{"id":64904,"date":"2023-09-24T14:53:41","date_gmt":"2023-09-24T18:53:41","guid":{"rendered":"https:\/\/ifintechworld.com\/markets\/what-is-structural-inflation-pt-1-a-compelling-case-study\/"},"modified":"2023-09-24T14:53:44","modified_gmt":"2023-09-24T18:53:44","slug":"what-is-structural-inflation-pt-1-a-compelling-case-study","status":"publish","type":"post","link":"https:\/\/ifintechworld.com\/?p=64904","title":{"rendered":"What Is \u201cStructural\u201d Inflation? Pt 1: A Compelling Case Study"},"content":{"rendered":"<div>\n<p>A big question for monetary policy today is whether the current bout of \u201cinflation\u201d is \u201ctransitory\u201d \u2013 or \u201cstructural.\u201d<\/p>\n<p>It is now pretty clear that the wave of price increases that swept through the economy in 2022 was indeed\u2026\u201ctransitory.\u201d Even the mainstream media and some of the more prominent pundits now admit as much.<\/p>\n<ul>\n<li>\u201cIt turns out\u2026 that <strong>Team Transitory\u2019s central idea may be vindicated.<\/strong>\u201d \u2013 Alan Blinder (former Vice-Chair of the Federal Reserve), writing in the <em>Wall Street Journal<\/em> (July 2023)<\/li>\n<li>\u201cInflation appears to have been<strong> transitory after all<\/strong>\u2026just as the U.S. got used to thinking high inflation could be here to stay, signs are emerging that most of the surge through 2021 and the first half of 2022 was actually transitory.\u201d \u2013 <em>The Wall Street Journal<\/em> (Jan 2023)<\/li>\n<li>\u201cGotta say it: the original Team Transitory proposition was that inflation would subside without the need for a big rise in unemployment. Not looking so wrong now\u2026.Actually, at this point<strong> inflation <em>is<\/em> looking somewhat transitory<\/strong>,\u201d \u2013 Paul Krugman on <em>Twitter <\/em>and in <em>The New York Times <\/em>(Jan 13, July 12, 2023)<sup>,<\/sup><\/li>\n<li>\u201c [Larry] Summers emphasizes that it was always the case that <strong>transitory factors pushed inflation up<\/strong>\u2026\u201d \u2013 reported in <em>The Washington Post<\/em> (Aug 13, 2023)<\/li>\n<li>\u201cConclusion: Turns out, Jay [i.e., Chairman Powell], that when you and your colleagues said <strong>inflation is transitory,<\/strong> you were correct.\u201d \u2013 <em>BusinessWeek<\/em> (August 2023)<\/li>\n<\/ul>\n<p>It is also becoming clear that the post-pandemic inflationary spasm is now quite over (see my previous column).<\/p>\n<ul>\n<li>\u201cThe inflation performance at this point is better than I think many standard models would have predicted.\u201d \u2013 Larry Summers (August 2023)<\/li>\n<\/ul>\n<p><em>[Note: Indeed. It was not long ago that Mr. Summers was predicting that it would take \u201cfive years of unemployment above 5%\u201d to contain inflation.]<\/em><\/p>\n<ul>\n<li>\u201cThe notion [behind \u201ctransitory\u201d] was that most of the rising inflation wasn\u2019t due to an overheated economy fueled by monetary and fiscal policy, but rather to several \u201cspecial factors\u201d that <strong>would disappear on their own<\/strong>\u2026. What matters for policy makers is that\u2026 inflation is falling.\u201d \u2013 Alan Blinder (July 2023)<\/li>\n<\/ul>\n<p><fbs-ad position=\"inread\" progressive=\"\" ad-id=\"article-0-inread\" aria-hidden=\"true\" role=\"presentation\"><\/fbs-ad><\/p>\n<p><em>[For a sampler of bad calls by prominent figures, see this <\/em><strong data-ga-track=\"ExternalLink:https:\/\/www.barrons.com\/articles\/fed-jobs-inflation-models-recession-forecast-17981edf\"><em data-ga-track=\"ExternalLink:https:\/\/www.barrons.com\/articles\/fed-jobs-inflation-models-recession-forecast-17981edf\">piece<\/em><\/strong><em> in Barron\u2019s from August. As well, some at the Federal Reserve are still \u201cdisinflation-deniers\u201d \u2013 see my previous<\/em><strong><em> <\/em><\/strong><strong data-ga-track=\"InternalLink:https:\/\/www.forbes.com\/sites\/georgecalhoun\/2023\/09\/18\/the-flawed-cpi-the-fallacy-of-year-over-year-inflation-reporting\/?sh=1da9a242194d\"><em data-ga-track=\"InternalLink:https:\/\/www.forbes.com\/sites\/georgecalhoun\/2023\/09\/18\/the-flawed-cpi-the-fallacy-of-year-over-year-inflation-reporting\/?sh=1da9a242194d\">column<\/em><\/strong><em> on inflation and the Consumer Price Index.] <\/em><\/p>\n<p>All that said, it may be a good moment to consider Transitory\u2019s more dangerous cousin: \u201cStructural\u201d Inflation. What is it, exactly? and why is it so frightening?