Inflation in the U.S. is creating financial hardships for nearly half of Americans. What is driving up the cost of goods and services right now — and how much is it related to supply and demand? Dr. Jonathan Rothwell, Gallup’s principal economist, joins the podcast to untangle these questions and more.
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Below is a full transcript of the conversation, including time stamps. Full audio is posted above.
Mohamed Younis 00:07
I’m Mohamed Younis, and this is The Gallup Podcast. This week, we take a closer look at inflation as it comes further into public focus across the globe. Dr Jonathan Rothwell is Gallup’s principal economist and author of the book, A Republic of Equals: A Manifesto for a Just Society. Jonathan, thanks for being with us this week.
Jonathan Rothwell 00:26
Sure. Always glad to be on the program.
Mohamed Younis 00:28
As we head into the peak of holiday season for many Western economies, and the winter for the Northern Hemisphere, concerns are growing — here in the U.S. and elsewhere — about the rise of consumer prices. When we asked, Jonathan, the U.S. public in November about concerns, the concerns with the rising costs of goods was on an order we haven’t seen in decades. So let me just back up by asking you first: What is inflation, in basic English?
Jonathan Rothwell 00:57
Sure. So it’s a subject of certainly a lot of confusion and even controversy. But in basic terms, “inflation” refers to the weakening in purchasing power of a currency — in this case the U.S. dollar. So the dollar becomes weaker; it doesn’t buy as much as it used to. And you can think of, you know, as much in, in some complicated ways. But you know, if you, if you think about it as a good, like it’s, it’s a car with certain features. Now the car with those identical features costs more than it used to. Or if it’s a service, like, that’s pretty easy to measure, like a haircut, now the haircut cost more. That is inflation.
Mohamed Younis 01:42
OK, is it at all related to like supply-demand, or is that like a totally different topic?
Jonathan Rothwell 01:48
It is related to supply and demand, in some complicated ways. So I would say, let me try to explain this in a few different ways. One: Long-term inflation is not really a supply-and-demand for goods and services issue so much as a supply-and-demand for money. So you can think of money as having a price, based on its supply and demand. And that price is basically the value of money. Demand for money goes up when people get richer, or if they increase how frequently they want to transact. So if you go out to eat five times a week when you used to only go out to eat one time a week, and you’re exchanging money all those extra times, that increases the demand for currency if you’re paying in cash; increases demand for money and bank accounts if you’re using your bank account. So that increases demand for money.
Jonathan Rothwell 02:56
What the government does through the Treasury, the Federal Reserve Bank is to try to have the supply of money growing at a rate that exceeds the growth in demand by roughly, but roughly in a way that creates inflation of 2% a year. So on purpose, the government creates 2% inflation every year, on average. That’s its target; it’s called, you know, that’s the target rate of inflation. And the reason it does that is because the thinking is that it kind of greases the wheels of the economy and encourages spending. It makes things easier during tough times. There’s, there’s a lot of rationale for it.
Mohamed Younis 03:42
And is this something that, like, the U.S. government is unique in doing? Is this — all governments do this? Some governments?
Jonathan Rothwell 03:48
Yeah, pretty much all modern, competent, democratic governments are doing this on purpose. So, you know, you’ve got some unusual circumstances and some authoritarian governments where inflation is, is really out of control, and there — they don’t practice modern monetary theory or, and they don’t have central banks that are using best practice. But basically this is sort of considered best practice macroeconomic policy from, from the perspective of managing the money supply: You want a little bit of inflation.
Mohamed Younis 04:23
So that 2% is the target. Yeah. And where it gets scary is when we kind of veer off.
Jonathan Rothwell 04:28
Right, and that’s what’s happened recently, where we’re around 5%,6% year-over-year. And what’s, what’s going on there, and what goes on in other cases where there’s kind of a sudden surge of inflation, can have things to do that you could say that are related to the market. There are a lot of, there’s a lot of speculation as to what’s going on in the current moment.
Jonathan Rothwell 04:55
It seems pretty clear to me, although I can’t say definitively, that the massive amount of spending that the government engaged in as a way to, you know, basically ease the pain of the pandemic and keep the economy going and make it so people could afford to stay home and not work — all that extra spending, and there’s been quite a bit of it, has to go somewhere. And it’s going to creating demand for new goods and services. And we haven’t, though, as a country, increased our productive capacity to make those goods and services.
Jonathan Rothwell 05:48
And in some ways, our capacity has been hindered because large groups of people dropped out of the labor force or became unemployed during a large stretch of the pandemic. Now we’re getting to the point where that is almost back to where it was, but basically have a situation where our productive capacity fell because people stayed home or, and/or were not working at all, and you had massive amounts of new money introduced through government borrowing. And so that extra money created massive extra demand for money, which lowered the value of money and made it impossible to keep up with the supply of either money, as well as goods, goods and services. So you have inflation.
