Every day’s an adventure for Menzie Chinn—for multiple reasons.
Some of it is software-related. Every day, Chinn, who teaches students about macroeconomic issues in his dual roles as a professor with the La Follette School of Public Affairs and the Department of Economics, has to parse, arrange and translate economics-related information through multiple software packages before presenting it to his students. But most of it is related to the topic he researches and discusses most frequently in recent years: inflation and the ways it’s affected by current events.
Inflation has grabbed a lot of headlines over the last year, as the U.S. economy continues to recover from the pandemic-fueled recession. The most recent U.S. inflation report for December, released last Thursday, showed the rate at 6.5 percent, down a percentage point from its height of 7.5 percent earlier in the year. Chinn, who analyzes economic conditions and policies as part of the writing he does for EconBrowser, the economics blog he co-authors, knows better than anyone that tracking and understanding inflation can be bewildering. Recently, we asked him to identify some of the most common things people get wrong about inflation.
Inflation and price hikes are not the same thing.
This is the big one, the one from which most of the confusion about inflation springs.
“As economists, we talk about inflation as the sustained rate of change in prices over time,” says Chinn, noting the critical importance of the “over time” part of the definition. “Consumers think about inflation as the prices of things. It’s very easy to get these things confused, and people need to understand the subtleties.”
In other words, if the price of milk jumps a quarter next week and stays there, that’s not inflation. If the price of milk, along with many other goods, continues to rise over a prolonged period of time, it is.
People routinely overpredict the rate of inflation.
“People pay a lot more attention to the prices of things they buy often,” says Chinn. “Things like gasoline and groceries.”
So when you recoil in sticker shock when you see that the price of a dozen eggs has rocketed above $7 at your local grocery store, you’re likely to think it’s due to inflation, when it’s far more likely to be caused by factors related to supply and demand. In the case of the eggs, a virus affecting chicken populations and disrupting the supply chain is a prime culprit.
Chinn says that, not only do people overestimate the current rate of inflation they’re experiencing, they also consistently overpredict the rate of inflation over the next year, higher by nearly half a percentage point, and the distortion is also tied to an individual’s economic situation: if someone is from a lower income group, for example, they’re more likely to overpredict the overall rate of inflation.
Very few government policies can affect whether inflation goes up or down.
It’s a popular practice to blame whichever political party or president is in power when inflation soars. If gas prices top four dollars a gallon, as they did at various points in 2022, it’s clearly Joe Biden’s fault. Members of Congress, meanwhile, will often tell their constituencies they’re gearing up to “tackle inflation.”
The truth is that politicians have about as much ability to control inflation as they do to control the world events that have a far greater impact on its trajectory.
“People love to say in these situations, ‘Well, we ought to pass a law to deal with inflation,’” Chinn laughs. “It’s not going to happen.”
As Chinn explains, our latest bout with soaring inflation rates is a result of several things, beginning with the re-opening of the U.S. economy in the wake of the pandemic. Fueled in part by federal recovery packages, customers looking to begin spending money again slammed up against a supply chain that was ill-equipped to deal with the spike in consumer demand for, in particular, consumer goods. (Think about that shortage of silicone semiconductor chips that made smartphones and PlayStation 5s so difficult to acquire.) Another big driver was Russia’s 2022 decision to invade Ukraine, a move that destabilized the region and sent oil and grain prices skyrocketing worldwide.
What's the only thing that can directly reduce inflation in a big way? The Federal Reserve’s decisions on monetary policy—more specifically, the decision to raise interest rates to cool off the economy. The federal government could also further cool off the economy by reducing spending or increasing taxes, although getting the timing right would be much more difficult.
There are, however, other governmental policy initiatives that can impact the economy, and by extension, inflation. Chinn points to removing the tariffs on imported steel and aluminum and allowing more immigration to help in sectors (agriculture, service industry) where workforce needs aren’t being met.
To Chinn, our current state of inflation most closely mirrors 1973-74, another point in history in which events in foreign countries sparked a steep spike in oil and gasoline prices. He’s also reminded of the years immediately following World War II, when the suspension of rationing created pent-up consumer demand at a point supply system that wasn’t prepared to handle it.
Like those points in history, the current inflation is likely to be temporary. That means things could be looking up for 2023. That’s also the consensus among economists.
“Inflation has been falling on a month-to-month basis, but not as fast as we would like,” says Chinn. “If we don’t get any more shocks like the Russian invasion, we could see inflation falling further.”