By Blu Putnam
U.S. inflation has risen to 7.5%. The shift in spending away from services and toward goods is the main culprit, and effective policy options are limited.
When the pandemic arrived, many restaurants, hotels, and airlines were hit hard. But with fiscal support from the U.S. Congress, individuals still had money to spend. They just shifted to spending more on goods and less on services. From December 2019, before the pandemic, to December 2021, goods spending rose 22% and services spending rose just 6%.
The inflation data reflect the relative demand shift. Services inflation is up only 4.6%, while non-durable goods inflation is just less than 10%, and durable good inflation is running at 18%.
The inflation is demand-driven by the relative consumption shift towards goods; not by an overall excessive rise in total consumption. That is, the pandemic caused a massive consumption shift to goods, which in turn caused the supply chain to be overwhelmed and fed inflation.
Because a relative demand shift and not an overall rise in demand is the culprit, effective policy options are limited. Only policies that directly address either supply chain challenges or might push consumers back toward services are going to make a difference in lowering inflation. So, the infrastructure fiscal spending might help a little, but not quickly, as it is spread over the coming decade.
The Federal Reserve is limited in influencing the relative mix of spending. The Fed may raise interest rates toward its longer-term neutral target of 2%, but rate rises impact the whole economy, not the mix of goods versus services spending. Supply chain disruptions are not easily solved with macro-economic policies.
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