<\/p>\n<h2 class=\"subhead-embed color-accent bg-base font-accent font-size text-align\"><strong>First, What <em>Is<\/em> Transitory Inflation?<\/strong><\/h2>\n<p>Since we will be differentiating \u201cstructural\u201d from \u201ctransitory\u201d it may be a good idea first to be clear about just what \u201ctransitory inflation\u201d really is, and is not. The term is widely misconstrued.<\/p>\n<h3 class=\"subhead3-embed color-body bg-base font-accent font-size text-align\"><em>1. \u201cTransitory Inflation\u201d is not defined by a specific time-frame.<\/em><\/h3>\n<p><strong><em> <\/em><\/strong>\u201cTransitory\u201d does <em>not<\/em> mean \u201cshort-term.\u201d It is not a question of whether the cycle takes two quarters or two years. \u201cTransitory\u201d is about causes, solutions, and outcomes.<\/p>\n<h3 class=\"subhead3-embed color-body bg-base font-accent font-size text-align\"><em>2. It\u2019s About Supply and Demand (But Usually Supply)<\/em><\/h3>\n<p>Transitory inflation is the result of a disequilibrium in the market, caused by one of two things: an unexpected shortage (supply), or an unexpected surge in demand. In economist-speak, it is either a <em>supply shock<\/em> or a <em>demand shock<\/em>. My view is that in most cases it is a supply shock, like OPEC\u2019s oil embargo in the 1970s.<\/p>\n<h3 class=\"subhead3-embed color-body bg-base font-accent font-size text-align\"><em>3. \u201cTransitory Inflation\u201d cures itself <\/em><\/h3>\n<p>\u201cTransitory inflation\u201d refers to price increases that are caused by factors in the economic system which create an imbalance between supply and demand \u2013 which are <em>self-correcting<\/em> as the market mechanism goes to work to find a new equilibrium. When the balance is restored, prices level off \u2013 and may even go into reverse. The initial imbalance and the resulting price increases may arise either from a surge in demand which catches the supply-side off guard, or a sudden constraint or bottleneck in the supply chain which creates a shortage.<\/p>\n<h3 class=\"subhead3-embed color-body bg-base font-accent font-size text-align\"><em>The Demand-Driven Case<\/em><\/h3>\n<p>For example, if the cause of a price increase is \u201cexcess demand\u201d resulting from, say, lavish stimulus measures in response to Covid which put extra money in consumers\u2019 hands (a favorite if inaccurate explanation for the recent inflationary trend), then the extra spending will chase prices up until they reach the point where demand throttles down again, and a new balance is achieved \u2013 at which point prices will stabilize. As the saying goes,<em> the cure for high prices is\u2026 high prices.<\/em><\/p>\n<p>There is truth to that. The trajectory of <strong>Used Car<\/strong> prices \u2013 a major driver of inflation in 2020 through 2022 \u2013 shows this sort of pattern. In the wake of the pandemic shock, demand for used cars rose nearly 50%.<\/p>\n<ul>\n<li>\u201cWith a lack of new cars from auto plants able to hit dealer lots, and consumers more cautious about spending on big items, used car sales boomed\u2026.demand is driving up prices\u2026. \u2018We\u2019re selling higher units today than we were pre-Covid.\u2019[said one industry CEO] \u201d \u2013 <em>CNBC<\/em> (Oct 15, 2020)<\/li>\n<\/ul>\n<p>High demand drove higher prices, which in turn moderated demand and prices stabilized. Used Car inflation turned into disinflation, and then deflation.<\/p>\n<p>The rise in Used Car prices was clearly demand-driven, and the market mechanism responded as one would expect, to bring down the rate of price increases and bring inflation in this sector under control.<\/p>\n<h3 class=\"subhead3-embed color-body bg-base font-accent font-size text-align\"><em>The Supply-Driven Case<\/em><\/h3>\n<p>If the problem is inadequate <em>supply, <\/em>rising prices will incentivize producers to raise their output, unlocking bottlenecks, expanding operations.<\/p>\n<p>The price of eggs offers a good example. Over the past 10 years, two outbreaks of avian flu have decimated the population of egg-laying hens (in 2015 and 2022). <strong>Egg prices<\/strong> soared \u2013 and then plummeted as poultry producers rebuilt their flocks. (I have written about the eggflation episode in several columns earlier this year.)<\/p>\n<p>Once again, the market mechanism worked as expected, restoring the supply-demand balance, and ending eggflation. The price increases were transitory, and in the case, even reversible.