The discussion about inflation is pretty muddled. There is a lot of confusion about aggregate demand versus individual demand, aggregate supply versus supply, and relative prices versus inflation.

My theme: inflation is entirely about demand, not supply. Fixing the ports, the chips, the pipelines, the labor disincentives, the regulations is all great and good and the key to economic growth. But all this on its own will not do much to slow inflation. We are having inflation because the government printed up a few trillion dollars, and borrowed a few trillion more, and wrote people checks. People are spending the checks.

At a superficial level, this is obvious. If people weren’t spending a lot of money, the ports would not be clogged. But it’s deeper than that.

Inflation is all prices and wages going up at the same time. Relative price changes are when one price goes up and other prices go down. Reality combines the two, but let’s use terms correctly for each element.

Supply shocks cause relative price changes, not inflation. Suppose the ports clog up, and you can’t get TVs off the boat from China. Then the price of TVs has to rise relative to other prices. The price of TVs has to go up relative to restaurant food, for example, so people buy fewer TVs and go out to eat more. Or the price of TVs has to go up relative to wages, so people buy less overall.

In practice, the world is a bit more complex. If prices and wages moved instantly, the price of restaurant food, or wages, would go down, the price of TVs would go up, and the overall price level would not change. In reality, the other prices go down slowly. So the price of TVs goes up, and other prices and wages only slowly go down. We observe a little bit of inflation, followed by a slow period of lower measured inflation.

This is one of the mechanisms people have in mind when they refer to supply shocks and say inflation will be transitory. But that’s clearly not what’s happening now. Everything is going up, though some things more than others.

Likewise what happens if people decide in a pandemic that they want to buy more TVs and go out to dinner less? That’s a relative demand shock. It drives up the price of TVs and down the price of restaurant food, and causes no overall inflation. But restaurant prices go down more slowly than TV prices go up, so we measure a bit of inflation and then less inflation. But that’s not what’s happening now. Restaurant prices are going up too.

For a thousand years, inflation has led to witch hunts for speculators, hoarders, and price-raising conspiracies, as well as to price controls, rationing, and needless economic chaos.

Aggregate supply is different than the supply of individual goods and services. Aggregate supply gets at the question: How much more does the economy produce when all prices and wages are moving up at the same rate—true, pure inflation? That’s a tricky and slippery concept! Sure, if wages rise more than prices, workers might work harder and produce more. If prices rise more than wages, companies might produce more in pursuit of higher profits. Since I told the same story both ways, you can see even this is slippery. But these stories are still about relative prices and wages, not both prices and wages rising together. If prices rise 10 percent and wages rise 10 percent, why does anybody do anything different? Welcome to the mysteries of aggregate supply.

It only makes sense if you think prices or wages were sticky and one or the other was stuck at too low a level. Then a bit of inflation could unstick the sticky prices or wages, and get the economy back to a more productive level. Aggregate supply is all about sticky prices and wages, not about the actual productive capacity of the economy. Another way to see it: Why does more money, more aggregate demand ever raise output rather than immediately raising inflation? Well, something had to be wrong that inflation could fix, and in macro theory that is “sticky prices.”

Yes, this is slippery, but let’s not get too far down the rabbit hole. The central point is that, as intuitive as it sounds, it is not true that unclogging the ports will soak up demand and stop pure inflation. It will lower the relative price of TVs, but that “more supply” doesn’t do much about all prices and wages rising together.

All prices and wages rising together means that one thing is falling in value: money—and with it, government debt. Inflation is a decline in the value of money and government debt relative to everything else. Thus, inflation comes fundamentally from too much supply versus demand for money and government debt.

We seem, sadly, to be repeating all the confusion on these affairs that prevailed in the 1970s. Then too inflation was initially blamed on oil “supply shocks,” and excused as “transitory.” Then too the government hounded companies and unions not to raise prices, culminating in the ridiculous “WIN” buttons (Whip Inflation Now) of the Ford administration. Now, US president Joe Biden is sending the Federal Trade Commission to hound the oil companies to lower prices. Senator Elizabeth Warren (Democrat of Massachusetts) is blaming a grocery store conspiracy. Price controls are already hot in left-wing commentary. Can government “guideposts” be far behind? The Council of Economic Advisers released a history of post–World War II US inflation that shamefully omits any mention of monetary or fiscal policy as a cause of inflation, ignoring everything economists have (re)learned since the 1960s.

For a thousand years, inflation has led to witch hunts for speculators, hoarders, and price-raising conspiracies, as well as to price controls, rationing, and needless economic chaos. Here we go again.

John H. Cochrane is a senior fellow of the Hoover Institution at Stanford University and was previously a professor of finance at Chicago Booth. This essay is adapted from a post on his blog, The Grumpy Economist.

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