Some thoughts on inflation and central bank expertise

It's now clear that the inflation genie is out of the bottle. How long will it take to put it back remains to be seen.

The last two to three decades were characterised by a confluence of factors which had the effect of keeping prices down. Consider the following:

1. Trade liberalisation and container shipping - created a globalised market in goods, which allowed for large manufacturers to reap economies of scale and lower cost of production.

2. ICT advances and off-shoring - apart from driving the boom in off-shoring of services, it also allowed for the emergence of global supply chains in manufacturing, both of which further reduced production costs.

3. The emergence of China - China became the ultra-cheap factory of the world, emerging as the home of component manufacturers to contract manufacturers for all major brands and non-branded items in the world.

4. Savings glut and ultra-low interest rates - it sharply lowered the cost of capital and allowed businesses to pass on the reduced capital costs. 

5. Start-up and venture capital - the plentiful cheap capital spawned business models which prioritised customer acquisition and growth even at the cost of piling up losses, thereby benefiting customers with cheap goods and services. 

Derek Thompson captures the last part evocatively,

If you woke up on a Casper mattress, worked out with a Peloton, Ubered to a WeWork, ordered on DoorDash for lunch, took a Lyft home, and ordered dinner through Postmates only to realize your partner had already started on a Blue Apron meal, your household had, in one day, interacted with eight unprofitable companies that collectively lost about $15 billion in one year... As long as money was cheap and Silicon Valley told itself the next world-conquering consumer-tech firm was one funding round away, the best way for a start-up to make money from venture capitalists was to lose money acquiring a gazillion customers. I call this arrangement the Millennial Consumer Subsidy. Now the subsidy is ending. Rising interest rates turned off the spigot for money-losing start-ups, which, combined with energy inflation and rising wages for low-income workers, has forced Uber, Lyft, and all the rest to make their services more expensive... the heavily discounted prices of the 2010s aren’t coming back. The Millennial Consumer Subsidy is over, and for the foreseeable future, metro residents will have to go about living the old-fashioned way: by paying what things actually cost.

Now all these trends are starting to reverse, thereby increasing cost of production. Exacerbating the cost problem are the supply shocks from the pandemic and the Ukraine war in quick succession. 

Businesses which sought to absorb the prices initially, are not left with no option but to pass on the higher costs. They are doing it both directly and indirectly. 

Alexis Leondis wrote here about drip-pricing, the practice of unbundling costs and passing them on as fee-based add-ons to the basic product. Allison Schrager has a good article. Another practice is that of shrinkflation - smaller size for the same price. It has reached even India. 

This is also an apt moment to draw attention to the narrative that  central bankers and their supporters spun around the infallibility and expertise of technocrats objectively pursuing monetary policy actions. The FT wrote,

For the past two decades, central bankers convinced themselves the public believed them to be such wonderful price controllers that they could sit back and relax. No company would seek to push prices higher and no worker would seek inflation-busting pay rises because they knew it would be defeated by the central bank. They believed their credibility was rock solid, so low and stable inflation was a self-fulfilling prophesy. That theory has failed and they are now in a fight to regain public trust. It is not surprising, for example, that net satisfaction with the Bank of England’s inflation management has fallen to its lowest level on record. The result of these analytical failings and complacency has been the recent rapid rises in interest rates, designed to show central banks are serious about defeating inflation.

If the central bankers then claimed more than their share of credit for the Great Moderation even though the decline was more due to the aforementioned factors associated with the times, it's only appropriate that they now accept their abject failure to not only control inflation but also being caught completely off-guard by the rising inflation. It's a sobering reminder to the limitations of central bank expertise and the wisdom of experts in general.