Posted 9:02 a.m. Friday, Dec. 3, 2021

The cost of items like lumber and gas are increasing. The big question is whether these prices will stay high.

UW-La Crosse economist talks about increased cost of gas, lumber and just about everything

If you’ve pulled up to the pump, started a home construction project, or bought food, you may have noticed that prices look high. Is the price of everything going up? Will these inflated prices ever go down? UW-La Crosse Professor and Economist John Nunley and UWL Associate Professor of Economics Adam Hoffer answers these questions and more.  

1. Are prices going up on everything?  

The price of goods and services purchased by a typical American family increased 6.2 percent from October 2020 to October 2021. That increase in prices — the inflation rate — is the fastest one-year increase in prices economists have observed in U.S. in the past 30 years. 

Prices started to rise around January 1, 2021.  

2. Are the increases more dramatic than we've seen in the past? 

The U.S. had extremely high core inflation rates in the 1970s. (Core inflation includes the price change of everything except food and energy). But since the 1990s, core inflation has been hovering around 2.0-2.5%.  

3. Is the price change transitory or a permanent shift to higher prices?  

No one really knows the answer to this. So, the short answer is it has been worse in the past, but over the last 25-30 years, we haven't seen core inflation rates this high.  

4. Why are prices going up?  

It is a combination of things.  

  • As the pandemic comes to end (maybe?), people are starting to do more things such as going out to eat and traveling. So, demand for goods is currently rising and that is putting upward pressure on prices.
  • The pandemic led to supply disruptions such as meat packing plants that had to close because of super spreader events. Once inventories are back to where they should be, the Federal Reserve Board posits that prices will revert to back to normal levels.

5. Why are gas prices rising?  

I think the main reason is that oil prices have been rising. Oil is a key input to make gasoline. So, when oil becomes more expensive, gasoline prices rise due to higher production costs. When the pandemic hit, demand for gasoline and, hence, oil collapsed. This lowered the price of both goods. So, as the pandemic ends, demand for gas/oil begins to rise. But it takes a while for supply to adjust to the greater demand. A driver of lower oil supplies comes from the Organization of the Petroleum Exporting Countries or OPEC (a cartel that decides how much oil to pump out of the ground). Members of OPEC and Russia have been cutting their extractions. So, less oil supply means higher oil prices, which means higher gasoline prices.  

6. Why are lumber prices going up?  

First of all, lumber prices fluctuate more than those of many other goods. This is because sawmills have limited capacity. Homebuilding, renovations and related work can increase or decrease, but the sawmills are unable to easily adjust to higher demand.  

Lumber is actually in abundant supply right now. So, what we are most likely experiencing is short-run fluctuations in supply and demand. During the pandemic, many people who could not vacation or do other things, took on home projects. Also, storms hit all across the U.S., a cohort larger than the boomers starting their careers (the millennials), and low interest rates encouraged home buying/building. All of these things point to greater demand for lumber, which will result in higher prices.  

Supply is also a problem. Mills find it difficult to hire workers (often located in rural areas where populations are declining). In addition, trucking companies need drivers and they are having a hard time finding people as well. These things by definition lower their capacity. Likewise, COVID outbreaks have closed down mills and other building-related production units. 

So, if I had to guess, prices will come down when demand wanes. It's hard for me to see supply increasing enough to lower lumber prices.  

7. What sectors are we seeing the most increase in prices?  

Building materials and energy-related goods are key areas that are seeing a rise in prices. These goods tend to have more volatile prices. So, it is likely these sectors of the economy would be affected the most by inflation. Health care is an example of something that likely won't be affected too greatly by the disruptions we are seeing. With health care, you would not expect to see the big increases in demand like we are seeing for autos/gas/lumber.  

8. Are these prices likely to fall again?  

It depends on who you ask. The key question relates to how much of the increase in prices is transitory vs. permanent. Let's assume the inflation rate is 10%. If half of it is transitory, then we have a big problem. A 5% increase in the price level is problematic. However, if 3/4 of it is transitory, then the FED is right at its target inflation rate of about 2-2.5%. The FED believes prices will come down to more normal level, but that it might take one to two years. Other prominent economists, such as a Larry Summers, believe that inflation is likely more permanent than transitory. Time will tell. I am concerned about it being permanent, but I recognize that it might not be.  

If prices don't cool in the next year or two, we will then know it wasn't transitory. We are in unchartered territory with the pandemic, recession, stimulus payments and more. It's really hard to predict how things will play out.  

9. What is the inflation rate? 

Two common methods for measuring inflation include the Consumer Price Index and the personal consumption expenditures price index.  The federal reserve board uses personal consumption expenditures inflation measure.  

10. Who benefits from inflation? 

The biggest benefactors of inflation are people — or governments — that are in debt. Why do in-debt governments love inflation? Let’s take a crazy example. The U.S. Federal government added more than $4,200,000,000,000 ($4.2 trillion) in debt to its books in 2020. Suppose the Federal Reserve printed so much money and prices adjusted so that a loaf of bread costs a $4 trillion. In that case, the government debt that could be used to purchase all the real estate in the state of Wisconsin –— every home, apartment building, and storefront — would be reduced to the point where it could only purchase a loaf of bread.

This example is extreme, of course, but with a quick internet search you can find evidence of governments who tried to use the printing press to solve their debt and spending issues: 100 Trillion Dollar Banknotes from Zimbabwe, images of Germans using hyperinflated currency for wallpaper and kindling during the 1920s, and modern stories of Venezuelans dealing with hyperinflation that exceeded 60,000 percent in 2018 (roughly a 7 percent increase in prices every hour for the entire year). Hyperinflation is one of the few tried and true ways of inducing economic and societal collapse.

In smaller doses, inflation can work in your favor. If you have a fixed rate mortgage, for example, your house increases in value, but your loan balance and monthly payments stay the same. Inflation favors debtors.

Inflation destroys savers and individuals on fixed incomes. As prices increase, any money you have saved in the bank and any income you earn simply buys less. Most Americans feel the pain of inflation because wage increases almost always lag behind the increase in prices of goods and services that Americans purchase. Over the past year, average wages only rose 4.5 percent, so real wages — wages adjusted for inflation — fell by 1.5 percent.

11. What causes inflation? 

We know from basic economics that prices only increase for two reasons: increases in demand or decreases in supply. Pandemic-related supply chain disruptions that began in 2020 persist in certain sectors and have taken their toll on businesses’ ability to supply products to customers, driving up prices.

But the fastest way to drive up prices — in every industry, across an entire country, and the only proven model for creating runaway hyperinflation — is to increase demand by creating more money. And the printing presses have been busy (figuratively speaking, most changes to the money supply are done so digitally by the Federal Reserve). The total amount of money in circulation in the U.S. increased nearly 40 percent over the past year and a half, from March 2020 to September 2021. The amount of money in circulation has doubled in the past seven years.

Once again, basic economics tells us that when the amount of money in circulation increases, doubling in seven years, for example, the only likely outcomes are an increase in prices and/or an increase in output. With output constrained due to various market and government forces, the natural result is that more printed money becomes higher prices.

12. What is a healthy inflation rate?  

Over the last couple of decades, the FED's goal has been a 2% inflation target. So, as you can see, we are over that at present.  

13. Is the inflation we are seeing good or bad or both?  

Inflation is not in itself bad. Actually, deflation (prices going down) is worse than inflation. The concern is that prices will start rising too fast. This type of thing can spiral out of control. The U.S. had out -of -control inflation in the 1970s. Germany did in the early 1920s, when it was cheaper to burn deutsche marks than wood.