Cost Push Inflation

This is the worst form of inflation. Traditionally, demand pull inflation is caused by consumers buying products quicker than manufacturers produce them. This drives up prices, eventually cooling demand, which lowers prices and consumers start buying again. Economists affectionately refer to this as the business cycle.

In the 1970s, we encountered the ugly cost-induced inflation. This results when a key component of production, say, oil, becomes more expensive. This means that producers have to charge more. Consumers, in turn, buy less, which causes producers to reduce production and leads to layoffs. This leads to lower incomes, and further reduced demand. However, if the price of, say, oil, continues to rise, prices will not fall and may even rise. This creates an environment of both high inflation and high unemployment.

Keynsian economics works well with the business cycle. You can use monetary and fiscal policy to ease the business cycle. The Fed raises and lowers interest rates to cool inflation or stimulate spending via cheap credit. The govt inputs money through unemployment insurance to make sure out of work consumers still spend money. Tax cuts can increase disposable income and encourage consumption to restart the economy.

Cost push inflation has few simple answers. Attempts to heighten employment exasperate the inflation problem. The Ford and Carter administrations, while nominally trying to end inflation, cared more about unemployment. They allowed inflation to remain high to prevent a deep recession. Ford's "WIN" buttons were a silly mask to cover up his pro-employment policies that allowed inflation to soar.

Attempts to lower inflation causes higher unemployment and deepens a recession. This is what Volcker opted to do in the early 1980s to end double-digit inflation from the 1970s. It resulted in the deep and difficult "Volcker Recession" of 1982-1983, but resulted in a long and prosperous recovering from 1984 (lucky for Ronnie) until 1990 (not so lucky for Pappi Bush).

While much of the higher inflation is caused by Katrina, a temporary issue, the steady rise in oil will continue. This will drive up the cost of everything related to petroleum: transportation, farming, paint, carpeting, pharmaceuticals, etc. All these costs will be pushed along by producers to other producers and ultimately to consumers. Since oil is a global commodity, the ensuing recession will be global.

The only real solution will be to wean ourselves from fossil fuels. This in itself would be worthwhile, since fossil fuels are highly damaging to the environment and our addiction warps our foreign policy. Why do you think we have sent troops to the Middle East so often over the last half century? There are plenty of nasty dictators in Africa to tackle.

With an oil president and an oil vice president, I doubt this administration will do much. At the very least, they could stop spending like there was no tomorrow. With a $500 billion deficit, the government won't be much help in the coming economic difficulties.

Katrina Sparks Inflation