Understanding Inflation After the Joe Biden Inflation Reduction Act

Many argue that inflation has risen since the signing of the Joe Biden Inflation Reduction Act. However, to truly understand this phenomenon, we must first define inflation and explore its causes. This piece aims to provide a clear and concise explanation, addressing common misconceptions about inflation in the context of the post-COVID economic recovery.

What is Inflation, and What is Not?

Inflation, at its core, refers to a systematic rise in general price levels across an economy over time. It is a process that occurs when the supply of money in an economy increases more than the supply of goods and services. This economic concept often gets conflated with day-to-day price fluctuations. The latter are more reflective of supply and demand dynamics in specific markets, rather than an overarching trend of inflation.

For instance, what many people perceive as spikes in food, gas, and rent prices are more indicative of supply chain disruptions, labor shortages, and cost-of-living adjustments. These are separate from general inflation but can contribute to the overall economic environment that drives inflationary pressures.

The Role of Government Spending and Deficit Management

In economics, governments have two primary tools to manage inflation: fiscal policy (through government spending) and monetary policy (managed by the Federal Reserve).

During the pandemic, the U.S. government implemented stimulus payments to mitigate the financial impact on individuals. This was the government's response to a multitude of challenges, including job losses and an economic shutdown, which led to a reduction in overall spending. In response to these challenges, the government spent more than it had to provide relief. This excess spending contributed to the inflationary pressures observed since 2021.

The Joe Biden Inflation Reduction Act, passed in 2022, aimed to stimulate economic recovery by investing in infrastructure and addressing environmental challenges. The act also provided loan support to businesses, further increasing the money supply in the economy. While some argue that this was excessive, the act's goal was to revitalize economic growth and create employment opportunities, which inadvertently fueled inflation.

Key Factors Contributing to Inflation

The current wave of inflation has several roots, summarized below:

COVID-19 Pandemic and Shutdown: In 2020, when the economy was largely shut down, businesses faced significant slowdowns in production and employment. Stimulus payments were designed to keep people employed and households afloat during the crisis. Supply Chain Disruptions: The pandemic caused global supply chains to be severely disrupted, leading to shortages of essential goods and services. This imbalance between supply and demand further pushed prices upward. Government Spending and Deficit: Excessive government spending, especially through stimulus payments and infrastructure projects, increased the money supply, leading to more demand than supply in the market.

Measuring and Understanding Inflation

Inflation is typically measured using the Consumer Price Index (CPI), which tracks changes in the prices of a market basket of goods and services. The CPI as of September 2024 is 2.4, which is close to the Federal Reserve's long-term target of 2%. This indicates that while inflation is a concern, it is within manageable levels.

The graph below shows how inflation (black line) compares to real wages (blue line). When real wages are rising, it suggests that the economic improvement is benefitting the workforce, even if the overall price level is increasing. This is an encouraging sign that the economy is recovering and improving the living standards of many Americans.

While it is true that some goods and services have seen significant price increases, the overall trend is not as dramatic as perceived. For instance, the current CPI suggests that prices have only increased about 19% from January 2021 to September 2024.

Closing Remarks

The post-COVID era has seen significant challenges and responses, leading to complex economic dynamics. It is important to understand that economic solutions often have both positive and negative consequences and are often a result of balancing various economic and social factors. The actions taken in the post-pandemic period, including the Joe Biden Inflation Reduction Act, were aimed at stabilizing the economy and promoting long-term recovery.

While the past is a useful reference, it is equally important to focus on current and future policies that ensure a sustainable and prosperous economic environment. The economic recovery, facilitated by acts like the Inflation Reduction Act, is a complex process that requires a nuanced understanding of its underlying causes and the ongoing efforts to mitigate its effects.