New inflation and the old descriptions

 

"Cost push inflation"

"Demand pull inflation"

When was the last time you heard those phrases? You may have to get into the way-back machine from decades ago. These inflation phrases are still taught in introductory macroeconomic costs, but little time was spent dwelling on the specifics especially given the sub 2% period post-GFC. Inflation was often discussed as a necessary evil to allow for policy flexibility.

We are certainly in a different inflation world than the 70's. Oil price shocks and union wage demands do not have the same potential impact for creating cost-push pressures. Globalization and output slack also does not allow for the demand pull reaction seen in the past. Yet, it may be time to brush up on inflation dynamics and their potential impact on the economy. 

Investors have to focus on two issues. 

1. What is the threat of pass-through from increases in input prices? If commodity prices increase, will there be an increase in end user prices? If there are increases in wages, will this translate into higher check-out prices? If supply chains are stressed, will prices increase? Given earnings have been high, profits can be squeezed without the failure of firms. Firms can choose to hold prices steady. Will they follow this strategy now?

2. What is the threat of price increases from excess demand? If incomes are higher, there can be stresses from higher demand that was not anticipated. We have already seen this  in the lumber market. Many lumber yards cut inventory in the spring of 2020 under the anticipation of falling demand. They were wrong and the cost has been demand-driven shortages. Again, firms have to determine whether to increases prices in the face of higher demand. Or, consumers have to determine whether they will pay higher prices to ensure delivery and reduce waiting times. 

The pricing game is simple - can firms adjust prices and get away with consumers accepting less at the same or higher price? If firms perceive that consumers will accept price increases, they will do it. We are seeing this with airfares. Prices are moving higher, and planes are being filled although load factor data are still not available for the current month. The increases are sticking, so demand pull price changes are happening. If this occurs across many industries, we have inflation.

"All inflation is transitory until after the fact."