In the third part of our 3-part series on inflation (part 1 & part 2), we explore how supply chain disruptions effect inflation (probably most relevant to our current situation).
This is what the press refers to as “supply chain disruptions”, really just a fancy way of saying that the suppliers don’t have enough to sell, providing them an opportunity to charge higher prices. This could be caused by a drought (food shortage), closed oil pipelines (gas shortage) or a lack of employees to work in the factories and to drive the delivery trucks (maybe because of covid fears or because of government assistance that has left them flush with cash). Notably, raising interest rates to check inflation caused by supply constraints is designed to lower demand to meet lower supply (bringing prices back down) when the real challenge is to increase supply to meet normal demand levels (something the Fed is not equipped to deal with).
In conclusion of our 3-part series, it is better not to try to flatten the economy’s natural up and down cycles by manipulating interest rates because this often leads to excesses that are even more difficult to manage. It would be better if consumers and businesses were not fooled into borrowing & spending more because of lower interest rates but, rather, made financial decisions based on their income levels guided by their long-term saving and investing goals. Also, it would be better if the Fed did not seek to put money into consumers’ pockets because this creates artificial demand that causes inflation while also decreasing the labor force’s motivation to work, thus decreasing supply and further fueling inflation.
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