Currently most of the western world is experiencing inflation of between 8% and 15% a year (although there are some stark outliers).  The question on everyone’s mind is “will this become persistent,” my question is “how will we know if it has?”  

The Federal Reserve’s view that inflation would be “transitory” didn’t seem so unreasonable when they made it in early 2021.  Inflation was caused in part by the sudden drop in supply due to the COVID19 pandemic.  That drop in supply had also caused a drop in demand, but as the economy opened up demand was rising and it was assumed supply would as well.  This could have meant that within a year or two supply and demand would restablize to somewhere around their 2019 levels, when the factories and supply chains were fully staffed and the consumers were fully consuming. But something went wrong, at some point it seems that demand got well ahead of supply and at that point supply couldn’t catch up as long as low rates and easy money remained a policy of the Fed. And so in 2022 the Fed quietly retired the “transitory” label and started raising rates in earnest.

To digress a little, Argentina experienced an inflation rate of around 300% on average from 1975 to 1990, and the results on consumer habits were amazing.  People generally spent all their money as soon as they had it, no saving in sight, because inflation erodes the value of saved money almost immediately.  People would buy cars as soon as they hit the market, drive the car for a few years, and then sell it used and were able to make a profit because with 300% inflation the price of their car had gone up tremendously even as they drove it.  The lack of any sort of savings, and the sky-high demand as people spent every peso they had, both became entrenched in the buying habits of Argentine consumers and those habits were difficult for the central bank to overcome.  Worse still, these habits created a “tragedy of the commons” among the Argentine consumers, if everyone would be willing to spend less pesos and save more, then demand could cool off and supply could increase to match it, taming the inflation.  But if only some of the consumers stopped spending and started saving, then inflation would persist at sky high levels and all those consumers would accomplish is the swift erosion of whatever money they put towards savings.  If you wanted to keep your wealth during hyperinflation, you had to spend it (or convert it to dollars, which also didn’t help the peso).

The persistence of Argentine inflation was what made it so impossible to cool, not just the constant sticker shock.  That’s part of why the Federal Reserve has been so deliberate and communicative, it wants to maintain the trust of the American consumers and producers.  As long as people trust that the central bank will cool inflation, they will continue to save and not just spend spend spend.  But if people don’t trust the institutions (as they did not in Argentina), then any attempts to maintain trust in the currency are futile.  I haven’t detected the sort of tell-tale signs that inflation is becoming ingrained in American’s buying habits, we’d know if it had when people start buying things today on the assumption the price will rise in the near future, and I haven’t seen a lot of that.  On the other hand I’m a scientist who doesn’t have much money for big purchases, so what do I know about spending habits?