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Jan 12, 2022

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Charles serves as CCLP's Income and Housing Policy Director using data and research to support our efforts to stand with diverse communities across Colorado in the fight against poverty. Staff page ›

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Making cents of the headlines, part 2: What causes inflation?

by | Jan 12, 2022

Income, News, Resources

stock image of the Apollo 7 rocket in flight, but the rocket is replaced by a dollar sign and the flames are green because money

Inflation numbers for December are out today. Prices of the goods included in the Consumer Price Index increased by 7.0 percent year-over-year in December 2021, a level not seen in 40 years. Excluding energy and food prices, which tend to be more volatile than other prices, core inflation last month was 5.5 percent.

While many policymakers and economists hoped the inflation we experienced over the course of 2021 would be transitory (economist-speak for “temporary”), the headline and core inflation rates continue to be well above the Federal Reserve Bank’s long-term target of 2.0 percent. Comparisons to the inflation our economy experienced during the 1970s are everywhere, as are warnings that the spending proposed as part of the Build Back Better Act (BBBA) will only make inflation trends worse.

Too often, however, pundits and doomsayers forget the basics: What really is inflation, why does it happen, and what factors are truly driving the inflation we currently see?

What is inflation and why does it happen?

Simply put, inflation is an increase in the prices consumers pay for the goods and services they buy.

While this definition helps us understand what inflation is, it does not tell us why inflation happens. To understand this, we must think about our economy in terms of two groups:

  1. Producers: the people or businesses who make goods or provide services
  2. Consumers: the people or businesses who buy those goods and services

In nearly all economic transactions, producers are the ones who set the price of their goods and services and consumers use their personal income to purchase them. If prices increase, it is because a producer decided to charge more for a good or service than they did previously.

Why would a producer choose to increase their prices?

There are many reasons why producers may choose to increase their prices:

  1. A producer may be a consumer themselves, purchasing their own goods (including raw materials) or services (including labor) in order to produce the good or service they intend to sell. Those purchases are called inputs. If the prices of the producer’s inputs increase, they might respond by raising their own prices, particularly if they want to continue earning the same profits from their enterprise.
  2. When many consumers in the economy see an increase in their incomes, producers may raise their prices knowing consumers have more money in their pockets and presumably can afford to pay more. Most consumers are willing to pay higher prices, so long as they can still buy the same amount of goods and services as before.
  3. When there aren’t many producers of a particular good or service in a sector or a market, such as in rural areas, producers may raise prices knowing consumers have limited alternatives, due to the lack of competition or availability of substitutes.
  4. Other times, producers of a good or service may be unable to ramp up production quickly enough to meet an unexpected increase in demand from consumers. Producers may then raise prices until production can increase, knowing that consumers will pay more for a scarce product and will try to out-bid one another in order to buy that good or service.
  5. Unforeseen events, such as a natural disaster or a labor strike, may disrupt the production of a good or service, preventing producers from supplying the same amount to consumers as they did before the event. As in the previous example, producers may then increase prices as consumers compete for a scarce product, at least until production is able to return to previous levels.[1]

While economists use fancy terms to describe the dynamics described above, such as demand-pull inflation, cost-push inflation, or expansion of the money supply, they are essentially saying the same thing. However, it is common to frame these causes of inflation as something that “just happens” in the market, ignoring the fact that markets are made up of people each making their own specific choices.

While this list is not exhaustive, these examples illustrate how inflation is a choice on the part of producers — NOT, as critics of BBBA argue, an inevitable outcome of federal government spending on social programs.

While economic conditions and government policies certainly influence the behavior of producers and consumers, it is the sum of the decisions of producers to charge more for their goods and services that ultimately results in inflation. This is not to say that producers are bad actors for raising prices—they may have very rational reasons for doing so. However, we cannot effectively address inflation unless we understand what is causing producers to raise prices.

For example, effective policy responses to price increases due to production disruptions (say, those caused by natural disasters) are entirely different from policy responses to price increases due to the monopoly power of a particular set of corporations.

How the Pandemic is contributing to inflation

The causes of the inflation we see today are many, and largely depend on the product or sector we are looking at. However, there are some general trends over the past two years that help us to understand what is happening today.