Mohamed Younis 06:41
That is, seriously, honest to God, one of the most awesome explanations I’ve heard since this whole thing came into focus. So thank you for that. So let me ask you now, aside from sort of the economics of it, the politics of it is fascinating to me — this political angle of how much control and influence does the president of the United States or the federal government have on the rate of inflation? What can they really do about it, other than try to sort of avoid the political blame? Is there, are there really steps they can take to address this issue?
Jonathan Rothwell 07:17
Well, the, I mean the most, you could say the federal government created the problem in, in passing all these stimulus bills and relief packages and all that. But at the same time, those really had profound benefits to people’s standard of living. So you could say the disease of inflation is less severe than the disease of recession that would have taken place or very long-term prolonged unemployment. But, you know, given what’s already happened, the typical way of addressing inflation is really not through Congress or the president, but through monetary policy.
Jonathan Rothwell 08:06
So the Federal Reserve Bank, in previous instances of high inflation, has successfully reduced inflation by essentially making the interest rates extremely high. And, and that discourages people from borrowing and it has an effect of reducing the money supply. It makes it harder for banks to lend money to one another. And it, it kind of locks up money in a way that that basically starts to raise the price, raise the value of money in a way that it hadn’t before. The other, other sorts of alternatives are the Federal Reserve Bank or Treasury selling or buying up government debt. Those are the other ways that controls the money supply and controls the rate of inflation. So in expansionary times, it can increase the money supply by buying government debt. And in times where it wants to lower inflation, it can, it can, it can sell more government debt and take money out of, out of circulation.
Jonathan Rothwell 09:26
So those are, those are some of the mechanical ways of reducing inflation. Those take time, and it’s not going to help necessarily with things like high gas prices. That has more to do with the planning of governments that control oil and gas markets and the accuracy of their forecasts. So I think what’s happened there is their forecast estimates were for weaker GDP growth or weaker demand than actually happened. So they didn’t have as much oil in supply as, as turned out to be needed.
Mohamed Younis 10:08
And it’s so fascinating, of course, that now this variant looks like it’s slowing everything down. And of course, the other way to look at that is they were trying to drive up the price and we’re trying to bring down the supply of oil.
Jonathan Rothwell 10:21
Certainly some of the OPEC countries even more so than others would really like the price to be high. I mean, at some point, you want the price, even if your goal is just to get as much revenue as possible, if you’re an oil-exporting company, you still don’t want the price to be infinity because you want, you want the optimal —
Mohamed Younis 10:41
Sustainable, of course —
Jonathan Rothwell 10:45
You don’t want to bankrupt your customers, and eventually they’ll turn to renewable energy or, you know, stop driving, stop using gas or use it less if the price keeps going up and up. There, there’s kind of an optimal balance there. And right now, it’s a little bit out of balance, but I think that will be corrected fairly quickly.
Mohamed Younis 11:03
Yeah, it’s actually been fascinating how quickly prices have kind of fluctuated in the last couple of weeks, faster than normal. Let me ask you, Jonathan, about the global nature of this. There’s a lot of focus on gas prices in the U.S., and there’s a lot of U.S. focus on it. How much of this is now becoming a global concern versus just kind of a U.S. phenomenon?
Jonathan Rothwell 11:25
Well, I was looking at data from the EU and they have, you know, the European Union shares a currency, and it’s fairly large number of countries with similar, you know, standards of living. And they are experiencing inflation that’s not quite as rapid as the United States, but it’s pretty close. And I think the same underlying explanation applies. They also experienced a huge loss of employment and productivity as a result of the coronavirus pandemic. And they responded to that by paying people to stay at home and, you know, paying businesses to keep workers on the payroll.
Jonathan Rothwell 12:14
And that was good for the standard of living of their constituents. But it was bad for inflation, and inflation is just kind of an inevitable cost of that kind of intervention. So it’s a little bit less, I think in part, because they spent less macroeconomically in terms of relief packages … and so on. Right. So I think that’s the main reason that it’s a little bit less, but it’s, it’s pretty comparable.
Mohamed Younis 12:43
So one of the things that fascinates me about the EU always is this idea that it’s like different countries with the same currency. So if Germany is experiencing like higher inflation, and France is not experiencing the same level of inflation, is it trickier for them to navigate that, being that they’re all on the same currency, or does that not really matter?
Jonathan Rothwell 13:05
It is trickier because the Central Bank of Europe can’t really, you know, it only has one currency to work with. So in the United States, there are a variety of tools that can be used to raise or lower interest rates, to buy or sell government debt, and, and tinker with the money supply and, hence, tinker with the rate of inflation. But those tools are all applied equally to U.S. states just as they are equally to European countries. And U.S. states vary in how much inflation they experience, just as European countries do.
