The Two Faces of Inflation: We’re Chasing the Wrong Culprit

By Shlomo Maital

    In Roman mythology, Janus was the god of doors, gates, and transitions. Janus was the middle ground between  concrete and abstract dualities such as life/death, beginning/end, youth/adulthood, rural/urban, war/peace, and barbarism/civilization.

    And today, 2023, Janus is a great analogy for inflation.  Inflation has played a trick on us.  During the COVID pandemic, we had inflation in the prices of goods. Janus Face One. Today, we have inflation in the price of services. Janus Face Two.

But Central Bank policy is still chasing Face One as the culprit. And we ordinary citizens will pay the price.

     The two inflations — they are NOT the same thing, they are different illnesses, and they have different cures and mitigating policies.  But are our Central Bankers agile enough to adapt?

     Here is what Matt Levin,  writing on the Marketplace website, observed last December, when new price data were published:  “The core price index for November was up 4.7% year-over-year. That’s down from a 5.0% increase in October. So, overall, it’s heading in the right direction.    But drilling deeper into those numbers, you see a story of two inflations: Price levels for goods dropped 0.4% from October to November, while price levels for services went up by 0.4% over the same period.   When the pandemic hit, we gorged ourselves on Pelotons, sofas, air fryers. So, the prices of goods went up, and that whole supply chain mess didn’t help. Then, we got through the delta variant and omicron and decided to gorge ourselves on flights, hotels and eating out.   

      “It’s all services inflation now. And it’s going to be a battle between goods prices declining and service sector prices rising, and also how people choose to spend their money,” said Drew Matus, chief market strategist at MetLife Investment Management.

       Goods prices are driven by costs of production and how productivity curtails them. This is a supply side phenomenon.  Because we do not really know much about how to foster supply-side policies, Central Banks battle goods inflation by raising interest rates and curtailing credit.  This can and does lead to recessions.  We may be in one now, or heading toward it. 

        Services prices, in contrast, are in large part a demand phenomenon —  as we  emerge from lockdown, the economy transitions back to service-driven —  but the labor supply is not matching the boom in demand, as the Great Resignation still keeps many out of the low-paying service jobs. 

         How do you control services inflation?  By labor market policies.  Training.  Competition.  Not by interest rate hikes.   Yet both the US Federal Reserve and the European Central Bank, knowingly facing services inflation,  continue to drive interest rates upward, risking recession (the EU may already be in the midst of one).

         Why?  The US Fed was too late in hiking interest rates.  It cannot now admit a grievous erroneous policy, especially after dropping the ball in three large bank failures, with its bank regulators asleep at he switch.

         The US Fed has a ridiculous unattainable inflation target of 2%, and is stubbornly sticking to it.  If it persists, it will cause much suffering, because recessions are far worse than inflations.  Inflations are numbers, the stickers on the price of goods and services.  Recession is losing your job, losing income, losing healthcare.  There is no symmetry here. 

         Is anybody listening?