First, the COVID-19 virus caused our economy to come to a screeching halt, as stay-at-home orders, business closures, goods shortages, and job losses kept consumers in Colorado and the rest of the country from spending on goods and services. In response, the U.S. Congress passed a number of measures that provided income supports to households and businesses.

Once the economy began reopening in April 2020, consumer spending quickly recovered to pre-pandemic levels, thanks to these programs and to increased saving by many households. Due to the ongoing pandemic and public health restrictions on the economy, however, this spending skewed heavily towards goods instead of services.

Personal consumption expenditures on goods by American consumers returned to pre-pandemic levels by June 2020, something that took 38 months during our recovery from the Great Recession. Demand was further juiced in March 2021, when the American Rescue Plan Act (ARPA) provided an additional round of stimulus payments.

On the other hand, personal consumption expenditures on services didn’t return to pre-pandemic levels until June 2021, months after COVID-19 vaccines were widely available in the United States.[2]

Chart of personal consumption expenditures of Americans during recessions, December 2007 vs February 2020

Note: Values for expenditures on goods and services are indexed to December 2007 for the Great Recession and February 2020 for the COVID-19 recession. 100 represents expenditures levels in those months, respectively.

Source: Colorado Center on Law and Policy analysis of U.S. Bureau of Economic Analysis Personal Consumption Expenditures data retrieved from FRED, Federal Reserve Bank of St. Louis

While pandemic-related legislation gave a large boost to demand for goods among American consumers, the pandemic disrupted — and continues to disrupt — production and supply chains around the world. Due to decades of outsourcing, most of the goods purchased by American consumers relied on supply chains that extend around the world, making them vulnerable to disruptions from the pandemic and foreign governments’ responses to it.

For instance, pandemic-related shutdowns of semiconductor microchip factories in East Asia at the start of the pandemic led to disruptions in the supply of such chips, which are used widely in many electronic devices and appliances. Companies who produced goods that used these microchips, including automobile manufacturers, faced shortages once their stockpile of chips had been depleted. These shortages were exacerbated once production restarted to meet the roaring demand for goods among consumers in the United States and around the world.

Carmakers not only had to compete with one another for these chips, but also with a whole range of other producers and manufacturers who faced similarly high demand for their own goods, such as laptops. As chip shortages created a shortage in new automobiles, for example, the prices of both new and used cars increased dramatically.[3],[4]

A similar story exists for many other goods that experienced inflation over the course of the past year. These disruptions in the supply of goods are what economists mean when they talk about “supply chain disruptions”. In these instances, there is a mismatch between the amounts of goods producers are able to supply, and the amounts of goods consumers are demanding to buy.

Our economy is huge and is interdependent on the economies of countries around the world. Any changes in production will take some time to make an impact on the inflation we are experiencing today. Unfortunately, COVID-19, specifically the Omicron variant, continues to create disruptions in production processes around the world.

However, supply chain disruption is not the only cause we see today, and in fact there are other forces at play that are likely making inflation worse, particularly in industries and markets where corporate consolidation is enabling firms to use their market power to raise prices by an even greater amount than their own costs have risen.

If supply chain disruption were the sole source of inflation, we would expect to see corporate profits hold steady or potentially decline. Indeed, in many sectors, the very opposite is true. Large corporations have made record profits throughout the ongoing challenges of the pandemic. We will take a closer look at this trend in our next blog post in this series.

 

[1] For more on what causes inflation see:
Harvey, John T. “What Actually Causes Inflation (and who gains from it)?”. Forbes (2011). Access from https://www.forbes.com/sites/johntharvey/2011/05/30/what-actually-causes-inflation/?sh=3bf244f9f9a9 on 16 December 2021.
Mason, J.W. and Lauren Melodia. “Rethinking Inflation Policy: A Toolkit for Economic Recovery”. Roosevelt Institute (2021). Accessed from: https://rooseveltinstitute.org/publications/rethinking-inflation-policy-a-toolkit-for-economic-recovery/ on 16 December 2021.

[2] U.S. Bureau of Economic Analysis, Personal Consumption Expenditures: Goods and Services, retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfred.org/series/PCES.