Jonathan Rothwell 13:45
And there’s, there’s quite a range: Looking at, you know, the data in Europe, the Nordic countries have barely experienced any inflation all; it’s just above 2%. Whereas a lot of countries in Eastern Europe, Southern Europe have experienced much more rapid inflation. And it’s not immediately obvious why, why, you know, some are more than other, have experienced more than others. But one thing to keep in mind is that every economy has a mix, a different mix, of goods and services. And ultimately, inflation is the weighted average of the price increases of everything that consumers buy if you’re using the consumer price index.
Mohamed Younis 14:28
So if an economy is leaning more on certain goods and services to export, they’re going to be hit differently if those particular goods and services are hit than others.
Jonathan Rothwell 14:37
Well, yes, and so countries also vary in how much they import and export. So, but exports are probably less important to think about than imports because the consumer, from the consumer’s perspective, whether something gets exported or not doesn’t really affect you. But the import side of it does, because you might be importing goods from a country with a different currency and with different rates of inflation. And so, and also imports are heavily affected by energy prices in many cases, as well as complications in supply chain linkages and transportation networks and so on. So a country that is very heavily dependent on imports is going to be at greater risk when energy prices go up or when the countries that they’re importing from are experiencing inflation.
Mohamed Younis 15:40
So a related topic, but one that I, again, kind of the last thing I would love for you to untangle for me is currency devaluation, on its own. So Turkey, the country, beautiful country of Turkey, has tragically been experiencing really severe currency devaluation this year. Just this year alone, their currency’s value has dropped by almost 45%. So you can imagine what you, you know, what your lira could buy at the beginning of the year, it’s only worth half as much now. How is it that, if at all, related to inflation, or is that a totally different challenge that an economy faces?
Jonathan Rothwell 16:19
It’s related. There’s some overlap in the dynamics with, with currency devaluation. But the important thing to keep in mind is it’s really, it really only affects international transactions, whereas inflation affects every transaction because it’s the weighted average of everything that people typically buy, which already takes into account imports. In some ways, currency devaluation is, is less of a problem than inflation, you know, all things being, other things being equal, in terms of if I could say, like, it’s, you know, 5% increase in prices or, you know, you otherwise try to make them comparable. But, yeah, the reason is because most of the economy, even in highly, you know, countries that are very dependent on trade, most of the economy is still domestic.
Jonathan Rothwell 17:19
So in Turkey, I just looked up the imports as a share of GDP, and they’re about 30% of GDP are from imports, and a little bit higher are from, are represented by exports. Whereas in the United States, only 15% of GDP is from imports. So Turkey is more dependent on trade than the United States. And thus, currency devaluation is going to, to hit the country harder. But it really only hits that 30% of the products that are imported. So it’s, it’s probably gonna be, you know, things like cars and electronic equipment.
Mohamed Younis 18:06
Not like your local vegetables and produce.
Jonathan Rothwell 18:09
Probably not. I don’t, I don’t know how much of their agricultural products are imported, but probably not a huge proportion. And, and those prices shouldn’t be greatly affected by currency devaluation. Certainly, domestic services like going out for coffee shop, going to get your hair cut, going for healthcare services, for education — those things probably aren’t going to be really affected by currency devaluation.
Jonathan Rothwell 18:41
And the, and the other thing that’s interesting about currency devaluation is a lot of countries used to do it on purpose, especially East Asian countries, in order to boost their exports, because it makes your products cheaper for, for other people to buy. And so it’s easier to, for your, for your export-oriented businesses to compete. And so that’s also good for tourism, because tourism is an export. So, you know, when a country is going through currency devaluation, it’s a great time for everybody else to go there to visit. I saw this little bit with Argentina when they went through a currency devaluation a decade or two ago. And, and it’s, it’s often the case that your exports will go up as a result. So that’s kind of an offsetting benefit that you don’t really get with runaway inflation.
Mohamed Younis 19:34
Jonathan, I can’t thank you enough for making sense of this quagmire — what is often a quagmire to me, at least — of economic “inside baseball” made into plain English. Jonathan Rothwell is Gallup’s principal economist and author of the great book that you should read: A Republic of Equals: A Manifesto for a Just Society. Jonathan, thanks for being with us.
Jonathan Rothwell 19:56
Always a pleasure, Mohamed.
Mohamed Younis 19:58
That’s our show. Thank you for tuning in. To subscribe and stay up to date with our latest conversations, just search for “The Gallup Podcast” wherever you podcast. And for more key findings from Gallup News, go to news.gallup.com or follow us on Twitter @gallupnews. If you have suggestions for the show, email [email protected] The Gallup Podcast is directed by Curtis Grubb and produced by Justin McCarthy. I’m Mohamed Younis, and this is Gallup: reporting on the will of the people since the 1930s.