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Inflation rates are rising in the US – an economist explains why

Rising inflation rates due to supply-side factors – COVID-19, Ukraine and supply chain shortages – make countering inflation difficult for the central…

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A variety of factors have caused the U.S. inflation rate to increase over the past few years, from the pandemic to the war in Ukraine. Javier Ghersi/Moment via Getty Images

Consumer prices in the U.S. are rising due to inflation at the fastest rate they have in decades. Earlier this summer, SciLine interviewed Martha Olney, a teaching professor emerita of economics at the University of California, Berkeley, about what’s causing prices to rise and what the government can do to encourage a return to stable prices.

The Conversation has collaborated with SciLine to bring you highlights from the discussion, which have been edited for brevity and clarity.

What factors are contributing to inflation?

Martha Olney: If more people want to buy things – that is, if there’s an increase in demand – that’s going to make prices go higher. The other thing that can drive prices up is a decrease in supply – for example, if it becomes more difficult to produce goods. This happens if there are supply chain disruptions or disruptions in transportation.

In the last couple of years, we’ve had both of those things. At the beginning of the pandemic, demand shifted and we started buying more goods, rather than services. We were buying more cars, more electronics, more goods for the home. And we saw that price impact. At the same time, we had supply chain disruptions. So, the demand for goods went up, but the things needed to produce those goods were not as available, and so those prices went up.

How has the war in Ukraine made inflation worse?

Olney: As we were still dealing with the pandemic, the war started in Ukraine. This impacted both energy prices and food prices. Energy prices increased because of sanctions on Russia – Russia provides oil to the global market. The price of oil is set in a global market, so any disruption to the oil supply impacts the oil price worldwide. Ukraine and Russia also provide a large share of the world’s wheat exports, and their ability to grow, harvest and export their grain has been impacted by the war as well.

How can previous periods of inflation help us understand what’s happening right now?

Olney: In the 1970s, the OPEC oil crisis led to a reduction in the oil supply, which sent oil and fuel prices up. And that was, again, a supply restriction. At the time, that led to increases in the prices of many things because fuel was an important ingredient in so many things that we produced, and inflation took off.

So that’s the historical period that I think is particularly relevant because it leads into how our expectations of inflation are changing. There is a survey that’s conducted every month where folks from the University of Michigan go out and ask a bunch of consumers what they think the inflation rate is going to be in the next month and the next year. Those answers are called our “inflationary expectations.”

The inflation of the 1970s followed a 15- to 20-year period of stable inflation, where people’s answers to that question had not changed much from month to month. This episode we’re going through right now is following 30 years of stable inflation, where people’s answers to that question have not changed much from month to month either. And so, the parallels are rising prices, driven at first by supply constraints, as well as people’s inflationary expectations. People are expecting a higher inflation rate than they were a few months ago.

Who is responsible for reducing inflation, and what tools do they have?

Olney: The primary agency in the United States for fighting inflation is the Federal Reserve. The tool that the Federal Reserve has is changing interest rates. There are some regulatory agencies that may be able to adjust their regulations and bring prices down a little, but the real changes that matter are the Federal Reserve and its use of interest rates. The Federal Reserve will either slow the economy by increasing interest rates, or boost the economy by decreasing interest rates.

What stabilized prices after that similar period in the 1970s?

Olney: The Federal Reserve broke that inflation by undertaking extraordinarily tight, conservative and contractionary monetary policies. They increased interest rates as high as 18%. So, to get a mortgage to buy a house, the interest rates were 16% to 18%. That brought demand to a screeching halt, made the economy contract and triggered the most severe recession we’d had since the 1930s. And that reduced demand for products and led to, ultimately, a decrease in prices.

The other piece of the inflation puzzle is what’s happening to people’s expectations. In the early 1980s, President Ronald Reagan went on camera from the White House and assured everyone that he was in control and the Federal Reserve was going to solve this problem. Together with the changes in interest rates that caused unemployment to soar, Reagan’s reassurances led to a drop in people’s expectations that some economists believe was key in lowering inflation in the early 1980s.

Is it possible to stabilize prices without causing a recession?

Olney: A recession is when the total amount of goods and services that are produced in a month is less than it was the month before. So, the amount of goods and services that we’re producing is getting smaller and smaller, month by month.

What the Fed is hoping to do is slow the rate of increase – that’s what they mean by a “soft landing.”