[3] Bellon, Tina and Paul Lienert, David Shepardson. “Inflation risk or profit engine? High car prices are both”. Reuters (August 2021). Accessed from: https://www.reuters.com/world/the-great-reboot/inflation-risk-or-profit-engine-high-car-prices-are-both-2021-08-10/ on 16 December 2021.

[4] “Explainer: Why is there a global chip shortage and why should you care?” Reuters (March 2021). Accessed from: https://www.reuters.com/article/chips-shortage-explainer-int/explainer-why-is-there-a-global-chip-shortage-and-why-should-you-care-idUSKBN2BN30J on 16 December 2021.

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HEALTH:
HEALTH FIRST COLORADO (MEDICAID)

Health First Colorado is the name given to Colorado’s Medicaid program. Medicaid provides public, low-cost health insurance to qualifying adults and children. It is an entitlement program funded by the federal, state, and county governments and is administered by counties in Colorado. Those who are required to pay must pay a small co-pay when receiving certain health care services.

State Department: Department of Health Care Policy and Financing

Eligibility: Most adults 18 to 64 are eligible for Medicaid in Colorado if their household income is at or below 133% of the federal poverty limit (FPL). Pregnant women are eligible with incomes of up to 195% FPL, while children under 18 may be eligible if the live in a household with income at or below 142% FPL. Some adults over 65 may also be eligible for Medicaid.

Program Benefits: Through Medicaid, low-income Coloradans are eligible for a range of health care services at little to not cost. Services provided include doctors visits, prescription drugs, mental health services, and dental care. Co-pays for certain individuals may be needed for certain services.

Program Funding and Access: Colorado funds our Medicaid program through state and federal dollars. Medicaid is an entitlement program, which means that all who are eligible for Medicaid can access the program, regardless of the funding level in a given year. This does not mean that it is always easy to access Medicaid, even when eligible. And since the program is administered by counties, funding levels for county staff and other administrative roles can make it easier or harder for Coloradans to access the program. On top of this, not all medical providers accept Medicaid which limits the ability of Coloradans to seek health services even if enrolled, such as if the nearest provider is a 2+ hour drive away.

Note: This data is from before the pandemic and does not reflect changes in enrollment rules during the COVID-19 pandemic and public health emergency.

Statewide Program Access 2015-19: Over the study period of this report, an average of 89.0% of the population at or below 133% of FPL (i.e., the population who is likely to be eligible for Medicaid) were enrolled in Medicaid in Colorado.

FOOD SECURITY:
SUPPLEMENTAL NUTRITION ASSISTANCE PROGRAM (SNAP)

The Supplemental Nutrition Assistance Program or SNAP helps low-income Coloradans purchase food by providing individuals and families with a monthly cash benefit that can be used to buy certain foods. SNAP is an entitlement program that is funded by the federal and state governments and administered by counties in Colorado.

State Department: Department of Human Services

Eligibility: Currently, Coloradans qualify for SNAP if they have incomes below 200% FPL, are unemployed or work part-time or receive other forms of assistance such as TANF, among other eligibility criteria. Income eligibility for SNAP was different during the study period of this report than today—it was 130% FPL back in 2019 for example. The US Department of Agriculture uses the population at or below 125% FPL when calculating the Program Access Index (or PAI) for SNAP. We follow this practice in our analysis despite Colorado currently having a higher income eligibility threshold.

Program Benefits: SNAP participants receive a monthly SNAP benefit that is determined by the number of people in their household and their income. Benefit amounts decrease as income increases, helping households avoid a sudden loss of SNAP when their incomes increase, even by a minor amount. Benefits are provided to an Electronic Benefit Transfer (EBT) card that can be used to purchase eligible food items, such as fruits and vegetables; meat, poultry, and fish; dairy products; and breads and cereals. Other items, such as foods that are hot at their point of sale, are not allowable purchases under current SNAP rules.

Program Funding and Access: SNAP, like Medicaid, is a federal entitlement program. This means that Colorado must serve any Coloradan who is eligible for the program. As such, funding should not be a limit to how many Coloradans can be served by the program. However, funding for administration of SNAP at the state and county level can limit the ability of county human service departments to enroll those who are eligible. Other program rules and administrative barriers can make it difficult for Coloradans to receive the benefits they are legally entitled to receive.