<\/p>\n<h3 class=\"subhead3-embed color-body bg-base font-accent font-size text-align\"><em>4. Monetary Policy has little or no effect on \u201cTransitory Inflation.\u201d<\/em><\/h3>\n<p>Episodes of transitory inflation are not affected by or responsive to monetary policy initiatives such as interest rate increases (within the normal range). The Federal Reserve can do nothing to bring down the price of eggs or used cars or natural gas or any other commodity price. Again, as Krugman muses:<\/p>\n<ul>\n<li>\u201cFed did raise rates a lot, although it\u2019s fairly unclear how that reduced inflation.\u201d<\/li>\n<\/ul>\n<h2 class=\"subhead-embed color-accent bg-base font-accent font-size text-align\">Transitory, In Sum<\/h2>\n<p>Transitory inflation responds to initiatives taken in the private sector, by producers and consumers, to react to higher prices by either reducing or delaying demand, or by increasing supply. That is what the price signal should do: it moves the market back towards equilibirum. When avian flu swept through the poultry industry, producers took measures to combat the disease and to rebuild their flocks. This brought prices down. When used car prices became exorbitant, buyers were able to delay their purchases, wait until prices moderated \u2013 which they did. Monetary policy played no role in these adjustments.<\/p>\n<p>Those are the signature facts about transitory inflation: (1) it is created by temporary imbalances in supply and\/or demand; (2) it is self-correcting through the working of the normal market mechanism; and (3) it is largely impervious to monetary policy countermeasures.<\/p>\n<h2 class=\"subhead-embed color-accent bg-base font-accent font-size text-align\"><strong>So, What <em>Is<\/em> Structural Inflation?<\/strong><\/h2>\n<p>Non-transitory inflation can carry a number labels, including \u201cbuilt-in inflation,\u201d \u201csystemic inflation, \u201csystemically significant inflation,\u201d \u201csustained inflation,\u201d \u201cpersistent inflation,\u201d \u201cunderlying inflation,\u201d \u201cdeeply entrenched inflation,\u201d and \u2013 the term I will use \u2013 <strong>structural inflation<\/strong>. The central idea in all cases can be described as follows.<\/p>\n<p>First of all, structural inflation is not temporary. It is a long-term, open-ended phenomenon.<\/p>\n<p>Second, it is not self-correcting, and may in fact be self-reinforcing.<\/p>\n<p>Third, and fundamentally, it is created and driven by significant changes in the structure of the economy, which alter the basic relationships between supply and demand in a more or less permanent (or at least long-lasting) way, or which distort the pricing mechanism so that the market can no longer find its equilibrium.<\/p>\n<p>The best way to grasp this idea is with an example.<\/p>\n<h2 class=\"subhead-embed color-accent bg-base font-accent font-size text-align\"><\/h2>\n<h2 class=\"subhead-embed color-accent bg-base font-accent font-size text-align\"><strong>Structural Inflation in Higher Education<\/strong><\/h2>\n<p>College tuition offers a classic case of structural inflation. In the last 20 years, college costs have grown much faster than overall inflation. It is widely seen as a crisis of \u201caffordability.\u201d<\/p>\n<ul>\n<li>\u201cThe significant increase in the cost of college has outpaced both inflation and \u2014 even more starkly \u2014 family income over recent decades.\u201d \u2013 <em>CNBC<\/em> (March 2021)<\/li>\n<\/ul>\n<p>Tuition inflation is clearly persistent. It is also \u201centrenched\u201d in the sense that it hardly shows any impact of the business cycle. College costs have gone up through good times and bad, powering through every downturn in the economy, including the 2008 financial crisis and the Great Recession and 10% unemployment, rising right on through the era of quantitative easing and near-zero interest rates, up and up through the Covid pandemic, up further as the Fed raised rates 500 basis points at the fastest pace in history. Tuition costs have kept rising even as demand for the product (indicated by the annual number of Fall enrollments \u2013 which is closest to the point where a \u201cdecision to purchase\u201d occurs, where consideration of the cost of tuition is most explicit) has leveled off since 2009, and started to decline.