So instead of increasing the production rate at, say, 2% per year from month to month, maybe we could increase it 1% per year. In that case, we wouldn’t have a recession; we would just have a decrease in the amount of growth.

Watch the full interview to hear more about how examining historical periods of inflation can help us understand what’s happening to markets now.

SciLine is a free service based at the nonprofit American Association for the Advancement of Science that helps journalists include scientific evidence and experts in their news stories.

Martha Olney does not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.

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Spread & Containment

$265 Billion In Added Value To Evaporate From Germany Economy Amid Energy Crisis, Study Warns

$265 Billion In Added Value To Evaporate From Germany Economy Amid Energy Crisis, Study Warns

A new report published by the Employment Research…

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$265 Billion In Added Value To Evaporate From Germany Economy Amid Energy Crisis, Study Warns

A new report published by the Employment Research (IAB) on Tuesday outlines how Germany's economy will lose a whopping 260 billion euros ($265 billion) in added value by the end of the decade due to high energy prices sparked by Russia's invasion of Ukraine which will have severe ramifications on the labor market, according to Reuters

IAB said Germany's price-adjusted GDP could be 1.7% lower in 2023, with approximately 240,000 job losses, adding labor market turmoil could last through 2026. It expects the labor market will begin rehealing by 2030 with 60,000 job additions.

The report pointed out the hospitality industry will be one of the biggest losers in the coming downturn that the coronavirus pandemic has already hit. Consumers who have seen their purchasing power collapse due to negative real wage growth as the highest inflation in decades runs rampant through the economy will reduce spending. 

IAB said energy-intensive industries, such as chemical and metal industries, will be significantly affected by soaring power prices. 

In one scenario, IAB said if energy prices, already up 160%, were to double again, Germany's economic output would crater by nearly 4% than it would have without energy supply disruptions from Russia. Under this assumption, 660,000 fewer people would be employed after three years and still 60,000 fewer in 2030. 

This week alone, German power prices hit record highs as a heat wave increased demand, putting pressure on energy supplies ahead of winter. 

Rising power costs are putting German households in economic misery as economic sentiment across the euro-area economy tumbled to a new record low. What happens in Germany tends to spread to the rest of the EU. 

There are concerns that a sharp weakening of growth in Germany could trigger stagflation as German inflation unexpectedly re-accelerated in July, with EU-Harmonized CPI rising 8.5% YoY. 

Germany is facing an unprecedented energy crisis as Russian natural gas cuts via the Nord Stream 1 pipeline will reverse the prosperity many have been accustomed to as the largest economy in Europe. 

"We are facing the biggest crisis the country has ever had. We have to be honest and say: First of all, we will lose the prosperity that we have had for years," Rainer Dulger, head of the Confederation of German Employers' Associations, warned last month. 

Besides Dulger, Economy Minister Robert Habeck warned of a "catastrophic winter" ahead over Russian NatGas cut fears.

Other officials and experts forecast bankruptcies, inflation, and energy rationing this winter that could unleash a tsunami of shockwaves across the German economy.  

Yasmin Fahimi, the head of the German Federation of Trade Unions, warned last month:

"Because of the NatGas bottlenecks, entire industries are in danger of permanently collapsing: aluminum, glass, the chemical industry." 

IAB's report appears to be on point as the German economy seems to be diving head first into an economic crisis. Much of this could've been prevented, but Europe and the US have been so adamant about slapping Russia with sanctions that have embarrassingly backfired. 

Tyler Durden Wed, 08/10/2022 - 04:15

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International

“Anything But A Cashless Society”: Physical Money Makes Comeback As UK Households Battle Inflation

"Anything But A Cashless Society": Physical Money Makes Comeback As UK Households Battle Inflation

The World Economic Forum (WEF) has been…

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"Anything But A Cashless Society": Physical Money Makes Comeback As UK Households Battle Inflation

The World Economic Forum (WEF) has been pushing hard for a 'cashless society' in a post-pandemic world, though physical money has made a comeback in at least one European country as consumers increasingly use notes and coins to help them balance household budgets amid an inflationary storm

Britain's Post Office released a report Monday that revealed even though the recent accelerated use of cards and digital payments on smartphones, demand for cash surged this summer, according to The Guardian. It said branches handled £801mln in personal cash withdrawals in July, an increase of 8% over June. The yearly change on last month's figures was up 20% versus the July 2021 figure of £665mln.

Across the Post Office's 11,500 branches, £3.31bln in cash was deposited and withdrawn in July -- a record high for any month dating back over three centuries of operations. 

