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Inflation pauses in August, but it will accelerate as Covid cases decline

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by Michael Busler

The Bureau of Labor Statistics just released the Consumer Price Index (CPI) for August. The number was .3%, which is the smallest monthly increase since January. That means consumer prices have increased by 5.3% since last August. That’s a slight decline from July’s rate.

Both the Biden administration and the Federal Reserve (Fed) will note that the monthly CPI number has decreased from the .9% recorded in June and .5% in July. This shows that the inflation problem seen in the first half of this year is transitory or temporary, meaning no Fed action is needed at this time.

Are they correct?

Unfortunately, they are probably wrong. Inflation may have taken a pause in the last month or two, but the forces that created inflation are set to take off once the virus ends. Frankly, I am surprised that the August number was .3%. I expected a lower number based on noting many prices, like airfares, have actually fallen in the last month or so.

Both Biden and the Fed continue to believe that the inflation problem we are experiencing in 2021 is temporary and will go away on its own, once the economy fully re-opens. While there are still some supply chain disruptions in some industries, like the auto industry, the economy is now operating at the same level as before the shutdown in March 2020.

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It is also true that there are container ships full of imported goods that are waiting in harbors to be unloaded. But those supply chain disruptions are but a minor contribution to the inflation problem.

Prices rise because demand for goods exceeds the supply.

The supply chain disruptions have put pressure on overall supply, but the vast majority of the inflation is caused by excess demand. What has caused the excess demand?

Fed policy that continues to keep interest rates near zero. That coupled with all of the free money the federal government has given to nearly all income earners means consumers have down payment money.

That means rational consumers who may not have considered buying a new house at this time, suddenly realize they can get a mortgage with a 2% interest rate. They also have the money for the down payment from the government. Hundreds of thousands of additional consumers have decided to look for a new house, increasing demand. The result is that housing prices are skyrocketing.

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The same is true with automobiles. Yes, there is a supply issue, but the higher prices come from many thousands of consumers deciding that with near 0% financing and with government-supplied down payments, it’s a good time to buy a new car.

The Fed has also increased the money supply by about 20% in the last 12 months as they purchase $120 billion monthly in bonds. This adds to the excess demand that has pulled up prices.

The government is fueling excess demand by spending trillions more than they receive in tax revenue. In fact, in 2020 and 2021, the federal government will have spent in excess of $6 trillion more than they received in revenue. In a $21 trillion economy, this excess demand will pull prices up.

There is also upward price pressure from energy, where the Biden administration has declared war on fossil fuels. This increase in energy costs will push prices up for finished goods.

Then there is the wage inflation problem. For whatever reason, many low-skilled workers are not returning to the workforce, even when their jobs call them back. To solve this, the business has had to raise wages. While that may be good for the workers, it drives up labor costs for businesses that will have to raise their prices to maintain profitability.

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One gauge of future consumer inflation is the producer price index, which shows inflation at the producer level. That number has increased by 8.3% in the last year  That means businesses will have to pass along the price increases to consumers.

The August CPI is a temporary pause due to temporarily reduced demand brought on by increases in COVID. Likely within the next month, those COVID cases will decrease and the economy can again fully re-open.  That will bring inflation up again.

It’s clear the Fed should act to slow the rate of growth in the money supply and gradually raise interest rates. The longer they wait to act, the more drastic the actions will be.

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