<\/p>\n<p>This is an inflation that seems impervious to macro-economic conditions, monetary policy, plague, politics and geopolitics. Prices keep rising even as demand softens. The market mechanism is not functioning properly.<\/p>\n<p>The <em>causes<\/em> of tuition inflation are many, including the growing overburden of administrative costs (so-called \u201cadministrative bloat\u201d \u2013 administrative costs per student growing much faster than other expense categories), and expensive campus renovations. But it is also clear that the cause is not to be found in the traditional theories of inflation which blame excess demand or a shortage of supply.<\/p>\n<h2 class=\"subhead-embed color-accent bg-base font-accent font-size text-align\">Tuition Cost Increases Are Not Demand-Driven: Demand is Dropping<\/h2>\n<p>As shown above, the rise in tuition prices has not been caused by \u201cincreased demand.\u201d Higher education is now experiencing a long-term decline in enrollment.<\/p>\n<ul>\n<li>The percentage of 18-24 year olds enrolled in college declined from 41% to 38% from 2010 to 2021<\/li>\n<li>The percentage of high school graduates enrolling in college fell from 70% in 2009 to 61% in 2021<\/li>\n<li>The total number of college students (different from Fall enrollments) fell by 15% (2.6 million) between 2010 and 2021<\/li>\n<li><em>US News &amp; World Report <\/em>cites a study forecasting a further 15% drop in enrollment between 2025 and 2029<\/li>\n<\/ul>\n<p>This decline in demand for higher education is driven in part by \u201c<strong data-ga-track=\"ExternalLink:https:\/\/eric.ed.gov\/?id=ED598390\">a looming demographic storm<\/strong>\u201d: a decrease in the size of the college-age cohort. There are simply fewer students graduating from high school, fewer potential customers for a college education. This demographic shift is itself a \u201cstructural\u201d factor, projecting a long-term and persistent downward trend in demand. But this would be a force of structural <em>deflation, <\/em>not inflation. (We will look at the phenomenon of structural deflation in a forthcoming column.) If the pricing mechanism were functioning properly, prices should moderate. Instead, they have accelerated.<\/p>\n<p>The supply side of this \u201ceducation industry\u201d is fairly stable in most respects. There is no scarcity of opportunities to obtain a college degree.<\/p>\n<ul>\n<li>The number of mainstream institutions that form the core of the higher education supply side \u2013 4-year private nonprofit and 4-year public degree-granting colleges \u2013 <em>increased<\/em> by 4% from 2012 to 2021<\/li>\n<li>The number of 2-year degree-granting colleges (community colleges) declined by about 13%<\/li>\n<li>For-profit colleges, both 2-year and 4-year, have seen a larger decline numbers, but they account for only about 5% of the market<\/li>\n<\/ul>\n<p>In short, there is no indication of a supply constraint. The modest reduction in some categories of higher education seems natural in light of the downward drift in demand cited above.<\/p>\n<h2 class=\"subhead-embed color-accent bg-base font-accent font-size text-align\">The Key Structural Driver: Student Loans<\/h2>\n<p>The main driver of college costs is <strong>the explosive growth of student loans<\/strong>. Beginning in about 1993, the Federal Government made it much easier for students to borrow to pay for their education. The market uptake of cheap and easy credit was phenomenal. From 2000 to 2020, overall inflation was up by a factor of 1.5, college tuition rose 2.2 times (private universities) and 2.8 times (public universities), while <strong>the volume of student loans grew by a factor of 25 times<\/strong>. Last year (2022) the loan balance reached <strong>$1.75 Trillion (<\/strong>92% of which was provided by the Federal government). The <em>average<\/em> college student graduated in 2023 with <strong>$37,718 in debt. <\/strong>Student loan debt accounted for 3.5% GDP in 2006. By 2020, it was up to <strong>7.8% GDP<\/strong>.<\/p>\n<p>This flood of cash mostly came from the government itself, which means that <em>the normal discipline of the credit market did not apply.<\/em> Today, almost anyone can obtain a government-backed student loan. The only requirements are (1) enrollment in college, (2) proof of citizenship or a greencard, and (3) a valid social security number. The Dept of Education website is clear: \u201cYou don\u2019t need a credit check or a cosigner to get most federal student loans.