Related to Public Buffer Stocks: General Principles

Pure inflation is the theoretical concept. It may be defined as the undifferentiated devaluation of the monetary unit in relation to all goods and services in the economy, on a continuing or sustained basis. This is the type known to acolytes of Milton Friedman as being “always and everywhere a monetary phenomenon.” (Henderson 2021) It is rarely (if ever) encountered in real life. Possibly in 16th-century Europe the influx of silver and gold from the Americas and their effect on the value of metallic monetary units then in use provides an approximate example. The modern hyperinflations and currency collapses of (among others) Germany and Zimbabwe conventionally fall into the same category, even though these undoubtedly had differential effects on exports, imports, and non-tradables. But by contrast, a single once-for-all devaluation (say, Mexico 1995) would not count, if the national money then stabilized, and the price shock passed through the domestic economy within a limited time.

The opposite case, everyday inflation, is of a once-for-all increase in the price of a core commodity – a price shock, typically in energy – that propagates through the general price structure in rough alignment with the factor-intensity of that commodity in different sectors. In the cases of oil and natural gas, direct derivatives such as fertilizer, plastics, and transportation would be hit hard, more remote sectors (such as housing and services) less so. In this case, an increase in the general price level is always observed, because almost all prices of produced goods and services, and especially wages, are sticky downward, so there is never a full offset of increased prices in one sector by decreases in another. However, the net effect is always a shift in the distribution of incomes toward the sectors experiencing the largest price and profit gains, which is why inflation of this type cannot be qualified as “pure.” Further, the shock to the general price level usually dissipates after a certain interval – perhaps normally a few months. It may persist in the data and headlines for longer, as discussed below.

Having identified the two polar cases, “pure” and “everyday” inflation, we may admit the possibility of an intermediate case. This could be called “hybrid” or “persistent everyday” inflation. It would be marked by a sequence of knock-on or ratchet effects (Wood 1978), in which relative price impulses are passed from one sector to another without major damping. A structure of staggered wage contracts across different powerful trade unions could have this quality, with wage and then price increases ricocheting from one industrial sector or public service to the next. The US and UK inflations of the 1950s through the 1970s were more-than-possibly of this type.

With this typology in mind, the US price increases of 2021-2022 were certainly an everyday inflation.

In the overlapping global emergencies of the pandemic, climate change and geopolitical confrontations, supply shocks have become frequent and inflation has returned. This raises the question of how sector-specific shocks are related to overall price stability. This paper simulates price shocks in an input–output model to identify sectors which present systemic vulnerabilities for monetary stability in the United States. We call these prices systemically significant. We find that in our simulations the pre-pandemic average price volatilities and the price shocks in the COVID-19 and Ukraine war inflation yield an almost identical set of systemically significant prices. The sectors with systemically significant prices fall into four groups: energy, basic production inputs other than energy, basic necessities, and commercial infrastructure. Specifically, they are “Petroleum and coal products,” “Oil and gas extraction,” “Utilities,” “Chemical products,” “Farms,” “Food and beverage and tobacco products,” “Housing,” and “Wholesale trade.” We argue that in times of overlapping emergencies, economic stabilization needs to go beyond monetary policy and requires institutions and policies that can target these systemically significant sectors.

The dominant view of inflation holds that it is macroeconomic in origin and must always be tackled with macroeconomic tightening. In contrast, we argue that the US COVID-19 inflation is predominantly a sellers’ inflation that derives from microeconomic origins, namely the ability of firms with market power to hike prices. Such firms are price makers, but they only engage in price hikes if they expect their competitors to do the same. This requires an implicit agreement which can be coordinated by sector-wide cost shocks and supply bottlenecks. We review the long-standing literature on price-setting in concentrated markets and survey earnings calls and compile firm-level data to derive a three-stage heuristic of the inflationary process: (1) Rising prices in systemically significant upstream sectors due to commodity market dynamics or bottlenecks create windfall profits and provide an impulse for further price hikes. (2) To protect profit margins from rising costs, downstream sectors propagate, or in cases of temporary monopolies due to bottlenecks, amplify price pressures. (3) Labor responds by trying to fend off real wage declines in the conflict stage. We argue that such sellers’ inflation generates a general price rise which may be transitory, but can also lead to self-sustaining inflationary spirals under certain conditions. Policy should aim to contain price hikes at the impulse stage to prevent inflation from the onset.