity Growth, 2001 – 2021 Q1

For much of the past decade, productivity growth has been sluggish, but now there are signs it’s picking up. (Courtesy: US Bureau of Labor Statistics)

Our optimism is grounded in our research which indicates that most OECD countries are just passing the lowest point in a productivity J-curve. Driven by advances in digital technologies, such as artificial intelligence, productivity growth is now headed up.

The productivity J-curve describes the historical pattern of initially slow productivity growth after a breakthrough technology is introduced, followed years later by a sharp takeoff. Our research and that of others has found that technology alone is rarely enough to create significant benefits.

Instead, technology investments must be combined with even larger investments in new business processes, skills, and other types of intangible capital before breakthroughs as diverse as the steam engine or computers ultimately boost productivity. For instance, after electricity was introduced to American factories, productivity was stagnant for more than two decades.

It was only after managers reinvented their production lines using distributed machinery, a technique made possible by electricity that productivity surged.

There are three reasons that this time around the productivity J-curve will be bigger and faster than in the past.

The first is technological: the past decade has delivered an astonishing cluster of technology breakthroughs. The most important ones are in AI: the development of machine learning algorithms combined with large decline in prices for data storage and improvements in computing power has allowed firms to address challenges from vision and speech to prediction and diagnosis.

The fast-growing cloud computing market has made these innovations accessible to smaller firms.

Significant innovations have also happened in biomedical sciences and energy. In drug discovery and development, new technologies have allowed researchers to optimize the design of new drugs and predict the 3D structures of proteins.

At the same time, breakthrough vaccine technology using messenger RNA has introduced a revolutionary approach that could lead to effective treatments for many other diseases. Moreover, major innovations have led to the steep decline in the price of solar energy and the sharp increase in its energy conversion efficiency rate with serious implications for the future of the energy sector as well as for the environment.

The costs of covid-19 have been tragic, but the pandemic has also compressed a decade’s worth of digital innovation in areas like remote work into less than a year. What’s more, evidence suggests that even after the pandemic, a significant fraction of work will be done remotely, while a new class of high-skill service workers, the digital nomads, is emerging.

As a result, the biggest productivity impact of the pandemic will be realized in the longer-run. Even technology skeptics like Robert Gordon are more optimistic this time. The digitization and reorganization of work has brought us to a turning point in the productivity J-curve.

The third reason to be optimistic about productivity has to do with the aggressive fiscal and monetary policy being implemented in the US. The recent covid-19 relief package is likely to reduce the unemployment rate from 5.8% (in May 2021) to the historically low pre-covid levels in the neighborhood of 4%. Running the economy hot with full employment can accelerate the arrival of the productivity boom.

Low unemployment levels drive higher wages which means firms have more incentive to harvest the potential benefits of technology to further improve productivity.

When you put these three factors together—the bounty of technological advances, the compressed restructuring timetable due to covid-19, and an economy finally running at full capacity—the ingredients are in place for a productivity boom.

This will not only boost living standards directly, but also frees up resources for a more ambitious policy agenda.

Nazarul Islam

The Bengal-born writer Nazarul Islam is a senior educationist based in USA. He writes for Sindh Courier and the newspapers of Bangladesh, India and America. He is author of a recently published book ‘Chasing Hope’ – a compilation of his 119 articles.

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By Nazarul Islam

As I imagine it, a ‘street side’, modern day picture of our US economy would give the viewer the impression of looking at the surface of an ocean at eye-level. That which is above the surface would be visible to anyone, but that which is below the surface would be invisible to all but the privileged viewer of the picture.

Above the surface teems a cornucopia of goods and services – goods and services the existence of which is made possible only by what is beneath the surface. The goods and services above the surface, available in abundance for ordinary people to consume, are all connected in intricate ways to the materials, machines, efforts, and processes – financial and ‘real’ – that churn beneath the surface.

Although the quantity of goods and services above the surface is immense, its size is minuscule compared to the colossal amount of economic inputs and activities beneath the surface—inputs and activities, including creative entrepreneurship and risk-taking and on-the-spot problem-solving – connected, in an unfathomable number of combinations, to each other and to the goods and services above the surface.

This web of connections is so complex as to be inconceivable to the human mind.

