Rampant misunderstanding of inflation could cause policy-makers and the public to take steps that harm, rather than help.
As gas prices soar, we must keep in mind that inflation is caused by monetary factors, not supply constraints.
G as prices are spiking due to Vladimir Putin’s unprovoked invasion of Ukraine. President Biden announced a ban on importing Russian oil, which accounts for 3 percent of U.S. oil consumption and will further increase gas prices. Some commentators are blaming the latest jump in gas prices on inflation. But that is a mistake. The price increases at the gas pump now are driven by a supply shock, and supply shocks are most definitely not inflation, whether due to broken pipelines, regulatory restrictions, or wars.
There is much confusion about inflation right now. That matters because inflation is the highest it’s been in 40 years and is easily the most pressing economic issue facing the country. It’s important to get it right. The right cure requires the right diagnosis.
Inflation is related to the amount of money in circulation. If it isn’t monetary, it isn’t inflation. Supply shocks have nothing to do with the money supply, and nothing to do with inflation. Putin’s war and the sanctions against him are pressuring oil supplies. Prices will stay up until people find ways to adapt. But again, none of this has anything to do with the money supply.
The increase in gasoline prices far exceeded the overall inflation rate. According to the St. Louis Federal Reserve’s FRED database, the average nationwide gas price was $3.37 per gallon at the end of January. On March 7, it was $4.10 — a 22 percent increase. In February, the consumer price index for all goods, which includes gasoline, increased by 0.8 percent. Even though the first week of March isn’t included in the CPI report, it’s clear that economy-wide inflationary pressures alone are insufficient to explain soaring gas prices. Again, blame Putin, not inflation, for rising prices at the pump.
This is not the only basic inflation error floating around. GasBuddy said on March 7 that gas prices would likely set an all-time high on March 8, but did not adjust for inflation. Students know to do this, but some professionals apparently do not. CNBC and The Hill reported GasBuddy’s numbers without pointing this out. USA Today mentions the error, but then carries on as if it didn’t matter. It does.
Going back to the FRED database, before now, the highest recorded nominal (not inflation-adjusted) gas price was $4.12 per gallon, in July 2008. Using the Minneapolis Fed’s handy inflation calculator, that would be $5.19 in 2021 dollars. With the inflation observed so far in 2022, it would be equivalent to $5.23 today.
GasBuddy’s analysts, and the journalists who parroted them, are off by about 25 percent. That makes for a juicier story, but a misleading one.
While monetary policy can get highly technical, the basics are easy enough for anyone to understand. If the money supply grows faster than economic output, inflation results. The larger the difference, the faster the inflation rate. Other price increases, like Putin’s oil shock, are not monetary, so it’s improper to call them inflation.
While the Fed can fix inflation by slowing money-supply growth, it can’t do anything about supply shocks. The elected parts of government can, however. For example, Congress and President Biden should repeal the Jones Act of 1920. That law makes domestic maritime shipping so expensive that it is often cheaper for coastal oil refiners to import oil from places like Russia, rather than pay the higher Jones Act shipping rates that domestic oil producers are forced to use.
Hopefully, Putin’s hubris will lead to his downfall, Ukraine and its neighbors will remain free, and the world will regain stability. Those things are more important than today’s gas prices. But rampant misunderstanding of inflation could cause policy-makers and the public to take steps that harm, rather than help.