The report pointed out that increasing physical cash demand was primarily due to more people managing their budgets via notes and coins on a "day-by-day basis." It said some withdrawals were from vacationers needing cash for "staycations" in the UK. About 600,000 cash payouts totaling £90mln were from people who received power bill support from the government, the Post Office noted. 

Britain is "anything but a cashless society," according to the Post Office's banking director Martin Kearsley.

"We're seeing more and more people increasingly reliant on cash as the tried and tested way to manage a budget. Whether that's for a staycation in the UK or if it's to help prepare for financial pressures expected in the autumn, cash access in every community is critical," Kearsley said.

We noted in February 2021, UK's largest ATM network saw plummeting demand as consumers reduced cash usage. At the time, we asked this question: "How long will the desire for good old-fashioned bank notes last?

... and the answer is not long per the Post Office's new report as The Guardian explains: "inflation going up and many bills expected to rise further – has led a growing numbers of people to turn once again to cash to help them plan their spending." 

So much for WEF, central banks, and major corporations pushing for cashless societies worldwide, more importantly, trying to usher in a hyper-centralized CBDC dystopia. With physical cash back in style in the UK, the move towards a cashless society could be a much more challenging task for elites than previously thought. 

Tyler Durden Wed, 08/10/2022 - 02:45

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International

Something Just Doesn’t Add Up In Chinese Trade Data

Something Just Doesn’t Add Up In Chinese Trade Data

By Ye Xie, Bloomberg markets live commentator and reporter

An unusual discrepancy has…

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Something Just Doesn’t Add Up In Chinese Trade Data

By Ye Xie, Bloomberg markets live commentator and reporter

An unusual discrepancy has showed up in two sets of trade data in China. Depending on which official sources you use, China’s trade surplus, could either be overstated or under-reported by a staggering $166 billion over the past year.

China watchers cannot fully explain the mystery. It’s as if Chinese residents bought a lot of stuff overseas, and instead of shipping the items home, they were kept abroad for some reason.  

China’s exports have been surprisingly resilient, despite a slowing global economy and Covid disruptions. On Monday, General Administration of Customs data showed China’s exports increased 18% in July from a year earlier. In contrast, imports grew only 2.3%, reflecting weak domestic demand.

The result is China’s trade surplus keeps swelling, which has underpinned the yuan by offsetting capital outflows. The surplus over the past year amounted to a record $864 billion, more than double the level at the end of 2019.

But when comparing the Customs data with that from the State Administration of Foreign Exchange (SAFE), a different picture emerges. The SAFE data shows the surplus is growing at a much slower pace -- about 20% less than the customs figure

The two data sets used to track each other closely. SAFE typically reports fewer imports, thus a higher surplus, because it excludes costs, insurance and freight from the value of goods imported, in line with the international standard practice, Adam Wolfe, an economist at Absolute Strategy Research, noted.

The other adjustments that SAFE does include:

  • It only records transactions that involve a change of ownership;
  • It adjusts for returned items;
  • It adds goods bought and resold abroad that don’t cross China’s border, but result in income for a Chinese entity -- a practice known  as “merchanting.”

The relationship between the two data sets has flipped since 2021, as SAFE reported higher imports, resulting in a smaller surplus than the Customs data.

It’s particularly odd because it happened at a time when shipping costs skyrocketed. When SAFE removes freight and insurance costs, it would have resulted in even lower, not higher, imports.

Taken at face value, the discrepancy suggests that somebody in China “bought” lots of goods from abroad, but they have never arrived in China. These transactions would be recorded by SAFE as imports, but not at the Customs office.

Craig Botham at Pantheon Macroeconomics, suspects that Covid-19 may be playing a role here. Foreign firms unable to manufacture in factories elsewhere during the pandemic might have transferred materials to China for assembly, a transaction excluded by SAFE.

Could Chinese buyers overstate their foreign purchases to SAFE, which regulates the capital account, so they can move money out of the country? The cross-border transactions show there was widespread overpaying for imports in 2014-2015, during a period of intense capital flight, but not at the moment, Wolfe pointed out.

Source: Absolute Strategy Research

The bottom line is that there aren’t many good explanations. As Alex Etra, a senior strategist at Exante Data, said, there’s “no smoking gun” to suggest something fishy is going on.

It’s another mysterious puzzle waiting to be solved.

Tyler Durden Tue, 08/09/2022 - 22:28

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