Statewide Program Access 2015-19: Over the study period of this report, an average of 61.1% of the population at or below 125% of FPL (i.e., the population who is likely to be eligible for SNAP) were enrolled.

FOOD SECURITY:
SPECIAL SUPPLEMENTAL NUTRITION PROGRAM FOR WOMEN, INFANTS AND CHILDREN (WIC)

The Special Supplemental Nutrition Program for Women, Infants, and Children, also know as WIC, provides healthcare and nutritional support to low-income Coloradans who are pregnant, recently pregnant, breastfeeding, and to children under 5 who are nutritionally at risk based on a nutrition assessment.

State Department: Department of Public Health and Environment

Eligibility: To participate in WIC you must be pregnant, pregnant in the last six months, breastfeeding a baby under 1 year of age, or a child under the age of 5. Coloradans do not need to be U.S. citizens to be eligible for WIC. In terms of income, households cannot have incomes that exceed 185% FPL. Families who are enrolled in SNAP, TANF, Food Distribution Program on Indian Reservations (FDPIR), or Medicaid are automatically eligible for WIC. Regardless of gender, any parents, foster parents, or caregivers are able to apply for and use WIC services for eligible children.

Program Benefits: WIC provides a range of services to young children and their parents. These include funds to purchase healthy, fresh foods; breastfeeding support; personalized nutrition education and shopping tips; and referrals to health care and other services participants may be eligible for.

Program Funding and Access: WIC is funded by the US Department of Agriculture. The state uses these federal funds to contract with local providers, known as WIC Clinics. In most cases, these are county public health agencies, but that is not the case in all Colorado counties. Some WIC Clinics cover multiple counties, while others are served by multiple clinics. Private non-profit providers are also eligible to be selected as a WIC Clinic.

Statewide Program Access 2015-17: Between 2015 and 2017, an average of 52.2% of the population eligible for WIC were enrolled in the program in Colorado.

Financial Security:
Colorado Works

Colorado Works is the name given to Colorado’s program for Temporary Assistance to Needy Families or TANF. It is an employment program that supports families with dependent children on their path to self-sufficiency. Participants can receive cash assistance, schooling, workforce development and skills training depending on the services available in their county.

State Department: Department of Human Services

Eligibility: In general, Coloradans are eligible to enroll in TANF if they are a resident of Colorado, have one or more children under the age of 18 or pregnant, and have very low or no income. For example, to be eligible to receive a basic cash assistance grant through TANF, a single-parent of one child could not earn more than $331 per month, with some exclusions—and would only receive $440 per month (as of 2022). That said, there are other services provided by counties through TANF that those with incomes as high as $75,000 may be eligible for. In addition to these, participants in TANF are required to work or be pursuing an eligible “work activity” or work-related activity. Any eligible individual can only receive assistance if they have not previously been enrolled in TANF for a cumulative amount of time of more than 60 months—this is a lifetime limit that does not reset. Counties may have additional requirements and offer benefits that are not available in other counties in Colorado.

Program Benefits:  While the exact benefits that one is eligible for under TANF can vary, all qualified participants are eligible to receive a monthly cash payment, call basic cash assistance. Other than cash assistance, counties are have a lot of choice in how to use their TANF funding; generally a use of TANF funds is appropriate so long as it advances one or more of the four purposes of the program: (1) provide assistance to needy families so that children can be cared for in their own homes or in the homes of their relatives; (2) end the dependence of needy families on government benefits by promoting job preparation, work, and marriage; (3) prevent and reduce the incidence of out-of-wedlock pregnancies; and (4) encourage the formation and maintenance of two-parent families.

It is important to note that those eligible for TANF are also eligible for many of the other programs we’ve included in this report, such as SNAP, Medicaid, and CCCAP.

Program Funding and Access: Colorado funds its TANF program through funds received from the federal government through the Temporary Assistance for Needy Families block grant. Most of the federal funds are allocated by the state to counties, which are required to provide a 20% match of state funding. Federal and state rules allow the state and counties to retain a portion of unspent funds in a TANF reserve.