\u201d<\/p>\n<p>For colleges, this new and market-discipline-free cash flow was a bonanza. By 2011, the value of student loans <strong>surpassed 116% of the total tuition revenue of <em>all<\/em> public and private nonprofit colleges <\/strong>in the United States. By 2020, the student loan levels had declined (due at least in part to the moderation of loan demand from students burdened with so much debt already). But the value of the new loans that year still amounted to 68% of the total tuition revenue.<\/p>\n<p>The mechanics are simple: <em>If students can pay more<\/em> \u2013 because they have access to easy credit \u2013 it means that <em>colleges can charge more<\/em> \u2013 without impacting the customers ability to pay. That is, they can raise prices without reducing demand. And so they have done so. Structural inflation, Q.E.D.<\/p>\n<p>The federal student loan program structurally altered the market for higher education, stimulating and supporting the extraordinary tuition price increases shown here. Customers (students) with leverage had more money to spend (and repay later). Prices could rise without crimping the customer (at least in the front end where the payment for the attenuated transaction called a \u201cgetting a college degree\u201d occurs \u2013 since no repayments are required until after graduation). College revenues meanwhile boomed, which allowed for the rapid expansion of expenses for non-teaching staff and infrastructure, and locked in the need for keeping the spigot open and flowing. That\u2019s how this type of inflation can be \u201cself-reinforcing\u201d rather than self-correcting.<\/p>\n<p>In short, the business model for higher education changed in a way that led to structural inflation. Tuition costs keep rising through good economic times and bad. They keep rising regardless of the direction of monetary policy. They keep rising even as fundamental demand softens, and the process appears to be self-reinforcing.<\/p>\n<h2 class=\"subhead-embed color-accent bg-base font-accent font-size text-align\">Summary<\/h2>\n<p>Some price trends are created by important changes in the structure of the economy, which alter the nature of supply and demand in ways that creation inflation (or deflation) that is much more persistent and much harder to counteract than the \u201cnormal\u201d form of inflation arising from transitory imbalances between supply and demand. The \u201caffordability crisis\u201d in higher education is an example of this type of inflation.<\/p>\n<p>The scary part is the self-reinforcing character of structural inflation. It makes stopping it much harder, because there is no natural support from the market mechanism. Prices are disconnected from normal supply and demand, and the equilibrium-seeking tendency of the market cannot function.<\/p>\n<p>College tuition only carries about a 1% weighting in the Consumer Price Index, and so contributes little to the broader inflationary trend. Yet there are other trends and factors which may create structural changes that are much broader, and may have macro-economic effects across the economy as whole. In the next installment, we will consider a number of these potential sources of structural inflation on a larger scale.<\/p>\n<p>For more on the topic of inflation, see also:<\/p>\n<\/div>\n<p>Read the full article <a href=\"https:\/\/www.forbes.com\/sites\/georgecalhoun\/2023\/09\/24\/what-is-structural-inflation-pt-1-a-compelling-case-study\/\" target=\"_blank\" rel=\"noopener\">here<\/a><\/p>\n","protected":false},"excerpt":{"rendered":"<p>A big question for monetary policy today is whether the current bout of \u201cinflation\u201d is \u201ctransitory\u201d \u2013 or \u201cstructural.\u201d It is now pretty clear that the wave of price increases that swept through the economy in 2022 was indeed\u2026\u201ctransitory.\u201d Even the mainstream media and some of the more prominent pundits now admit as much. \u201cIt [&hellip;]<\/p>\n","protected":false},"author":1,"featured_media":64905,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[241],"tags":[83],"class_list":["post-64904","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-markets","tag-featured"],"yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v20.6 - https:\/\/yoast.com\/wordpress\/plugins\/seo\/ -->\n<title>What Is \u201cStructural\u201d Inflation? 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