Do you wonder why we sometimes face inflation? Understanding complex macroeconomic systems is helped by analogy. Our economy is comparable to a stock and flow framework. That is -- a bucket (stock) of economic activity, represented by money, with flows both in and out. Using a water bucket helps paint an understandable picture.
An inflation analogy - policy oversteering causes overfilling the water bucket:
Think of economic policy oversteering and the resulting inflation as overfilling a water bucket.
In more calm, normal economic times [1], monetary macroeconomic policy is able to maintain optimal levels of inflation and economic activity. Metaphorically, standard macro policy appropriately maintains the bucket's optimal water level. In 2020, the pandemic caused a large, water-gushing hole [2] in our economic bucket. As a result, both monetary and fiscal policymakers blasted water -- actually money -- into this bucket while the hole was being fixed. They did this with the well-intended desire to maintain the correct water level and reduce the emergency water flow [3] once the hole is patched up. Unfortunately, the big fiscal and monetary policy spigots kept flowing even after the hole was fixed. Macroeconomic policy is subject to difficult-to-control inertia. The water overrunning the optimal level [4] is inflation faced in the post-pandemic world.
At this point in the economic cycle, we are on the precipice of the typical substitution phase that leads into the shakeout phase. For a deeper dive into the phases of the Creative Destruction Transformation, please see:
About the Author: Jeff Hulett is a career banker, data scientist, economist, and choice architect. He teaches personal finance at James Madison University and provides personal finance seminars. His new book -- Making Choice, Making Money: Your Guide to Making Confident Financial Decisions --will be published in Summer 2023. You may register for pre-order information at jeffhulett.com.
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