Statewide Program Access 2015-19: Over the study period of this report, an average of 50.7% of the population at or below 100% of FPL (i.e., the population who is likely to be eligible for TANF) were enrolled in TANF in Colorado.

EARLY LEARNING:
COLORADO CHILD CARE ASSISTANCE PROGRAM (CCCAP)

The Colorado Child Care Assistance Program provides child care assistance to low-income families and caregivers living in Colorado in the form of reduced payments for child care. It is a program funded by the federal, state, and county governments and is administered by counties in Colorado. The share owed by parents/caregivers is determined on a sliding scale based on the family’s income.

State Department: Department of Early Childhood Education

Eligibility: Counties set eligibility for families separately, but must serve families with incomes at or below 185% of the Federal Poverty Limit. Families accepted to the program are no longer eligible once their income exceeds 85% of the state median income. Parents or caregivers must be employed, searching for work, or engaged in another approved activity to be eligible for CCCAP. Parents and caregivers enrolled in Colorado Works (Temporary Assistance to Needy Families or TANF) or in the child welfare system are also eligible to participate in CCCAP. Generally, CCCAP serves families with children under 13, although children as old as 19 may be eligible under certain circumstances.

Program Benefits: If a family is eligible for CCCAP and has income, they may likely have to pay a portion of their child’s or children’s child care costs each month. The amount that families owe is based on their gross income, number of household members, and the number of children in child care in the household. As such, households tend not to experience a benefit cliff with CCCAP when they see their incomes increase

Program Funding and Access: Colorado funds the CCCAP program using federal dollars it receives from the Child Care and Development Block Grant program. The state allocates federal and state funds to counties using a formula that takes into account factors like current caseloads and the number of eligible residents. Assistance is available until the county’s funds are spent, so the number of families that can be served is often a function of how much funding is available and the income and composition of the household that applies. It is not uncommon for counties to overspend or underspend their allocations of funds. The state reallocates unspent funds from counties who underspent to those who overspent. While underspending could indicate a problem with the way a county administers its CCCAP program, it could just as likely be a sign that there are few providers in the county who participate in CCCAP—or a lack of providers generally.

Statewide Program Access 2015-19: Over the study period of this report, an average of 10.8% of the population at or below 165% of FPL and younger than age 13 (i.e., the population who is likely to be eligible for CCCAP) were enrolled in CCCAP.

Housing:
HUD rental assistance programs

The US Department of Housing and Urban Development (HUD) has three housing assistance programs that we look at together: Housing Choice Vouchers (Section 8), Project-based Section 8, and Public Housing. In Colorado, these programs provided assistance to over 90% of the households who received federal housing assistance from all HUD programs. Through federally funded, local or regional public housing agencies (PHAs) are the agencies that administer these programs, through not all are available in all counties. These are not the only programs available in Colorado that assist households afford the cost of housing, such as units funded through federal and state tax credit programs.

State Department: Department of Local Affairs

Eligibility: Generally, households with incomes under 50% of the area median income (AMI) of the county they live in are eligible for these rental assistance programs, although PHAs have discretion to select households with incomes at higher percentages of AMI. That said, HUD requires that 75% of new vouchers issued through the Housing Choice Voucher/Section 8 program in a given year are targeted to households with incomes at or below 30% of AMI. PHAs are also able to create criteria that give priority to certain types of households who are on waiting lists for these programs.

Program Benefits: These rental assistance programs help households afford the cost of housing by reducing their housing costs to around 30% of their household income. In the case of the Housing Choice Voucher program, the PHA pays the voucher holder’s landlord the remaining portion of the rent.

Program Funding and Access: Funding and access are both challenges for these rental assistance programs. In addition to limitations on the number of public housing units or housing vouchers a PHA can manage or issue, lack of funding compared to the need constrains the ability of PHAs to assist low-income households. In 2020, Coloradans were on waitlists for Housing Choice Vouchers for an average of 17 months. Waitlists also exist for the other rental assistance programs.

Statewide Program Access 2015-19: Over the study period of this report, an average of 21.1% of renter households with incomes at or below 50% AMI (i.e., the population who is likely to be eligible for HUD rental assistance programs) were living in subsidized housing.