The human eye can very easily see that which in reality is, so to speak, above the economy’s surface. In plain sight are the huge amounts of food, drink, and other household goods that are always available in every supermarket throughout the modern world—the automobiles whizzing along boulevards and autobahns —the seemingly endless menu of choices at retailers such as Amazon and Walmart —the army of oncologists, cardiologists, neurologists, podiatrists, obstetricians, pediatricians, gastroenterologists, pediatric gastroenterologists, and other medical specialists – the blogs, books, movies, streaming music, movies-on-demand, guided tours, and sports-league television networks to entertain or challenge your mind—the jetliners that carry you away for holidays or home from job assignments—the high and rising life-expectancy—the infants not dying (nor their mothers), the parents not grieving – the artificially cooled indoor air during the summer and artificially heated indoor air during the winter—the new app for smartphones—smartphones! – goods and services galore.

From the gaudy to the glorious and each and every one the fruit of this inconceivably complex and spontaneously ordered web of economic relationships and processes, there exists a mix of peaceful competition and cooperation that works so silently and invisibly that almost no one knows of its existence.

In contrast, the human eye cannot see the full extent of the productive processes that make this cornucopia a reality. Indeed, this massive, ‘below-the-surface’ market activity is easy to deny or to trivialize. And it’s therefore tempting for those who are unhappy with what they see on the surface to demand that the surface phenomena be rearranged to be more pleasing to the unhappy complainers’ eyes.

However, many these unhappy complainers don’t realize that to knowingly meddle with that which is on the surface is to unknowingly meddle with far more; it’s to unknowingly yank on an uncountably large number of cords by which the surface phenomena are connected to the Everest of market processes beneath the surface.

Meddling with the surface phenomena causes these unseen cords to pull, twist, and rearrange in unpredictable ways many beneath-the-surface economic arrangements and processes. Among the simplest examples of such unseen pulling, twisting, and rearranging involves raising tariffs on imported steel in order to protect the jobs of today’s steelworkers or to better ensure supplies of a critical military input. Seems simple; and, indeed, it’s likely that such tariffs work—at least for a time —to ensure that more steel is produced domestically and, hence, to protect some steelworker jobs that would otherwise be made redundant by imports.

But peer beneath the surface. The higher tariffs on steel artificially raise the costs to other domestic producers of supplying the likes of precision tools, automobiles, home appliances, and office buildings. These producers of goods made with metal react with some combination of reduced outputs, lowered quality, and greater use of aluminum and other substitutes for steel. Buyers pay higher prices for these goods, thus generally leaving them less to spend to buy other goods and services —such as health care, restaurant meals, nights out at movie theaters, and vacations to Disney World. Employment in these other industries falls, thus offsetting any tariff-engendered gains in the employment of steelworkers.

The unseen consequences continue. As more aluminum is used domestically to produce (say) home appliances, the price of aluminum rises. The cost of supplying some military hardware thus also rises both, because of the higher prices of steel and because of the higher prices of aluminum. The defense budget grows, causing either taxes to rise today or – through debt issuance today – taxes to rise tomorrow.

The need to pay these higher taxes reduces consumer spending and business investment in ways unforeseeable, thus causing contractions in the size of some industries. As these industries contract, they employ fewer workers and buy fewer inputs from suppliers.

Yet (because) the consequences of tariffs play out over large numbers of economic relationships in space and time, no one can trace out their details. We know – chiefly through economic theory – that these consequences are real and generally worse than what would prevail absent any tariffs. But out of sight – out of mind. If the surface economic phenomena can be manhandled in ways that give it a better appearance to those who mistake the surface for the entire economy, then that’s that. The manhandling of the surface phenomena is mistakenly thought to work.

“See! Steel tariffs ensure that we produce more steel!” boasts the protectionist. The economist is left to verbally insist – quite correctly – that this visible ‘success’ comes at too hefty a price paid in the form of invisible distortions now infecting the vast subsurface web of market processes.

I wish (oh how I wish!) that I had artistic talent enough to paint such a picture!

How I wish that I could make more visible – literally visible – to the eye the economy’s teeming, streaming, pulsing, gargantuan – yet almost completely invisible and silent – interconnectedness and complexity.

The person who paints such a picture would provide a great service to our teachers….and the students of Economics!

Nazarul Islam

The Bengal-born writer Nazarul Islam is a senior educationist based in USA. He writes for Sindh Courier and the newspapers of Bangladesh, India and America. He is author of a recently published book ‘Chasing Hope’ – a compilation of his 119 articles.

The post A street side view of modern Economics… first appeared on Sindh Courier.